The lack of Corporate Governance leads to a company breakdown
The due diligence process in early-stage companies is often based on loose facts and comparative market data such as background checks, legal and finance diligence, and the evaluation of the technology or the IP. Corporate governance is usually a quick checkbox, especially at the seed stage or series A. There is an optimistic belief for many early-stage investors that the founders are incentivized to succeed and will steer the company to higher valuations and, hopefully, an exit event. However, according to the BLS, 65% of startups in the US fail within the first ten years.
Top Reasons for failing:
Money Ran out
Lack of Research
Not an Expert
Whether the business is $20 million or $2 billion, accountability to corporate governance and a balanced distribution of power and decision-making among founders is non-negotiable. There must be checks and balances for early-stage founders who think they are the next Steve Jobs, Jeff Bezos, Mark Zuckerberg or Elon Musk. These guys did it during historically low-interest rates with groundbreaking technology and massive technology moats. They are the exception to the rule.
“Bad corporate governance leads to a company breakdown, often resulting in scandals and bankruptcy.” (Investopedia).
If you’re actively investing in startups, here’s a list of things to consider as you perform your due diligence on the target's corporate governance structure.
How to Assess Corporate Governance:
Executive Compensation structure (whether it is tied only to performance or also other metrics)
Risk management ( the checks and balances on decision-making)
Policies and procedures for reconciling conflicts of interest (how the company approaches business decisions that might conflict with its mission statement)
The members of the board of directors (their stake in profits or conflicting interests)
Contractual and social obligations (how a company approaches areas such as climate change)
Relationships with vendors
Complaints received from shareholders and how they were addressed
Audits (the frequency of internal and external audits and how issues have been handled)
Types of bad governance practices include:
Companies that do not cooperate sufficiently with auditors or do not select auditors with the appropriate scale, resulting in the publication of spurious or noncompliant financial documents
Bad executive compensation packages that fail to create an optimal incentive for corporate officers
Poorly structured boards that make it too difficult for shareholders to oust ineffective incumbents