Advice

Corporate Governance 101 for Startups

co-authored by Riyad Abou Jaoudeh and Naldo Bejjani

The recent FTX collapse has underscored the significance of good corporate governance in the world of cryptocurrency, startups, and venture capital. Corporate governance ensures that a company is managed in a transparent, accountable, and responsible manner, and is essential for a startup’s long-term success. The principles of good corporate governance include transparency, fairness, responsibility, risk management, and accountability, and these principles ensure that the interests of all stakeholders are considered.

The scandal at FTX highlights the importance of good corporate governance in ensuring a company is managed in a transparent, accountable, and responsible manner. Lack of governance was a major contributing factor to the scandal, as evidenced by the congressional hearing of the new CEO of FTX. Poor governance practices, such as one person controlling all financial transactions, inadequate oversight, and a lack of systems and processes in place, were prevalent.

It is important to note that this type of incident is not limited to a specific industry or sector and can impact companies of any stage. Startups often neglect corporate governance in their pursuit of rapid growth and efficiency. However, prioritizing corporate governance is essential for long-term success and can prevent similar scandals from occurring.

As venture capital investors, it is our responsibility to prepare startups for the next phase of growth and prevent any downside scenarios such as fraud. A lack of governance during growth stages can create bottlenecks across the management team, leading to confusion and fear of making mistakes. Furthermore, a lack of governance can also negatively impact a startup’s exit process, causing potential acquirers to walk away from a deal or forcing them to perform additional audits and due diligence.

We have created an online startup governance checklist for founders to refer to, which includes a summary of governance components such as the Board of Directors, Committees, and Roles and Responsibilities Matrix. By following this checklist, startups can ensure that they have integrated sound corporate governance systems and are on track for long-term success.

Access the checklist here; a summary is provided at the end of this article.

Governance components

Board of Directors: The Board of Directors is a key component of good corporate governance. It is a group of individuals who oversee the activities of an organization and are responsible for making strategic decisions. The Board typically includes representatives of major shareholders, the founding team, and management, as well as independent industry experts. They meet regularly or as needed to discuss important matters such as company strategies, budgets, employee stock options, executive compensation, and other high-level decisions. To ensure transparency and accountability, it is important for the Board to appoint a secretary to document and distribute the minutes of their meetings and for the minutes to be reviewed and ratified by the Board.

Committees: Committees are an important aspect of corporate governance. They are made up of a group of board members, employees, and advisors, and are responsible for making specific decisions related to different business needs. These committees can address various topics such as management compensation, audits, risk management, or any other areas deemed important based on the nature of the business. They are also formed to address contentious topics or when certain board members have a conflict of interest.

Committees provide a platform to bring in specialized knowledge and experience in certain areas and make recommendations to the Board of Directors for final decisions. This allows for more detailed and focused discussions and decision-making, in comparison to the Board of Directors as a whole.

Roles and Responsibilities Matrix: The Roles and Responsibilities Matrix is an important tool for corporate governance, as it outlines the roles and responsibilities of individuals or teams within the organization. It is used to clearly define who is responsible for making specific decisions, and how those decisions are approved. This can include decisions around large payments, opening and closing bank accounts, establishing subsidiaries, acquiring stakes in other companies, and appointing auditors.

The matrix is often created using a framework such as RACI (Responsible, Accountable, Consulted, and Informed) which clearly outlines the different roles and responsibilities of each individual or team. By establishing this matrix, an organization can ensure that there is clear accountability and oversight for key decisions, reducing the risk of mismanagement or fraud.

Budget: A budget is an important aspect of corporate governance as it provides a yearly financial plan for the company. It outlines the company’s financial targets, associated costs, and sources of funding. The budget should include details on initiatives the company will undertake, including associated costs and hiring plans. It should also identify the sources of capital by predicting revenues and specifying other sources of financing in case of a mismatch. The budget should be regularly reviewed and updated throughout the year to ensure that the company stays on track to meet its financial goals and make any necessary adjustments. It serves as a guide to keep the company on track with its financial plan and to ensure that resources are allocated efficiently.

Founders: Founders and executives play a critical role in the success of a company. To ensure that the interests of the founders and executives are aligned with those of the investors, certain restrictions and incentives may be put in place. This can include things like stock options, performance-based bonuses, and other forms of equity-based compensation. By aligning the incentives of the founders and executives with those of the investors, the chances of a successful investment outcome are increased. Investors may also seek to have certain rights to have a say in key decisions, or have representation on the board of directors, to make sure that the company’s strategy and operations align with their interests.

Management & Employees: Management and employees play a crucial role in the success of a company. Management is responsible for ensuring that the company’s strategic goals are communicated and understood throughout the organization and that business activities are aligned with those goals. Employees, on the other hand, are the backbone of the company, and they require proper training on important subjects such as ethics, anti-bribery, and anti-harassment.
It is important to establish mechanisms for employees to raise any concerns they may have to manage safely and anonymously. This can include an employee hotline or an anonymous feedback system. By fostering a culture of open communication and accountability, companies can ensure that any issues are addressed in a timely and appropriate manner and that employees feel safe and comfortable in the workplace.

Audits: Conducting regular financial audits is a key aspect of good corporate governance. Even if they are not legally required, it is important for companies to conduct annual financial audits to ensure that their financial statements and records are accurate and in compliance with accounting standards. These audits should be conducted by a reputable and independent accounting firm to ensure impartiality and objectivity.

Regular financial audits provide valuable insight into the company’s financial health, help identify any potential risks or issues, and provide assurance to stakeholders that the company’s financial statements are accurate and reliable. Additionally, regular audits can help the company to identify opportunities for cost savings and improvements in financial processes and controls.

Information Transparency: Transparency in communication and information sharing is crucial for good corporate governance. It is important for companies to regularly report information to stakeholders such as management, the board of directors, and shareholders. This can include:

– Performance dashboards on a monthly basis.
– Profit and Loss statements on a monthly basis.
– Operational updates on a monthly basis.
– Management accounts on a quarterly basis and yearly audits shared with relevant parties.

By providing regular and transparent updates on the company’s performance, management and the board can make informed decisions and take corrective actions when necessary. It also helps shareholders to understand the company’s performance and make informed decisions. Additionally, regular and transparent information sharing can also help to build trust and credibility with stakeholders.

Documents and Procedures: Having clear and well-documented procedures and processes is a key aspect of good corporate governance. Every company should have written documents that detail its internal processes, including:

– Employee handbooks that outline company policies, procedures and expectations for employees.
– Clear procedures for various processes such as financial transactions, decision-making, and risk management.
– Processes for handling sensitive information and data.
– HR manuals that detail the company’s human resources policies and procedures.
– Cybersecurity and IT security policies.

Having these documents in place helps ensure consistency and compliance with laws and regulations, and it can also help the management and employees to understand their roles and responsibilities within the company. It also serves as a reference guide for new employees, and it can be used to train and inform them about the company’s policies and procedures.

Other Matters: Joint ventures and other complex business arrangements require additional oversight and governance structures to ensure that they are managed effectively and in compliance with laws and regulations. In addition, companies should closely monitor the transactions and business dealings of related parties and partners to ensure that they are conducted ethically and in the best interests of the company and its stakeholders.

To navigate the uncertainty of business successfully, companies need to have clear structures and workflows in place to protect all stakeholders. This includes not only shareholders and investors, but also employees, customers, and the wider community. By implementing good corporate governance practices, companies can ensure that they are operating in an ethical, transparent, and accountable manner and that they are well-positioned to achieve long-term success.

You can find the downloadable version of the list here.

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