Why Governance Matters for Startups

Governance remains a challenge for most startups in the region, according to a study conducted in partnership with IDB Invest and six other organizations. A majority of startups think their governance is top notch, but the reality is very different.

Corporate governance startup team

There are many perspectives on corporate governance for startup and scale-up businesses throughout the venture capital ecosystem within Latin America and the Caribbean. So it remains challenging for founders of these companies to identify which governance practices are most beneficial to focus on and strengthen during the initial growth stage of the business.

Taking the right approach to developing proportional corporate governance structures in young businesses experiencing rapid growth is a balancing act between enabling lean and agile decision making, on one hand, and providing sufficient levels of oversight of the company’s strategy and internal controls on the other.

Moreover, a recent study of Brazilian startups has provided insight that there exists an important detachment between how founders view the stage of their business’ development and the maturity of its corporate governance practices. The study by Better Governance, conducted in partnership with IDB Invest and six other organizations and published during IDB Invest’s 2022 Sustainability Week, surveyed more than 140 Brazilian startups to understand their application of 24 corporate governance practices across six dimensions, comparing the growth stage of the company with its governance maturity level.

The results revealed a large disconnect between these two factors with 60% of the startups declaring themselves as most advanced, but with 82% of these exhibiting only initial stages of governance maturity. This finding implies a lack of understanding or implementation of appropriate governance practices within startup and scale-up businesses not only in Brazil, but potentially more widely within the region.

The study is being expanded to other countries, with IDB Invest, via its partner institution, IDB Lab, inviting startups and scale-ups to complete it to bolster its findings. The hoped resulting overview of governance maturity levels in the LAC entrepreneurship ecosystem will help showcase the progress achieved so far, as well as spotlight opportunities to strengthen governance of startups and scale-ups in the region as they seek to attract more sources of capital.
 

 
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Seeking to bridge the knowledge gap, during Sustainability Week a panel discussion was held specifically on why governance matters for innovative growth businesses, featuring Evan Epstein, executive director of the Hasting Center for Business Law (University of California), Carol Lacombe, principal and director of community for Valor Capital Group and Nelson Azevedo, startups practice leader at Better Governance, moderated by Magdalena Coronel, Chief Investment Officer at IDB Lab.

For startup and scale-ups, irrespective of their current growth stage, the panelists agreed that corporate governance should fundamentally determine the balance of power between founders and investors in a way which allows for both to work closely for the benefit of the company. It should manage the tensions in interests that can exist between the two regarding the goals of maximizing return on investment versus company portfolio, for example.

The Board of Directors is the most important governance body of a company, providing the link between founders and investors, with Board composition being crucial in ensuring it operates efficiently as a driver of strategy and overseer of its implementation. It is commonplace for startups and scale-ups to have a Board composition initially made up of founders and then by initial-stage investors.

The panel discussed how the Board dynamics of a startup and scale-up must shift along with the respective growth of business:

·           The Boards of early-stage startups should allow founders to move quickly, with recurrent touchpoints to ensure that strategy is being followed.

·           Moving to seed or Series A investment, venture capital funds are more attentive to Boards and what matters are discussed by them versus by management.

·           For Series B and C investment, venture funds expect more sophisticated practices such as the presence of committees supporting the Board’s oversight role.

chart

The panel also highlighted that there is often a lack of independent directors and overall low levels of diversity among startup and scale-up Boards, which can lead to groupthink and a lack of separation between the Board and the operations it oversees. Adding independent Board members is very impactful in breaking this dynamic and ensuring the Board effectively fulfills its strategic and oversight roles. 

Overall, both founders and initial investors of startups and scale-ups should be aware that corporate governance is a progressive journey that will continuously support a company's strategic decision-making process and oversight, thereby helping to enhance its long-term value. Just as a company’s operational volume and complexity evolves, so too should its governance structures, in particular the role of its Board of Directors.

 

Authors

Christopher Burt

Christopher Burt is a Corporate Governance Officer within the Environmental, Social and Governance Division of IDB Invest, based in Buenos Aires, help

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    Why Governance Matters for Startups

    Governance remains a challenge for most startups in the region, according to a study conducted in partnership with IDB Invest and six other organizations. A majority of startups think their governance is top notch, but the reality is very different.