ENTREPRENEURSHIP

DR M MUNEER

Govern Pre-IPO Unicorns to Create Value; Not Valuation

Billion-dollar startups always make the headlines. But is there true value behind those eye-catching valuations? How can proper governance be implemented for these much-hyped companies?

Whether right, left or centre, Indians have a penchant for cherry-picking data to suit their narrative. In 2022 India scored a century of Unicorns, those privately held startups with a valuation of over a billion USD. Media and government boasted of beating China in the number of new unicorns added this year. But no one talked about the issue of value creation, and whether the IPOs depleted public wealth.

As one startup founder says, the venture capitalists (in his words, vulture capitalists) push for high burn rate (some unicorns burn as much as Rs 750 to generate one rupee of revenue) to play up the valuation game and get their several X return by exiting via IPO within 3-4 years as against the earlier norm of 10+ years. They don’t hesitate to spend crores on media buzz to hype up public imagination, and transfer the burden of their profiteering!

The median post-money valuation (PMV) of a unicorn is USD 1.3B. According to Stanford research, PMV is almost always higher than fair market

value (by as much as 50%), which means startups with a USD 1B PMV in a private round would not be counted as unicorns if measured by fair market value. Together, the 100 Indian unicorns have raised over USD 90B at the combined PMV of USD 340B. The post-IPO performance of the few has not been great and they will take years to turn a profit.

Isn’t it time for the deep-pocketed investors to also insist on good governance systems to drive profitability instead of just valuation, discounting years of earnings down the line? Zomato, valued at USD 9B pre-IPO, has a market cap of USD 7B, with preIPO revenue of just under Rs 2000 Cr and over Rs 800 cr loss. And its founder has just stepped down! Byju’s, the highest valued Unicorn in India at USD 23B, has FY21 loss that is 10 times more than the cumulative losses of its previous 7 years. Globally too, there are enough examples from Lyft and Uber to DoorDash and WeWork. The tech revolution has driven the lightning growth of both valuation and publicity.

These fast-growing startups pose many challenges to leadership, society and stakeholders and their inexperience in governance can cost immensely if not tamed right. Recall the founder imbroglio at PhonePe and Zomato, and how many founders globally have been removed from CEO roles. Recall also the recent reports of accounting malpractices at Byju’s. The value of good governance may not be immediately apparent to the “Vulture Capitalists”, but not having one will impact the interests of public investors adversely.

While lean startup, disruptive innovation, digitiaation, etc might benefit enterprises of all types; poor governance cannot be justified when valuations are so high. What’s more, unicorns are much bigger in valuation than many large enterprises, which are regulated by SEBI and the like – Byju’s is more valuable than NTPC, ONGC or Tata Motors. Why shouldn’t they be under scrutiny? That doesn’t mean a regulatory noose but nudging for better governance, fiduciary control and disciplined management.

Isn’t it time for the deep-pocketed investors to also insist on good governance systems to drive profitability instead of just valuation?

The unicorn founders, VCs and even policymakers may question the need for proactive governance and scrutiny when they are starting up and successful in terms of employment generation, contribution to economic growth and so on. But the fact is, their failures can cause massive disruption in the society, economy and personal lives. Assess the impact of recent mass layoffs at Twitter and Meta on society and economy in different geographies.

Startups need not have fullstrength boards and the founders themselves could be the directors with rotational chair roles. It does not really matter who the

designated chair is. Yes, these boards may not have much diversity, inclusion, or wider expertise in areas other than the uniform tech skills they share. Scaling up skills, governance, human capital, systems and processes and such will be largely absent. There will be fewer executive directors in startups-on-steroid in comparison to other established companies. Most startups also don’t have a clue on board committees. Clearly, regulatory dynamics, oversight and audit aren’t the priorities for such boards – Managing growth and scaling up are. Not surprisingly, a recent survey found board and governance at 49th in the top 100 things founders lose sleep on.

While deep-pocketed investors demand a board role in the startups, they are unable to invest enough time for governance. The misalignment between funders and founders needs governance.

Unicorn boards must evaluate a few things to steer the shift from valuation to value creation. Check how the equity and voting rights are vested, and how it affects the governance issues in the growth phase. At what point should independent directors be invited in – too many internal directors create tunnel vision and external expertise may be needed at some point. Should the chair be the founder/CEO or should the roles be separated? Should the board size be increased at the growth stage itself or at the preIPO stage? With a billion dollar valuation, audit, compensation, and nomination committees must be constituted.

Investors will also have to think how to upskill the founders who may be young and/or have no experience with board roles, and decide how to balance this with their key expertise so needed for creating value. On their part, the founders must imbibe the value of driving purposeful growth and not take IPO as the be-all and end-all. Governance will involve a lot of paperwork for which few founders will have the stomach.

Having certain control systems will help in growing professionally, and can attract the right kind of investors at different growth stages. Another critical governance issue is the discipline of distributing shares and options. Have a clearly articulated document on allocation that can help prompt investor decisions.

Creating the right governance for value creation will benefit both economic and social outcomes but doing it without killing innovation and entrepreneurship will be key to driving win-win all around.

DR MUNEER is the co-founder of the nonprofit Medici Institute and mentors several tech startups globally. Twitter @MuneerMuh