About the Author: Neeraj Singh Rathore is IICA-MCA Qualified Independent Director, ICF Certified Business Coach, Author, Speaker, PMP, NLP Master, Executive Coach & an Entrepreneur. With a 26+ years of Experience and a accomplished professional with a strong track record of driving organizational success. Strong leadership and decision-making abilities with a focus on ethical and responsible governance for SME.
Corporate governance, which ensures that the business is run in a transparent, accountable, and responsible manner, is crucial for a start-up’s long-term success. Effective corporate governance procedures support the development of credibility and confidence among clients and investors.
Despite resource limitations and the particular difficulties faced by entrepreneurs, putting a high priority on corporate governance ensures integrity, draws investors, and promotes sustainable growth.
It includes a set of regulations, procedures, and practises that guide a business and encourage openness, responsibility, and ethical behaviour in the workplace. These attributes enhance a company’s reputation and helps avoid red flags.
Red flags in Corporate Governance. Red flags are signs that things are not going well in the organization in case you plan to invest or interested in the company affairs.
- Resignation of auditors – While the majority of auditors frequently fail to state their reasons for leaving, repeated resignations of auditors or the big four firms are certain warning signs that institutional investors are watching for.
- Unusual accounting transactions – At first, institutional investors opposed a number of deals, primarily mergers and acquisitions. However, over time, things have evolved, and investors are increasingly worried about director salaries, director reshuffles, related-party transactions, asset sales, and asset acquisitions.
- Absence of independent directors – As one starts thinking about issues, for a long time, global investors were worried about induction of independent directors but now domestic investors too are taking note to induct Independent Directors in the board.
- An irregular profit and loss statement. By examining these figures (P&L, cash flow, balance sheet, etc.), an investor can determine how much debt the company has relative to equity, whether cash is decreasing or increasing in the short term, the tangible assets, where the profits are being spent, and whether there has been financial mismanagement.
- Negative cash flows – suggest that the promoter is unable to manage the business well unless it’s for investment in production facilities. In that case one has to assess when the company could turn cash surplus.
- Other crucial areas – In addition to looking at cash flows, evaluating labour costs, interest costs, manufacturing expenses, and electricity costs in proportion to sales during the last three years is necessary to assess efficiency levels. Investors can rest assured if the business continually performs well.
- The need for working cash is also significant. Everything will be OK if a business can get and use working cash efficiently. However, the mismatch appears when working capital is switched to long-term capital (which happens in the majority of situations), which suggests that the promoters may be attempting to manipulate the accounting.
- For transactions involving related parties, disclosure and shareholder approval must be handled impartially and in the company’s best interests. Companies are required to provide pertinent information including financial statements and annual reports, with a focus on timely and accurate disclosures.
The Indian Government has taken notable steps to strengthen Corporate Governance practices by establishing various committees.
- The necessity of independent directors and their function in ensuring corporate governance was emphasised by the Kumar Mangalam Birla Committee. As a result, measures pertaining to independent directors, including their nomination, qualifications, and duties, were integrated into the Companies Act of 2013.
- The Narayana Murthy Committee also emphasised the value of audit committees in financial reporting and accountability. As a result, the Companies Act of 2013 required some businesses to create audit committees and set down the details of their structure and duties.
- The Uday Kotak Committee concentrated on improving corporate governance in publicly traded corporations. The Securities & Exchange Board of India ((Listing Obligations and Disclosure Requirements) Regulations 2015 adopted some of its recommendations, including separating the Chairman and Managing Director responsibilities, improving board performance, and addressing related-party transactions.
These regulations impose compliance requirements on listed companies regarding board composition, disclosure, and governance practices.
To uphold transparency and fairness, Indian companies are required to
Recognizing the importance of shareholder rights, the Companies Act 2013 guarantees shareholders the right to vote, participate in general meetings, and access corporate records.
Furthermore, companies are encouraged to establish mechanisms that allow employees and stakeholders to report concerns regarding unethical practices, fraud, or other misconduct. These whistle-blower mechanisms foster a culture of transparency, accountability, and early detection and resolution of malpractices. Also allocate a portion of their profits towards Corporate Social Responsibility (CSR) activities,
Conclusion : In case the above red flags goes unnoticed : If the business has a substantial or catastrophic corporate governance failure as a result of the aforementioned warning signs/Red flags going missed, it is clear to wonder who should have been in a position to recognise the risks and why prompt remedial action was not taken e.g., Vijay Mallaya/Nirav Modi case. The board has ultimate responsibility for risk management and the company’s success or failure.
Additionally, if the poor management raises suspicions of illegal or unethical activities, they may have the necessary swap to help turn the situation around. Consequently, paying closer attention to the governance of enterprises in more depth.
Recent corporate scandals have highlighted that there needs to be greater oversight of management’s actions and corporate strategy, as well as more effective scrutiny and challenge from the organisation’s assurance providers and auditors.
The Indian Government has taken various steps to strengthen Corporate Governance practices in the country. Good governance practices not only benefit start-ups but also streamline decision-making, facilitate effective communication, and ensure harmonious relationships with investors. It is through these efforts that start-ups can thrive, attract investments, and drive long-term growth, while contributing to India’s economic progress and global standing.