Yogesh Pathak, an advisor for many startups, argues that it is very important for startup founders to clearly lay out the ethical rules that the startup is going to play by. He points out the various issues on which the founders need to make their stand clear to all concerned stakeholders.

Governance has come in spotlight again in India due to scandals like Satyam. Normally governance is talked about in the context of large companies. However governance is a fundamental quality of any institution, small or large, for-profit or nonprofit, so here’s an attempt to highlight some issues about startup governance. Basically what “ethics” is at personal level, “governance” is at an institutional level.

Founders need to agree on an ethics policy in a startup

In countries that are high on the corruption index, India included, variation in standards of ethics affect pretty much everyone in the country: industrialists, government, entrepreneurs, citizens, and so on. It is key for even a small enterprise to have an ethics policy of its own and not just react to ethical dilemmas as they arrive. Differences between ethical preferences of individuals may crop up and create periods of conflict in a startup. Some standardization of rules of engagement (and ethics) between co-founders is ideal. e.g. Being open and upfront about any conflict of interest scenarios, etc.

A hypothetical example: A startup develops a cutting edge product and takes it to emerging markets, say Africa or other countries. Many large enterprises in such countries may be owned by the government. Let’s say a sale is possible at such a customer but a bribe is asked. What if some of the founder/management time are all right about paying bribes (to build revenue scale, which is very critical for startups) while some consider it unethical. Such a situation can result in conflict and affect the overall team spirit at a startup.

Accounting policies

Most startups work in cutting-edge areas and break ground on new business models, new streams of revenues etc. Often, established definitions and norms of accounting may conflict with the context of a new market, product, or service. Such areas include

• what are the various types of revenues, policies regarding adjustments to revenues, what is revenue for accounting purposes, etc
• how does the company define bad debt (collections awaited from customers)
• expense heads and related accounting policies
• what expense items should be used when computing gross margin, operating margin, etc

At times there may be a lot of discussion between startup management, board members, auditors, etc about what norms are prudent. While being conservative is usually a safer strategy, it is also key to listen to everyone’s viewpoint and make an informed, objective decision that is fair to all stakeholders and follows the law of the land both in letter and in spirit.

Fair treatment of customers

At times, companies may get creative in their communication with customers in order to keep customers longer or maximize revenues and profits. For example, not all costs to a customer may be transparent, sometimes un-subscribing from a service may be difficult for customers to do, or sometimes customers’ confidential information with the company may be used without their consent.

Startups need to be cognizant of an average customer’s expectations on fair treatment, as well as consumer protection laws across countries, and need to build it seamlessly in their customer experience design. Again, being proactive works better than being reactive.

Fair treatment of employees

While the laws of land, best practices in HR, and a free market for labor will usually take care that employees are treated fairly, it is key for employers to consciously design ethical treatment of employees in all their HR processes.

Investor communication

Startups are always in the market to raise capital for growth and make their dreams possible. Business plans are their main communication tools with investors. It is important to convey information such that is verifiable, accurate, and generally defensible in due diligence.

Once an investment is made, investors ask for detailed financial and operating information, usually at a monthly frequency. This information is their main tool for keeping a track of the health of the business. Investors appreciate companies providing information in agreed-upon formats, data not being re-stated frequently, knowing any surprises earlier rather than later, and an easy-to-understand explanation for the business drivers behind the numbers.

While a startup board may not have lots of formal committees, VC/PE investors are usually very active on boards, and play multiple roles in terms of tracking governance, evaluating the business, and being a mentor to the management team. It is important to form governance policies with mutual discussion and then follow them in a disciplined manner.

I am sure there are more unique aspects having to do with ethics and governance depending on the nature of business of a startup (utilizing 3rd party data on the web or IP protection, are some issues that come to mind). The above is a just a starting point touching upon major areas. Entrepreneurs have a clean slate on how to develop the culture within their companies. They will be expetced to set prudent norms and then lead by example.

About the author – Yogesh Pathak

Yogesh Pathak is founder of Path Knowledge, a business research, consulting, and startup advisory firm based in Pune.