Small and medium-sized businesses (SMEs) are regarded as the backbone of emerging economies’ financial activity. Despite the increased interest in these businesses, facets of their corporate governance are still understudied. SMEs being small companies are not bound to do corporate governance hence they are highly vulnerable to governance issues. The Companies Act, 2013 (Companies Act) and thereafter rules formulated govern corporate governance in Indian companies.
For the success and growth of an organisation, a good governance mechanism is important. It will lead to internal discipline, accountability, and transparency within the stakeholders of the organisation. Striking a balance between the interests of the board, promoters, and shareholders is significant. Unfortunately, it seems to take a back seat for many Indian companies in SME and start-up spaces. Organisations struggle with transparency and disclosure of information, contributing to fraud and governance failures in SMEs. In the Indian scenario, the past few decades have seen several corporate frauds in various small businesses.
In this blog post, we will examine contributors to corporate fraud in SMEs. It will start with the current governance issue with the fintech start-up Bharat Pe. Secondly, we seek to analyse the importance of corporate governance in SMEs.
Governance Failure at Bharat Pe
The start-ups in India create remarkable wealth which has been witnessed in recent years. Although there are laws and regulations in place, the governance issues in the start-up space have received significant attention from regulatory authorities. The background of problems in the fintech start-up Bharat Pe has been discussed below.
Bharat Pe the fintech start-up was co-founded by Ashneer Grover and Shashvat Nakrani in 2018 to cater to small merchants and help them accept digital payments. The company came to the spotlight after an audio clip was leaked about a conversation between co-founder Ashneer Grover and a Kotak Mahindra Bank employee. Ashneer was heard abusing a bank employee for denying financing for Nykaa’s IPO. Following this, the company was brought under the lens of scrutiny. The co-founder resigned as managing director, as well as from the board. Later, Grover announced his voluntary leave from the affairs of the company till March, 2022. After 10 days, the company appointed a management consultancy and risk advisory firm, Alvarez and Marshal (A&M) for investigating internal processes and systems. The preliminary report by A&M showed that the company was routing money through HR consultancy firms who were allegedly recruiting employees in the company. Also, the report exposed some of the fake vendors, the company was dealing with. It was alleged that Madhuri Jain, Head of Controls and wife of co-founder Ashneer Grover was involved in these fake transactions. The dealing with fake vendors was highlighted earlier by the Directorate General of GST Intelligence (DGGI) in October, 2021. It was settled by the company by paying dues and penalties. After Grover was exposed, the company appointed accounting giant PwC to conduct an independent audit. This was in pursuance of the MoU clause for termination of services of the co-founder and head of controls. After the audit, a notice of the board meeting was given for the discussion related to the PwC report. This was followed by the resignation of Ashneer Grover and his wife Madhuri Jain Grover.
Between the founders, the board, and the investors, there has been a barrage of accusations and counter-accusations, after Ashneer Grover and Madhuri Jain were facing fraud and misappropriation charges. Investors and the board of directors were letting these malpractices fester for years. The board largely had investors as directors, which includes Sequoia Capital India, Tiger Global Management, etc. Investors prioritise increasing the valuation over protecting stakeholders’ interests. Lack of transparency of information regarding details of the business of the company fostered the present issues of misappropriation in the company. Further, Madhuri Jain, being a design graduate, was holding a crucial position as head of controls. The board of directors should have questioned such allocation of departments with more scrutiny. This pushed the question of investors’ roles and relationships with founders to the fore.
Following the reports, the company planned to modify its governance policies and appoint more independent directors. The unchecked behaviour of a co-founder and his wife were to be blamed for hampering investors’ interest.
Delineating Governance Standards For Smes
Bharat Pe’s issue shows that smooth ownership and management transition is difficult in start-ups. Founders, not shareholders, dominate Indian start-up governance. This creates the greatest agency cost for governing these companies. The influence of Ashneer Grover on the company’s management was due to the restricted makeup of the board, lack of internal control, and absence of an external auditor. Furthermore, the shareholders and non-promotor board members were passive.
A rising SME’s long-term viability depends heavily on balancing the interests of the company’s expanding family and the increasing interests of a growing number of shareholders. The Bharat Pe debacle was largely a corporate governance problem that calls for efficient and mandatory governance regimes in the Indian SMEs in the following aspects:
The absence of disclosure of relevant financial and non-financial information to shareholders and investors is to blame for the problem of transparency. The inconsistencies of fake invoices in Bharat Pe can be attributed to the lack of proper disclosure by family members.
In India, SMEs are obligated under the Company Accounting (Standard) Rules and the Companies Act to make public their financial information. However, the disclosure of financial and non-financial information is inefficient since the SMEs are under the authority of the founding families. All the stakeholders from employees to shareholders shall have equal access to information. The roles and responsibilities of founders shall be finalised and limited. Standardised disclosure mechanism shall be formulated by the company that ensures the delivery of reliable financial statements/reports and an overview of the company’s current performance, future plans, governance processes, and corporate social responsibility practises to shareholders. The regulators shall formulate regulations to regulate founders involved in Related Party Transactions and fraud in SMEs.
2. Appointment of Directors
Ashneer Grover being co-founder and director had a great influence in the company. It is critical for small businesses to progressively shift decision-making from highly centralised to more dispersed and collaborative. Founders and CEOs of SMEs are often the primary decision-makers in the early stages of the business. It raises the chance of making sub-optimal decisions due to personal biases, insufficient information, and experience. Effective delegation of power is crucial because the executive directors of a start-up are often members of the founding families. A formal board of directors provides monitoring and control, as well as strategic counsel and direction. Furthermore, independent directors (with skill and financial understanding) shall also be mandated by law to be appointed in SMEs in order to promote oversight roles and provide fair recommendations. These individuals have no financial links to the company’s management, stockholders, or any of its board members. They provide strategic advice to promotors/directors and management and act as a watchdog to protect the shareholders.
Directors should have their noses in the company, but hands out. Founders often want to prolong their involvement in day-to-day operations. They become narcissistic and self-absorbed as a result. Grover apparently sent money to HR agencies that recruited business employees. For this reason, succession planning in small businesses must be subject to checks and balances. Good business development needs the appointment of external executive teams uninfluenced by founders.
3. Internal Controls and Auditors’ Appointment
Internal controls should be put in place to guarantee that the company strategy is being met while also ensuring that risks are being addressed. Risks include fraud, cost overruns, and reporting errors may occur. Management is in charge of putting in place internal controls, with the board of directors providing direction and supervision. Other Bharat Pe directors and shareholders were inactive. Lack of internal oversight allowed Ashneer Grover and his wife to commit fraud before the event. Hence, a mandatory audit committee headed by an independent director shall be established. They shall evaluate the internal audit report and the internal control mechanism.
Due to Bharat pe’s failure to appropriately hire an external auditor, all of the fraudulent transactions were unnoticed. An external auditor verifies severe control weakness assessments and reports. Internal auditors, management, and executive directors/founders hiding vital data and auditing errors are under independent oversight. Lastly, rotation of auditors will prevent passivity and undue influence from promotors.
Corporate governance is an essential aspect of every organisation regardless of its size. Managing corporate governance in a small or start-up business is typically seen as an expensive proposition. However, in recent years, there have been a number of corporate governance challenges among SMEs in their expansion stage. The Indian paradox of Bharat Pe is a good example of this pattern. This necessitates a primary set of mandatory governance principles. The blog proposes to include principles such as transparency, the establishment of a formal board, internal control, the appointment of an external auditor, and succession planning. It is the need of the hour to enforce these principles in order to prevent debacles like Satyam in SME and start-up businesses.
(This article is written by Akshita Modi and Simran Lunagariya. Akshita Modi and Simran Lunagariya are 5th year students, pursuing B.Com LLB at Institute of Law, Nirma University. )
Cite as: Akshita Modi and Simran Lunagariya, ‘the Debacle Of Bharat Pe – An Exemplar of Start-Up Governance Failure in India’ (The Contemporary Law Forum, 24 July 2022) <https://tclf.in/2022/07/25/the-debacle-of-bharat-pe–an-exemplar-of-start-up-governance-failure-in-india/> date of access.