Better Governance Crucial for Indian Startups' Survival, Says Private Equity Expert TV Mohandas Pai

Corporate governance issues at Indian startups dominated headlines throughout 2022 and 2023. High-profile cases included former MD of fintech company BharatPe Ashneer Grover and Broker Network’s Rahul Yadav facing court proceedings, while edtech giant BYJU’S was subjected to law enforcement raids. There was also the poster boy of Indian start ups, Vijay Shekhar Sharma, being pulled up by the Reserve Bank of India and banning Paytm Payments Bank from receiving or lending deposits.

“There have to be checks and balances, there has to be a very clear strategic intent and there has to be proper allocation of capital. For a superstar CEO, you need to have a good board with strong people who can make sure that things happen the way they should,” TV Mohandas Pai, chairman of Aarin Capital and former chief financial officer of Infosys, told The Core.

Pai said that the world is going through a digital revolution, where out of the world's eight billion people, five billion have mobile phones and almost four billion are connected to the internet. This new era of business would be different from the global supply chain model of the Industrial Revolution. With the advent of artificial intelligence, quantum computing, affordable cloud data processing, humanoids, and robotics, the next five years will significantly impact how businesses function.

“The degree for greater understanding, greater knowledge, and greater governance (needs to increase) in the next five years, because if you don't take certain precautions, survival will be more difficult in the next five years than the previous five years, the previous ten years for everybody,” Pai said.

In The Core Report: Weekend Edition, financial journalist Govindraj Ethiraj talks to Pai about all that is ailing the Indian startup ecosystem.

Edited excerpts:

Let me start with the most recent trigger for this conversation, which is that you were taken on the board of BYJU'S as an advisor in June last year and one year later you stepped down. There is a problem with the company’s accounts, there's a problem with the company's governance. The auditors also resigned. What does this tell you?

Well, first of all, we are on the advisory board, not on the board. Our agreement was for one year to work with him and try to help him, both Rajnish Kumar and I. We've completed one year, so we are stepping down. There's nothing more to that.

The lessons from BYJU'S are very clear. When you have a superstar CEO and he's a superstar, he's done extraordinary work, very charismatic, and a great teacher. You need to have a strong set of people to work with him to make sure as the company grows, you improve processes, and systems, and create structures. You cannot deal with a large company the way you deal with a small company because as a company grows, the process is important to bring in certainty. There have to be checks and balances, there has to be a very clear strategic intent and there has to be proper allocation of capital. And for that, for a superstar CEO, you need to have a good board with strong people who can talk to the CEO and make sure that things happen the way they should. Remember, I will not go by revenues in this case or any other case. I'll go by valuation.

If you're a billion-dollar unicorn, it's a big company. There are only 550 companies in the stock market that are billions of dollars. Only 550. There are five and a half thousand listed companies. There are 18 lakh companies in the country. You are a very small sample. And once you have a billion dollar valuation, even if you have 50 million, 100 million revenues, I mean, you are a big company and there is so much at stake, so much money at stake, so much of investors stake money, and that reserves greater respect.

In this case, I think the board was weak. It consists of only investors and none of the investors, I believe had any experience of building a company, growing a company, understanding the challenges. Most of them are driven by increasing valuation. Increasing valuation, creating more money, spending that money became the primary objective and it broke when the music stopped.

For example, there was massive growth during the Covid when everything went digital. When you are trying to acquire more companies, when the market is hot and the market cools down, then people back out. A lot of things happen. But the basic message is as the company grows in value, you must bring in processes, you must bring in proper teams or checks and balances, have independent people on the board. Investors themselves, the fund managers themselves are not the appropriate people for this kind of board positions as they grow because most of them don't have any operating knowledge or never run companies to guide the founder.

You're saying that people who came in from Sequoia, Chan Zuckerberg Initiative, Russell Dreisenstock of Prosus, I mean, he's the individual. They had not run companies ever. Or at least it didn't reflect in their role in BYJU’S.

It didn't reflect in the roles in BYJU’S. You ask them yourself, you check out their background because you see, contrary to what happens in America, in the US, many of the fund managers are operating people and when they come on the board they have operating experience and that's how they can bring a sense of balance. Here, most of them are young people, MBAs, fresh out of college, otherwise, which is good, there's nothing wrong with that because they're very enthusiastic, they understand technology, they bring value.

But do they bring value in growing the company? Do they bring value to governance? I don't think so. But that is required. The other day for a very big company, they said: Oh, we're getting an independent director who is a senior vice president of another startup. I mean, I don't know what that means. I mean, I wouldn't go along that pathway. I will get a battle-scarred veteran who has been through many crises, who has been in traditional companies, and who understands how to bring balance. There's nothing wrong with younger people, but I think governance means that you have to look at your fiduciary responsibilities. The fiduciary responsibility becomes more important. And sometimes investor interest and the company interest may not go in sync because the company may need to take a pass, the company may need to slow down growth, the company may need to build in processes where the investors will keep saying, I want valuation. It happened in a large number of cases because remember, all these founders in India are young people, they never run companies. Most of them it is the first company. They're learning on the job. They're learning on the job or they have been managers in some companies, low down and they've never been at the top. Even if they've been on the top, they have run smaller companies that never had any challenges.

I think governance is extremely important because of fiduciary responsibility, treating capital concerning growth, believing in a competitive world, and believing in a world that goes in cycles. In the last ten years in the startup industry, we've been to at least four cycles where euphoria started and then money poured in, valuation went up and then suddenly fear took over, valuation fell, and value creation was not ahead of valuation and everything fell down. Then value creation started, it grew up and again the euphoria started, and then the money came in and then it went on. There have been four cycles, except the latest cycle has been a long time.

I think we go through these cycles, and the cycles are not too long. And when we go through it, unless you are able to ride the cycles and keep enough cash in the bank, knowing very well that these are cycles, don't get carried away. Don't blow up money. Treat money with respect. And look at the listed companies. Only one company just blew up because of bad governance. Another company just talked high, toned down, and put their head to the wheel and said EBITDA. And now they got some value up.

Now when you joined as an advisory board member to or advisory member to BYJU’S last year, wasn't all of this already clear?

No. I think when we came, three directors had resigned from the board suddenly and they had some borrowing from NBFCs, they were all called in and there was a big crisis… because you know, look, these three investor directors sat on the board, and suddenly resigned and went public. I mean what does this show? You put in $5 billion, you don't want to carry on and you just walk away. I mean what are they showing?

I'm guessing it was because some investigation was opened up or had already opened up. There was an enforcement directorate investigation that had opened up.

Look, whatever happened till that point in time, if you're a board member, you're culpable. You can't escape by just walking away. Because, you know, you are looking at events that happened during your term. What you should have said is you should have worked with the founder to say: Hey, we have this crisis. We're forming a group, we're bringing in experts from outside to help us navigate this crisis. And we'll work with the founder to write it out.

When the Adani thing happened, please remember that if the entire independent members of the board had walked out and resigned. It would be a mess. Because the value of directors comes, when there's a crisis. The value of a director, apart from the founder or the managing director, comes when there's a crisis. The crisis is where you must step up to the plate.

But then one year later, you too, along with the former State Bank of India chairman, have stepped down.

Look, we are advisors, we are not investors. We are advisors. We are not investors. We came in to help BYJU’S out of emotion, that's all. And now the matter has gone to court. What further contribution can you make when everything is in court? When everything is in court, the court has to decide. It goes on and on and on. What are you going to do? The investors went to court and it became a perfect storm and let them now manage it.

Let me come back to the role of investors. And you pointed out that, you know, these were investors who were sitting on the board who did not have much operational experience and they don't elsewhere too. Now, these investors are also responsible to their investors globally. So why is it that they do not create the right governance structure when they move into a company and take such large positions?

Well, they should. I don't think. They don't create it, as far as I can see, because I don't think they understand the importance of governance. They don't understand the importance of why you must get independent people on the board, create checks and balances, and all the nice stuff.

Remember, Infosys went public when our revenues were maybe 3 million or something. I mean, immediately after one year or so, we got a good board. We were so small, we got a good board, we had a lead independent director, we had regular processes, and we announced results within one week, ten days. All the things we did, we didn't have to do all that, we did it. Why? Because we said, look, we are listed, we have got a fiduciary obligation, we must discharge it. It can only be discharged if there are independent people who sit on the board and look at us and tell us we are on the right path and we must create those structures and give them space. Now, we did that. That is what these investors should have done.

That's why I think once a company startup reaches a level of valuation, let's say 500 million, I want to go by valuation, not revenues, because some may get a valuation of 500 million with 10 million revenues. 500 million is a lot of money. That's when you must start looking at independent directors.

When Infosys was listed, which is about 30 years ago from now, there was no concept of governance or corporate governance. Even Adrian Cadbury's report on governance was just being written at that time. Whatever Infosys did, I'm assuming it did intuitively.

It did because one, we had good people. We had people with some maturity who understood when you go public, your responsibility increases. You are in the public eye. You got other people's money with you. Now, for ordinary middle-class people taking money from others, it's a very worrying sign. You have to deliver value. And that says we have to step up to the plate. What do we do? We need boards. Get independent people, give them the space, review, present to them, listen to them, make them work. You got to make them work.

We want to be the best in the business, globally, best in the business in terms of governance, in terms of processes, in terms of technology, in terms of people, in terms of marketing, in terms of campus, everything. We want to be the best. What is the global best? This is the global best. Be it the best. That's what the ambition, a burning desire was there.

If, and this is again going back 30 years, NR Narayana Murthy had the vision and he created many of these things and you continued it. Over the years, and in that same spirit that it was first started. Now, my question, therefore, is in the case of Infosys, and all of this came from within the team, including yourself and all the senior stakeholders. But when you contrast that with, let's say, BYJU’S or many of these other companies, the sense I'm getting is that there is no such desire even 30 years later. There's no inbuilt desire to say that I want to be the best in governance. And if there isn't, then isn't it a lost case to start with?

No, it's not a lost case, because the first decade of any new thing happening is a decade of discovery. This is a decade of discovery where everybody discovered themselves. The investors discovered themselves. What works, and what does not work. They don't know what works, or what may not work. They invest in the seed, in an idea, in something that does not have a background. A lot of money is coming in, and this creates its own challenges. And you spread the portfolio. You create a portfolio spread it around many companies and you work with them. But the key differential is that the people who invest the money on behalf of investors, the fund managers should have this passion: that I'm going to put in good governance to protect myself, at least as a question of risk management. What are the risks when I invest? The risk when I invest is, yes, the technology may not work, the company may not grow, it may not get a sustainable revenue model, and the founders may come up short and all that. How do I manage the risk?

Now, you must not kill the entrepreneur. You must not reduce their drive, energy, and passion. But capital allocation, investment, and putting in financial plans are very important because that's the code. You can't just go on burning money. For that, you need to have people who can bring in that kind of discipline and oversight, and that should be something the fund managers should do.

The problems or the excesses of the last decade in many ways are also getting carried through to this decade. I don't know if PayTm is a good example of that, but there are several other companies. One symptom is when they take so long to declare their results. While we are moving from a decade of discovery to a decade of consolidation and growth, we're also still carrying some of the problems of the past.

Yeah, that's true. Because it doesn't happen on a cut-off date. It is a process. If I were the investor, large investor from a mutual fund in all the digital companies, I would go question them and say, please declare results within ten days. Because the longer you take to declare the result, the larger the chance of leakage of information. Why do you want to fall victim? You may not fall victim, but why do you want to have a chance? It's not worth it.

I wish the mutual funds would go to them and tell them to please announce within ten days or 15 days. And you know, one of the big ones… I told him, why not announce it? No, no, sir. He said that auditors are not saying that… We'll do it later. We got to work. And they kick out the auditors. Sack them, get somebody else. Who cares? The auditor cannot dictate when I want my results to be out. This is where maturity comes in. A board member comes in.

(In the case of) Paytm crisis. What did RBI say? RBI just said this payment bank is going to stop. They can't accept anything. But you forget to add. RBI had given them 22 months. There's a matter of 22 months. 22 months, is a long enough time. And when it happened, I saw many young founders saying RBI. Who is RBI? This is all rubbish. In 22 months, what was the board doing in that company? What were the directors doing in the company? Why didn't they hold their founders' feet to the fire? Because when a regulator tells you something, you better be careful. And when the regulator is somebody who can destroy you, you better be more careful. Your business will go now. The company is gone.

Who's accountable? The independent directors should have stepped in. That's the governance failure. And what happens to the parent company? The parent company had a related party transaction. They should monitor that, they should be careful. And when this happened, they should have taken charge.

In the Adani case, when the Hindenburg thing hit the ceiling and the stock prices fell, their independent directors should have stepped up to the plate and said, we are forming a group, here are three or four people, we will look at all this, we will work with management and we will give all the information to the public and will tackle this. That will show arm's length. The charge of Hindenburg is again the management, the man, the controlling shareholder. Now you are listed, when you are listed, you're not a proprietorship. You treat the company like a proprietorship, personal property. That's not okay when you are listed, correct?

But in the case of independent directors, I think there is a legacy. The legacy is that in promoter-run companies, independent directors do not think that they're signing up to do anything independent, at least from whatever I've seen. How does one change that?

I understand what you're saying, but I don't think we should take that attitude. We must hold their feet to the fire. Now, independent directors should understand that their role becomes most important in a crisis. It is in a crisis where they must stand up to defend the company. And the crisis happened because of some management lapses. It can be a regulatory crisis. It can be the crisis of the CEO succession or the CEO getting contaminated. It can be a crisis of acquisition. Where they must step up, there is a job or they must leave, they should resign and go. They're all people of self-respect and self-worth. That is the problem.

And now, why aren't the media and others holding the independent directors to account? What is the board for? Why are there no questions asked by major investors?

So as an investor now in your own funds, are you, let's say, using some of these lessons, when you look at potential entrepreneurs or entrepreneurs who come to you and then maybe taking slightly different calls today from the way you were doing earlier?

Yes. As investors, we tell the founders, look, you should not lose money. The money that you have as a loss should be the investment that you make ahead of the need to grow faster. That's fine. You must respect capital, you must always have one year, or two years of cash in the bank, you must have proper budgets, you must have processes, and you must have regular board meetings and analyse it. And once you come to a size, you must get people to come.

Now we are appointing, and asking some mentors in financial matters to work with the startup companies. And the founders are very grateful. They acknowledge they need help because they don't know how to cut costs, and they don't know how to do many things. If we get somebody from the outside, so we have put people and they're all agreeing, they're all growing up. And then the investors in the board also become more careful. They don't want to lose their investment. Because they'll be held accountable.

The dialogue has changed, the context has changed, and people are much more aware because remember, in the first ten years, the failures were few and plenty only because of some lapses by founders like Housing.com. Now, the governance failures have come to the fore. They understood the failures because of governance.

The last ten years have proved and provided an important benchmark and in its aggregate, for definitely the next. That's what's important. People forget it when the market is euphoric. People forget everything. You know that we have seen that. The Harshad Mehta time, we see that Ketan Parekh time. We've seen all that euphoria of the past. We can only write stories, we can only tell people. And hopefully, things will improve.

The point is that capital flows are fickle or can be fickle and therefore you need to be careful and not get led away with theories that drive such capital flows. I'm assuming that's the conclusion?

That is true. And the only reality in life is free cash flows, where you generate your own resources to survive. To good and thick, to thick and thin. When things go well, you get great value. When things go bad, you have enough cash in a balance sheet to write it out.

In Infosys, we always used to have enough cash in the balance sheet to meet one year's expenditure with no revenues. It never happened except during Covid there was a fear — it never happened for 25 years. Suddenly one Covid once in a hundred years. They had enough money to write it out for two years. Now, when you want to sustain your business, you have to make sure. Because when things go very wrong, there's nobody to give you the cash.

But the bigger issue which I want to talk to you about is we are in the midst of the digital revolution, globally. Now, out of 8 billion people on the planet, 500 billion people have a mobile phone. About 5- 500 quarter billion are on the internet. The new business model is opposed to the business global supply chain or/of the industrial revolution. And now with AI coming in, quantum computing coming in, cheap data processing through the cloud, and humanoids and robotics coming in, everything in the next five years will change and the impact will be felt. The change has been happening for the last ten years. Now five years, the impact will be felt.

How do all these startups and our industry react to the impact when a business has become more globalised, the business has become more volatile, and these people have to grow? The degree for greater understanding, greater knowledge, and greater governance (needs to increase) in the next five years, because if you don't take certain precautions, survival will be more difficult in the next five years than the previous five years, the previous ten years for everybody.