Compliance Hacks for Startups: Don't Be a Cautionary Tale!

Startups often navigate uncharted territories, bringing innovative solutions and disrupting traditional markets. However, this pioneering spirit sometimes leads them into regulatory and compliance troubles. The reasons for these issues are manifold: rapid expansion, evolving regulations, lack of robust internal controls, and sometimes, oversight. As startups scale, maintaining compliance with regulations becomes increasingly complex and critical.

In this article we will look into three major startups – DroneAcharya, Paytm, and Byju’s – that have faced significant regulatory and compliance challenges, highlighting the lessons other startups can learn from their experiences.

Startups prioritize valuation, often placing it before value creation. Investors enter businesses at various stages and valuations. Incidents like this can significantly impact not only any particular brand's future valuation but the entire startup ecosystem, as the global investors will scrutinize the event carefully, potentially influencing their decision-making process whether to invest or not to invest.

Additionally, we will explore how the Corporate Governance Charter introduced by the Confederation of Indian Industry (CII)  helps startups strengthen their governance frameworks.

DroneAcharya: Delayed Financial Reporting

DroneAcharya Aerial Innovations, a Pune-based drone startup, was fined INR 5,900 by the Bombay Stock Exchange (BSE) on July 3, 2024 for delaying the submission of its financial results for FY24. The company initially provided some financial figures after a board meeting on May 30, 2024, but the complete financial statement was only submitted the following day.

Despite a doubling of its consolidated profit after tax to INR 6.2 crore from INR 3.4 crore the previous year, the delay in reporting overshadowed this success. The fine imposed by BSE, though nominal, highlights the importance of timely financial disclosures, which are crucial for maintaining investor trust and regulatory compliance.

Paytm Payments Bank: Regulatory Crackdown

In February 2024, the Reserve Bank of India (RBI) imposed severe restrictions on Paytm Payments Bank Ltd (PPBL). The RBI barred PPBL from accepting new deposits or top-ups in customer accounts, wallets, FASTags, and other instruments due to significant irregularities in Know Your Customer (KYC) processes.

The RBI's actions, including barring PPBL from onboarding new customers and extending the compliance deadline, underscore the critical importance of robust KYC protocols. These measures are designed to protect consumers and ensure the financial stability of the system. The regulatory body’s stringent actions serve as a stark reminder that no matter how big the company grows, adherence to KYC norms is non-negotiable in the financial sector.

Byju’s: Foreign Exchange Violations

In November 2022, the Enforcement Directorate (ED) issued showcause notices to edtech giant Byju’s and its founder Byju Raveendran over alleged violations of the Foreign Exchange Management Act (FEMA), amounting to over INR 9,362 crore. At that time Byju's was one of the most popular edtechs gobally with USD 22 Billion valuation. The ED accused Think & Learn Pvt Ltd (Byju’s parent company) of making significant foreign remittances and investments abroad that were in violation of FEMA provisions.

Byju’s case highlights the complexities of international financial transactions and the stringent regulatory environment governing such activities. For startups with global operations, understanding and complying with foreign exchange regulations is paramount. Non-compliance can lead to substantial penalties and reputational damage.

Why Startups Overlook Regulatory and Compliance Norms

Startups frequently face regulatory troubles due to a combination of factors:

1. Focus on Rapid Growth: Startups are driven by the need to scale quickly, often prioritizing growth metrics over regulatory adherence. The pressure to demonstrate rapid progress to investors can lead to shortcuts in compliance.

2. Resource Constraints: Many startups operate with limited resources, both financial and human. Allocating funds and personnel to compliance can seem secondary to activities directly linked to growth and revenue generation.

3. Lack of Regulatory Knowledge: Founders and early team members may lack the expertise in legal and regulatory frameworks, leading to unintentional non-compliance. Startups often lack dedicated legal departments or compliance officers in their early stages.

4. Complex Regulatory Landscape: Navigating the regulatory environment can be particularly challenging for startups, especially those operating in multiple jurisdictions or emerging industries. The complexity and variability of regulations can result in inadvertent lapses.

5. Perceived Low Risk: Some startups may underestimate the risks associated with non-compliance, believing that regulatory authorities are more lenient towards new and innovative businesses. This perception can lead to complacency in following compliance norms.

6. Reactive Approach: Startups often adopt a reactive rather than proactive approach to compliance. They may only address regulatory issues when faced with enforcement actions or legal challenges, which can be too late to avoid significant consequences.

What are the major Consequences of Non-Compliance

• Investor Scrutiny: Incidents of non-compliance can severely impact investor confidence. Investors meticulously scrutinize regulatory lapses, which can influence their decision to invest and affect the valuation of the startup.

• Reputational Damage: Regulatory troubles can tarnish a startup's reputation, making it difficult to attract customers, partners, and top talent. Trust and credibility are crucial for long-term success.

• Legal Penalties: Non-compliance can result in substantial fines, legal fees, and other penalties. These financial burdens can strain a startup’s limited resources and impede growth.

• Operational Disruptions: Regulatory issues can lead to operational disruptions, including product recalls, service interruptions, or even shutdowns, hampering the startup’s ability to compete effectively.

The Corporate Governance Charter by CII

In response to growing concerns about governance in startups, the Confederation of Indian Industry (CII) had introduced a Corporate Governance Charter specifically for startups. This initiative aims to instill transparency, accountability, and long-term sustainability in the startup ecosystem.

The charter ioutlined an innovative online self-evaluative governance scorecard, designed to serve as a dynamic tool for startups to assess their current governance status and track improvements over time. This scorecard allows startups to measure their progress, with score fluctuations indicating advancements in governance practices as evaluated against the comprehensive criteria outlined in the charter.

The introduction of this Corporate Governance Charter comes against the backdrop of mounting concerns surrounding governance standards within the startup ecosystem. Notable startups such as Byju’s, BharatPe, GoMechanic, Paytm have recently faced scrutiny over governance lapses, prompting industry stakeholders to reassess and fortify governance frameworks.

Key Recommendations from the CII Corporate Governance Charter for Startups

The CII charter advises startups to follow these guidelines to enhance their governance practices, avoid regulatory setbacks, and build investor confidence.

Startup Governance: Building for Long-Term Success

The journey from startup inception to going public is fraught with challenges, but implementing robust governance practices at each stage can significantly mitigate risks and pave the way for sustainable growth. By prioritizing governance from the outset, startups can build trust with investors, stakeholders, and the public, ultimately setting themselves up for long-term success.

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