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How should you balance entrepreneurialism with governance standards?

How should you balance entrepreneurialism with governance standards?

The collapse of BHS, one of Britain’s best-known retailers, left a hole in many a high street and left many stakeholders out of pocket. Such scandals are rare, but they can have serious implications for shareholders, and for the UK’s reputation as a good place to do business. As a consequence, the UK Government is working on a new set of governance standards.

Governance and private companies

The UK Government’s response to the green paper consultation on governance standards was published in August. The focus of the consultation has been on:

  • executive pay;
  • corporate governance of large privately-held companies, and;
  • how companies engage with and listen to key stakeholders such as employees, customers and suppliers.

  • The consultation’s focus on privately-held companies indicates the Government’s intent to bring them under the same governance umbrella as public companies. Private companies must take note, and work closely with their investors and Government if they are to keep the symbiotic forces of governance and entrepreneurialism in balance.

    Private companies have historically been seen as better aligned and more accountable to investors than public companies. Board composition and alignment had historically been seen to deliver better strategic leadership, and superior stakeholder management. But recent scandals such as that of BHS have called received wisdom in to question.

    The unicorns

    A ‘unicorn’ is a start-up company, without an established performance record, valued at $1 billion or more. Cheap and plentiful money supply has helped fuel the unicorn phenomenon in recent years. Other factors such as the move from hardware to software-based systems have also had a significant impact. Nevertheless, historically, early-stage companies would have had better access to capital if they were publicly traded. Today, however, many venture-backed companies can remain in private hands for longer, while also becoming much larger.

    Because power is often concentrated in the founder’s hands, and because growth is sometimes valued above all else, governance standards that most investors would take for granted are absent in some cases.

    When is a public company not public?

    Snap’s initial public offering of non-voting shares quite rightly led to questions of alignment and accountability. Several well-recognised brands such as Google and Facebook have been able to list as publicly-held companies without founders ceding control.

    Some public firms such as Sports Direct have been able to act like private companies, and to defy their independent shareholders by keeping people in positions of influence, in spite of flouting governance standards.

    Possible remedies

    So what can be done to address these issues, particularly in the case of privately-held companies? In 2007, the Walker Report was commissioned to provide guidelines for transparency of private equity companies due to significant industry growth. While the report did not propose new governance standards, it did reference the Combined Code on Corporate Governance set by the Financial Reporting Council (FRC) as a basis for designing a set of standards.

    These standards are born out of the original Cadbury Code, set out in 1992, which states:

    “Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting.”

    This would probably still be a good place to start for today’s purposes. Privately-held companies could be held to a ‘comply or explain’ framework for corporate governance standards. This is not without complications, however. This approach could be overwhelming or inappropriate for such a diverse set of businesses, where specific standards are unlikely to apply universally.

    The way forward is likely to be decided in consultation with the FRC over the coming year.

    There is a fine balance to be struck between entrepreneurialism and governance as an increasingly burdensome regulatory environment can stifle entrepreneurialism.

    The balancing act

    There is a fine balance to be struck between entrepreneurialism and governance as an increasingly burdensome regulatory environment can stifle entrepreneurialism.

    In France, for example, there are an overwhelming number of companies employing 49 people. Why? A raft of regulations that are designed to protect those in work are enforced when headcount hits 50 people. If these companies need to hire in order to grow but can’t absorb the additional regulatory burden, fewer jobs are created and economic growth is limited as a result.

    However, the scope of the consultation currently takes in only the largest companies, which is welcome news to the UK venture capital industry. It needs to remain flexible and competitive in order to attract the best entrepreneurs. It faces competition predominantly from Silicon Valley, but is also likely to face competition from France and Germany post-Brexit. This, coupled with the withdrawal of the European Investment Fund, the largest investor in UK venture capital firms are headwinds enough.

    Nevertheless, it is right that companies are concerned about the unintended consequences of some forms of regulation. Engagement with the FRC over the coming months will be key to the success of the new governance framework.

    Poor governance can affect performance

    While rare, poor governance and related scandals occur in both publicly and privately held companies. But in either case, poor governance can negatively impact investment returns, and should be carefully considered by investors, and addressed by policymakers.

    The fine balance will be in ensuring that entrepreneurialism – and its benefits to the economy – is not stifled in the process.