Canadian startups need to focus on corporate governance to grow and thrive

Michael Robinson, University of Calgary

December 1, 2020

To help recover from our current economic crisis, Canada needs to develop the next generation of world-leading technology corporations.

The venture capital (VC) industry is seeking more government support, including direct funding, for early-stage technology corporations. Unfortunately, any potential increased financing will not help the vast majority of entrepreneurs.

That’s because most entrepreneurs don’t understand how to structure their corporations to attract VC financing. This is partly due to a lack of respect for the needs of investors, and an associated weak understanding about corporate governance matters.

VC frustrations

Venture capitalists are specialized intermediaries who raise money from institutions to invest in technology-oriented corporations. VCs become frustrated when entrepreneurs do not put in the time required to learn about, and implement, effective governance practices before launching their startups.

They complain that entrepreneurs often expect them to spend multiple hours learning about their business before making an investment, even though the entrepreneurs have neglected to take the time to learn about investor needs. Investors in early-stage corporations are active, and want to be heavily involved when key decisions are being made.

VCs, and other startup investors, review hundreds of potential companies a year in order to make a handful of investments. Early-stage investors will spend an average of under five minutes reviewing an entrepreneur’s pitch deck, and will use that time to see if there are any critical flaws in the startup’s plans.

In a specialized program at the Haskayne School of Business at the University of Calgary, we’ve noticed that when investors identify a potentially interesting opportunity, the entrepreneur will be asked to provide two sets of detailed corporate information: a list of all shareholders and key governance documents.

If entrepreneurs have been too generous, or too miserly, in the distribution of shares, this will lessen their ability to grow a strong leadership team, will reflect poorly on the entrepreneur’s skills and is a big red flag for investors.

Complex governance challenges

Most entrepreneurs don’t appreciate that the governance challenges of a startup are in many ways more complex than those of an established corporation. The type of securities used to raise financing, for example, and the arrangements negotiated between entrepreneurs and investors can be quite complicated.

That means specialized governance mechanisms are needed that can be put into place at a relatively low cost during the early years of a startup. Once a corporation has developed past a certain point, any governance deficiencies may be impossible to correct or may require too much time and money, scaring away potential investors.

An investor’s time is valuable and is better spent helping a startup move forward as opposed to helping an entrepreneur clean up past mistakes. Taken together, the failure to attract investors and to build a strong management team have been identified as the second and third most important reasons for startup failure — and together they add up to a higher value than the first reason: no market need for the startup’s product or service.

There is information available that can help entrepreneurs learn how to work with investors. Canadian sources include the National Angel Capital Organization (NACO) and the Canadian Venture Capital Association (CVCA).

Unfortunately, however, much of the governance information on these types of sites is highly technical and it takes experience to understand which governance practices are reasonable. An entrepreneur is encouraged to seek out experienced practitioners to assist in making this determination.

Since this is such a specialized area, the number of such practitioners is limited. Even seasoned lawyers and directors who have spent their careers working with large publicly traded firms can struggle when dealing with the governance issues faced by startups.

A solution for the governance gap

Drawing upon academic research, and insights from leading governance practitioners, researchers at the Haskayne School developed and delivered Canada’s first governance course specifically designed to meet the needs of early-stage start-ups this year.

Six months post-program, several entrepreneurs discussed how they had effectively restructured their share ownership to make their corporation more investable, while others indicated that they had been able to attract significant capital after the course.

One director participant indicated that he was able to provide valuable direction as an angel investor and mentor to a startup that increased the confidence of the startup’s CEO, and its advisory board, in their fund-raising efforts.

Entrepreneurs provided with guidance at critical stages of their corporation’s development have a much higher chance of success. Developing strong governance practices will increase an entrepreneur’s ability to attract this support.

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Good business requires good governance, and startups require a particular kind of governance to help them grow and prosper. Ensuring effective governance at Canadian technology startups needs to be part of any solution aimed at accelerating the development of these corporations.

Michael Robinson, Professor and Chen Fong Fellow in Entrepreneurial Finance, University of Calgary

This article is republished from The Conversation under a Creative Commons license. Read the original article.