Posted By
Eldon Chan

For many entrepreneurs and investors who are familiar with the US venture capital scene, you may be surprised to hear the details of the bespoke corporate governance terms that are often negotiated in Southeast Asia and India deals, some of which are ordinarily viewed as non-starters or off-market in the US.

As the venture capital scene continues to mature in both Southeast Asia and India, and market norms become more defined, this article seeks to highlight three common corporate governance issues in companies operating in these markets, with the aim of helping founders navigate their next fundraise with these issues in mind.

Anchoring Effect

Many early-stage founders often adopt the mentality of obtaining funding at all costs. The rationale is understandable and tempting – once the company is up and running and hits its operational stride, the company will have new leverage over its existing and prospective investors and can scale back some of the previous points they conceded in order to secure early stage funding.  Although this is true to some extent, founders often don’t realize how much of an uphill battle those negotiations can be.

In both Southeast Asia and India, a company’s existing investors are often reluctant to cede any existing rights and prefer to anchor heavily to the prior round (particularly if the investors are institutional funds).  A common phrase we hear is that, if the company would like to close the round quickly, it must adhere closely to the existing terms in the documents from the prior round.  In a worst case scenario, founders may even find themselves with increasingly onerous obligations as they face both new asks from incoming investors and resistance from shareholders to amend existing investor-favorable terms.  Of course, with appropriate leverage and the right advisors, founders may be able to move the governance and other rights in a more founder-favorable direction.  The important point to note is that this can be difficult and is never guaranteed. 

Therefore, founders are strongly encouraged to take a holistic long-term view of the underlying governance of the company, with the expectation that what is negotiated today will may well serve as the baseline for tomorrow.   

Founder Control

For founders, maintaining control of the board is important, as it gives them the freedom to operate the company in the manner they think best aligns with their vision (subject to the investors’ negative control or “blocking” rights, see “Reserved Matters” below).  However, in many cases companies cede control of their boards far too early in their life cycle. Although this may sometimes be necessary to get a funding round over the line, it should not be done lightly, as once control is lost it is very difficult for the founders to regain control. This is particularly true in both Southeast Asia and India, where the negotiation dynamic is generally more investor-favourable than in the US.

This problem often arises when there are multiple investors in a funding round and who each demand a board seat (and who are holding stakes significant enough to legitimately argue for one), such that there are not sufficient founders to counter-balance the number of agreed board seats allocated to investors.  There are multiple ways to solve for this problem without the founders ceding control.  Most simply, the founders could convince one or more investors to accept a non-voting board observer role, in lieu of a director seat, such that the founder directors still outnumber the investor directors.  Investors may be more likely to accept this proposal if they are already receiving blocking rights (discussed below) that sufficiently protect them from a majority-founder board taking certain significant actions without their consent.

It’s also common, as is the case in markets like the US, for early-round investor directors to yield their seats, as the company matures and additional funding rounds occur. Alternatively, the founders could increase the number of board seats beyond the number of founders themselves (e.g. they could appoint a professional CFO, if they have hired one, to fill that seat).  For Singapore companies, it is also possible to give the founder director(s) extra votes (e.g. 2 votes per founder director) in order to give them control despite being outnumbered on the board; this option is particularly attractive where there is only a single founder and he or she does not have any other suitable candidates to fill other founder director seats.

Suffice to say that there are multiple ways to address investor concerns while still retaining founder control of the board.  And the overarching point is to think carefully about this very important topic in the course of your financing.  Because once lost, given the anchoring effect mentioned above, it is very difficult for a founder to regain control. 

Reserved Matters

Reserved matters (also known as protective provisions or blocking rights) are a list of actions that cannot be taken by the company without first obtaining the required approval from its shareholders or board of directors. Reserved matters can include matters such as incorporating new subsidiaries, changing the direction of the business, filing for an IPO and incurring certain levels of indebtedness.

Founders are encouraged to carefully review the required threshold and list of reserved matters, and discuss with their legal counsel the practical implications of each. Founders and management teams also must re-check reserved matters, in a subsequent funding round; the key is to identify reserved matters which are “too tight,” such that shareholder approvals are required for what may have become routine actions. To be clear, this also is in investors’ interests: recurring shareholder consents may mean that necessary business decisions are delayed by weeks (or months) while seeking approvals, which is not optimal for high-growth companies.

We have come across many Southeast Asian and Indian startups with high approval thresholds and extensive lists of reserved matters with specific investor veto rights. While some shareholders are responsive and generally defer operational decisions to the founders, some shareholders can also be unresponsive or challenge management’s business rationale for proposing actions. In some extreme cases, soliciting shareholder approval can take a few months’ time. Giving in to an extensive list of reserved matters can unnecessarily fetter decision making, causing the company to lose out on important operational flexibility to adapt quickly to changing business environments, which, again, may ultimately harm both the company’s and ts investors’ interests.

Conclusion

In today’s highly competitive market, the familiar proverb of “move fast and break things” still rings true. However, founders are well-advised to invest time by paying careful attention to the long-term implications of the company’s corporate governance framework. A careful and well thought out framework will serve as a convenient blueprint in the future and help facilitate subsequent fundraisings, whereas a hastily agreed framework may prove to be a stumbling block and operational hindrance.