Corporate Governance in Startups – Loopholes in the Law?

While listed companies are bound by stringent regulatory norms, startups and unlisted entities operate in a comparatively relaxed regime, opening doors to loopholes, founder overreach, and even financial mismanagement. From Zilingo to BharatPe and Byju’s, recent governance failures raise a critical question—Is India's startup ecosystem thriving at the cost of accountability?

This blog explores how regulatory gaps, excessive founder control, and misuse of legal grey zones threaten the long-term health of India's startup economy.

Legal Framework: What Does the Law Say?

Unlike listed companies, Indian startups—often structured as private limited companies or unlisted public companies—are exempt from many compliance norms under the Companies Act, 2013. Here are some key distinctions:

Fewer Independent Directors required

No obligation to form key board committees like Audit or Nomination &

Remuneration Committees

Exempt from SEBI's LODR (Listing Obligations and Disclosure Requirements) Minimal disclosures and reporting requirements

This gives founders immense flexibility, but also creates a vacuum of accountability when millions of dollars of public and private funds are involved.

The Core Issue: Loopholes and Lapses

In the absence of robust regulatory scrutiny, startups are often governed more by internal agreements than legal norms. This flexibility becomes risky when:

• Founders misuse power due to unbalanced shareholding or board composition

• Investors are side-lined, especially early-stage ones

• Key decisions are taken without proper disclosures or fiduciary care

The absence of mandatory governance mechanisms, like whistle-blower policies, risk committees, or even conflict-of-interest disclosures, has led to high-profile crises in several prominent start-ups.

Case Studies: Governance Gone Wrong

Zilingo – Valuation vs. Verification

A once-celebrated Singapore-based fashion-tech unicorn, Zilingo collapsed after its CEO Ankiti Bose was suspended for financial irregularities. Despite significant VC interest and funding, Zilingo had no CFO for months, and basic financial audits were reportedly missing. The incident exposed how weak governance at the board level led to unchecked spending and opaque financial management.

BharatPe – The Founder's Fiasco

In 2022, co-founder Ashneer Grover was forced to resign after a string of controversies, including abusive behavior, conflict of interest, and alleged financial misconduct. An internal audit revealed irregularities like fake vendors and inflated bills. The root cause? No real checks and balances on founder conduct, no independent oversight, and too much power concentrated in one individual.

Byju’s – EdTech Giant with Growing Pains

Once a poster child of India's startup success, Byju’s has drawn flak for:

• Delayed financial disclosures

• Alleged revenue recognition irregularities

• Board resignations from key investors like Prosus

Despite being a unicorn, its board lacked transparency and independence. Its external auditor (Deloitte) resigned, citing governance concerns, exposing the regulatory blind spot for even the biggest unlisted firms.

Governance Mechanisms Missing in Action

A well-governed company typically has:

• A diversified, independent board

• Internal audit and risk oversight

• Ethical codes, conflict of interest disclosures

• Transparent financial reporting

Startups often skip these safeguards, claiming they are in “growth mode.” But when millions of dollars from public markets or pension funds are involved, this defence no longer holds.

Why the Loopholes Exist

• Relaxed compliance norms under Indian company law for private and unlisted entities

• Venture capital prioritizing growth over governance

• Use of Differential Voting Rights (DVRs), which allow founders to retain decisionmaking control despite diluted equity

• Founders sitting on multiple roles (CEO, CFO, Director), leading to concentration of power

• Lack of whistle-blower protection and internal grievance mechanisms

These loopholes are not always illegal—but they are often unethical or risky.

Global Comparison: How Start-ups Are Governed Elsewhere

Country Governance in Startups Oversight

USA Startups must comply with Sarbanes-Oxley post-IPO Strong SEC oversight post-listing

UK "Comply or Explain" under UK Corporate

Governance Code Mandatory governance disclosures

Singapore Mandatory audit committees for larger unlisted

companies Government-backed ethical boards

India Fewer checks for unlisted companies/startups MCA/ROC audits often reactive, not preventive

Globally, governance is increasingly seen as value-enhancing, not just compliance. India, however, still sees it as a hurdle in the startup world.

Calls for Reform and Recent Developments

After multiple debacles, industry experts and regulators have called for:

• Voluntary adoption of governance codes for large startups

• Mandatory internal audits for unicorns and funded startups

• SEBI-like frameworks for late-stage startups raising funds from the public or institutional investors

• ESG and ethics training for startup boards

NASSCOM and Indian Venture Capital Association (IVCA) have also released best practices guides, but adoption remains voluntary.

Expert Opinions / Commentary

“Governance lapses don’t happen overnight. They begin with ignorance, thrive on opacity, and collapse under scrutiny.”

— Shailendra Singh, VC Partner, Sequoia Capital

“Startups are not too young to govern. They are too young to fail due to bad governance.”

— Prof. Ritu Sinha, Corporate Law Expert, NLUD

Conclusion: Time to Rethink Start-up Governance

The current startup governance model in India is a double-edged sword. Flexibility and innovation are essential, but not at the cost of ethical blindness and unchecked founder power.

As startups mature and handle public money, user data, and large teams, their governance structures must also grow up.

The future lies in proactive, principle-based governance—not reactive, rule-based punishment. Startups need to internalize that good governance is not a barrier to growth; it is the foundation of sustainable success.

References

1. Companies Act, 2013 – Provisions for Private Companies

2. Zilingo Suspension Case – Bloomberg, 2022

3. BharatPe Internal Audit Report – Alvarez & Marsal, 2022

4. Byju’s Auditor Resignation – Economic Times, 2023

5. SEBI and MCA Guidelines

6. NASSCOM’s Corporate Governance Best Practices for Startups (2023)