Adapting Corporate Governance for UK Startup Success
Introduction
In a time of rapid technological advancement and burgeoning entrepreneurial spirit, startups, which are newly founded companies and predominantly small ones, have emerged as significant players in the UK’s economic landscape.
The role of corporate governance in aiding startups to achieve success and longevity often remains underexplored in the complex business world. Unlike publicly traded or larger corporations, the principles and practices of corporate governance are crucial yet not mandatory for startups.
This article aims to analyse the role and impact of corporate governance principles on the growth and sustainability of startups in the UK and provide some recommendations for those companies.
UK Startup Dynamics and Challenges
First, it is important to understand that startups typically transition through identifiable stages, each characterised by specific operational and governance challenges. There are three main stages of startup:
- Seed Stage: Startups in their formative years, typically 0-3 years old, with a team that may range from just the founder to a few employees.
- Early Stage: In the developmental phase, startups typically have a moderate number of employees and have been established for 3 to 8 years.
- Growth Stage: As startups grow beyond eight years, they often experience significant expansion in their workforce. This calls for enhanced expertise and systematic governance to adeptly handle the complexities of scaling up.
Determining the various stages of a startup’s growth is essential as each phase of its evolution demands distinct strategies, resources, and governance structures.
The number of new startup companies in the UK is growing. There were over 800,000 company incorporations in the financial year ending 2023, an increase of 6.4% compared with the previous financial year. While this growth is a positive indicator of entrepreneurial activity, survival rates are crucial for understanding the broader economic impact. This five-year survival rate suggests that while many startups begin with promise, only a fraction sustain and grow over the medium term. For example, startups born in the UK in 2016 and 2017 have an estimated five-year survival rate of only around 38%.
The high attrition rate underscores the challenges of scaling and maintaining a business. These include certain difficulties that might be minimised or avoided by implementing robust corporate governance principles. Therefore, the question arises: Could implementing robust corporate governance principles reduce the number of failures among startups and improve their growth prospects?
Corporate Governance
Corporate governance is a system that promotes long-term corporate success and economic growth. It encompasses processes and principles that guide a company to operate in the best interests of all its stakeholders, including management, the board, shareholders, and other related parties. Moreover, effective corporate governance identifies a company’s strengths and weaknesses and also aids in mitigating those shortcomings.
UK Corporate Governance Code 2018 (Code) is the most important regulatory instrument in corporate governance within the UK company ecosystem. It sets standards for good governance practices, enhances board performance, ensures accountability, and fosters healthy relationships with shareholders. The Code is soft law, which means that it outlines recommended but non-legally binding norms of behaviour. The new revised Code will apply to financial years beginning on or after 1 January 2025.
The Code applies to all companies with a premium listing and comprises five sections: (i) board leadership and company purpose; (ii)division of responsibilities; (iii)composition, succession and evaluation; (iv)audit, risk and internal controls; and (v)remuneration.
Premium-listed companies must declare how they have applied those principles in their annual financial reports or, if not, provide an explanation.
Let’s look at the principles of the Code in more detail and examine whether implementing robust governance frameworks can significantly enhance a startup’s ability to successfully scale and maintain longevity in a challenging and dynamic business environment.
Board Leadership and Company Purpose
Board leadership is the process of guiding the board of directors to effectively and efficiently achieve organisational goals. An effective board embodies and upholds the organisation’s core values, purpose, and strategic vision. Board members must demonstrate these values and purpose in their actions, setting a precedent for the company’s culture. This alignment of culture, strategy, and leadership is fundamental in guiding the company’s direction and ensuring its integrity.
Furthermore, the Code emphasises that the board should establish the company’s purpose helping companies stay focused on their core mission, ensuring their growth and expansion align with their foundational objectives.
Recommendations for startups:
- Definition of a clear purpose: A startup should clearly articulate its purpose, mission, and values early on. This foundational clarity not only steers strategic decision-making and operational approaches but also cultivates a strong, resonant company culture.
- Formation of a board of directors: A board plays a pivotal role in guiding the strategic direction, ensuring accountability, and enhancing the credibility of the startup. As a startup moves beyond the initial seed stage, the formation of a formal board of directors should be considered. Initially, if it comes to a certain size, this board may consist of the Chairperson, the CEO, and at least one executive director. In the growth stage, as the startup expands, it is often beneficial to broaden the board to include additional independent directors. These individuals can provide impartial insights and help balance the interests of founders, investors, and other stakeholders.
Division of Responsibilities
This principle focuses on effectively distributing duties among board members to enhance corporate governance. The Code emphasises the importance of separating the roles of the Chairperson and the CEO. It advises against the CEO becoming the Chairperson to maintain impartiality and effectiveness in governance. The Code also highlights the significance of executive and non-executive directors and their crucial role in preventing individuals or groups from exerting undue influence.
Recommendations for startups:
- Clear separation of roles: If a startup comes to a certain size, it is advisable to clearly define and separate the roles of the Chairperson and the CEO. The Chairperson should focus on guiding the board and maintaining its independence, while the CEO should manage daily operations and strategic implementation. Furthermore, it will help avoid one person’s concentration of power.
- Incorporation of executive and non-executive directors: As a startup evolves, including both executive and non-executive directors on the board can provide independent oversight and strategic guidance. They bring different perspectives and experiences, which are crucial for balanced decision-making.
Composition, succession and evaluation
This principle is a critical framework for ensuring diversity, structured leadership progression, and board effectiveness.
Under this principle, a board is responsible for establishing a nomination committee primarily comprised of independent directors. The committee’s duty is to manage the director appointment process with diligence and transparency, to oversee the board’s balance in skills, knowledge, experience, independence, and diversity, including gender, and to ensure there are structured succession plans for both the board and senior management. There is a compelling argument that the nomination committee is the most important committee of the board. It ensures that the top team is the best the organisation deserves.
Recommendations for startups:
- Board composition and diversity: As a startup gains resources and reaches a certain size, it should focus on forming a diverse board with balanced skills, knowledge, and experiences. As the company grows, it is advisable to establish a formal nomination committee to manage board appointments and succession planning, ensuring continued diversity and strategic alignment with the company’s evolving objectives.
Audit, risk and internal control
Fourth principle emphasises the board’s crucial role in ensuring the integrity and effectiveness of internal and external audit functions.
Central to this principle is the formation of an audit committee, primarily composed of independent non-executive directors. Their critical responsibilities include overseeing financial reporting, evaluating internal financial controls and risk management systems, managing external auditors, and developing policies to preserve auditor independence.
Recommendations for startups:
- Formation of an audit committee: As a startup reaches a certain size, it should form an audit committee, ideally with at least one financial expert, as early as possible. This committee is crucial in overseeing financial reporting and risk management processes.
- Implementation of a risk register: Adopting a risk register at an early stage can be highly beneficial. It serves as a central document for identifying, analysing, and managing potential risks and helps in informed decision-making.
Remuneration
The final principle of the Code focuses on executive remuneration, emphasising that remuneration policies and practices should align with the organisation’s strategy and foster long-term success. Executive compensation should reflect the company’s values and be connected to its long-term objectives.
The board’s duty includes forming a remuneration committee composed of non-executive directors. This committee oversees remuneration processes to ensure they are transparent and accountable. The purpose of this committee is to prevent directors from setting their own salaries and to maintain a straightforward, formal procedure for remuneration.
Recommendations for startups:
- Establishment of transparent and strategic remuneration policies: If there are more than two people in a startup, the company should develop clear remuneration policies that align with its financial capabilities and strategic goals. This includes incorporating both salary and equity-based compensation to align executives’ long-term interests with the company’s growth and success. Transparency in these policies is crucial for building trust with stakeholders.
- Formation of a remuneration committee: As a startup grows and reaches a certain size, it should consider forming a remuneration committee, preferably with independent directors, to oversee executive compensation. This committee should ensure that executive pay is linked to company performance and strategic objectives, balancing the need to attract top talent with financial sustainability and shareholder expectations.
Conclusion
Robust corporate governance is not a mere regulatory obligation but a strategic tool that can significantly enhance a startup’s prospects for success and reduce the number of failures. All the core principles outlined in the Code apply to startups at all stages. However, the degree to which the practices are implemented depends on the business’s size and complexity. Startups should apply each principle to their specific business circumstances, considering their unique organisational structure and stage of development. It is essential to view these principles not as a rigid “checklist” but as a set of flexible guidelines aimed at enhancing professionalism, effectiveness, and long-term viability in building a strong, credible, and sustainable business.
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