British technology “unicorn” Ve Interactive’s recent fall from grace and its purchase out of administration for a meagre price of £2 million, after it was once valued at £1.5 billion, has sent shockwaves across the tech community and intensified talks of a tech bubble. For many experts it seems indisputable that we are experiencing such a bubble, and the concern is that VE isn’t the only start-up vulnerable to collapse.
Fuelled by a swathe of investors who appear willing to accept ever greater risks against a backdrop of low interest rates, the reality is that it has never been easier for tech start-ups to raise capital. The downside of this liquid market is that the entrepreneurial founders of such companies often burn through cash quickly, without necessarily spending it effectively. This, in turn, leads to more and more funding rounds and inevitably inflated company valuations. Regardless of the fact that most start-ups don’t generate any profits, tech company valuations continue to skyrocket. For example, only months before its administration, VE was still valued at 22 times its revenue.
The consequence of such high valuations is that investors are often limited to taking only a small shareholding in these start-ups and thus, are less able to exercise any meaningful control over them. As private companies, start-ups are not subject to the same rigorous disclosure requirements as listed companies, and this can lead to inadequate monitoring and mis-management. If the tech bubble were to burst, the real danger is that there could be more significant tech company failures on the horizon. In order to prevent this, and to help them stand out from the crowd, growing tech companies need to consider implementing proper good governance principles to provide the necessary checks and balances from the outset.
In 2010, the Institute of Directors published fourteen principles of good governance for unlisted companies in the UK. However, many private companies still fail to follow those voluntary principles. In fact, many start-ups even lack an appropriate board structure. Ve, for example, stood out for having no well-known directors or executives. Good corporate governance dictates that boards should contain directors with a sufficient mix of competencies and experiences suitable for the business, and who fully understand their responsibility for risk oversight and the maintenance of internal controls sufficient to safeguard shareholders’ investments and company assets.
Directors have important statutory duties and obligations under the Companies Act 2006, such as a duty to promote the success of a company for the benefit of its shareholders. Yet, as has been highlighted recently by ICSA, many directors are not familiar with these duties. Better understanding and oversight of these legal obligations is therefore needed. Notably, the former CEO of Ve, David Brown, is currently being investigated for alleged fraud over allegations that he spent some of Ve’s money on other business ventures linked to him. Strong, pragmatic corporate governance practices can provide the necessary checks and deterrents to help protect against this type of activity.
In November 2016, the Department for Business, Energy & Industrial Strategy published its Green Paper on corporate governance reform. This sets out a number of options for change, including the possibility of extending the UK Corporate Governance Code to large privately-held businesses with limited liability. Such proposals represent a positive shift in approach and highlight the importance of corporate governance for the future of all UK businesses.
Corporate governance is a crucial tool for the long-term success and stability of businesses and should not be overlooked by start-ups.
Frankie Cooke and Jeannette Meyer are Associates in the Corporate Team at Faegre Baker Daniels.