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From Innovation to Scrutiny: The Corporate Governance Pitfalls of Paytm and Byju's Evolution

In the fast-changing startup world, the stories of Paytm and Byju's stand out, not only for their spectacular development but also for the controversies that have surrounded them. These instances serve as compelling narratives that underscore the importance of effective corporate governance in the modern business world. This blog aims to dissect these debates, shed light on the complex dynamics at work, and provide critical lessons for businesses, investors, and regulators.


Understanding Corporate Governance

The framework of systems, principles, and procedures that regulate and oversee organisations is known as corporate governance. It comprises the mechanisms employed by organisations and their stakeholders to ensure transparency, impartiality, and accountability in the firm's interactions with its diverse stakeholders.  Corporate governance is essential because it protects the interests of stakeholders and enhances the integrity of the financial markets while establishing a structure that guarantees the company's long-term success.


From Innovation to Scrutiny: The Corporate Governance Pitfalls of Paytm and Byju's Evolution

Paytm’s Corporate Governance Failure

As an innovator in digital payment and financial services, Paytm has been at the forefront of the fintech revolution in India. Nevertheless, its trajectory has not been devoid of examination and contention.  Paytm's trajectory exemplifies the intricacies associated with swift expansion within a heavily regulated industry, encompassing uncertainties regarding the business model's sustainability, regulatory hurdles, and corporate governance protocols.


On January 31, the Reserve Bank of India delivered a significant shock to the fintech behemoth Paytm. The banking regulator prohibited Paytm Payments Bank from accepting deposits, credit transactions, or top-ups from consumers after February 29, 2022, in response to a rap that occurred on March 11, 2022. A "sufficient time" had been allotted for the fintech to make course corrections, according to the central bank. The company might have been able to prevent this crisis had its board of directors acted expeditiously. 


The initial public offering (IPO) and subsequent stock market performance of Paytm have been subjects of extensive discourse within the company's narrative. The largely anticipated initial public offering, which was also among the most substantial in India, was subsequently met with investor scepticism regarding the firm's path to profitability. This circumstance underscores the importance of maintaining transparent lines of communication with shareholders and implementing sustainable business strategies that instill confidence in investors. 


CNBC TV18 questioned Vijay Shekhar Sharma, the founder and CEO of Paytm, regarding the opinions of the "new-economy contingent" that he would be representing at the 2023 Davos World Economic Forum. VSS, as he is commonly known, was asked about their frequent "accounting issues" and what advice he, as a start-up icon, would offer. “You make choices,” said Sharma. “If you want to build long, you build an institution that sits on a strong foundation; if you want to build an institution that can be executed and flipped, you do it like that.”


It has been a story full of twists and turns. On November 8, 2016, Prime Minister Narendra Modi announced a demonetization drive that would send India's cash-based economy into a tailspin. However, there was only one clear winner. Paytm, which has been working on payment solutions for offline merchants since 2015, jumped right in. Paytm's mobile wallet platform was the solution if a cash-strapped economy was the issue. Sharma commissioned Paytm to run front-page advertisements in major newspapers, with the Prime Minister's photograph and the company hailing demonetisation as the "boldest decision in the financial history of independent India."


By the end of that month, One97 Communications Ltd.'s Paytm network of businesses accepting digital wallet payments had grown to 1.5 lakh. Paytm claimed that this network had expanded to 10 lakh merchants across India. It has signed up more than five million new users and served more than 45 million users, according to the company. "Ab ATM nahin, Paytm karo" (Do not use the ATM, use Paytm) was the platform's renowned slogan.


Clashes with the RBI

A timeline on the Paytm website provides comprehensive information about the company's various services and products. These include a payment gateway, mobile wallet, Paytm Gold, equity trading, movie and flight ticket payments, and, notably, Paytm Payments Bank Ltd.-powered transactions.


"Licencing of Payments Banks" and "Licencing of Small Banks" were provisional guidelines that the RBI issued in 2014. The common objective of the central bank, which is to expand financial inclusion, would be positively impacted by these institutions. With the exception of remote regions, payments institutions would primarily operate through their branch networks, business correspondents, or external networks to maintain an extensive network of access points despite offering a limited selection of products. 


It was assumed that value would be added as a consequence of cost reductions achieved through technological adaptation. Not-for-profit financial institutions, mobile phone companies, supermarket chains, real-sector cooperatives, and public entities were all eligible to obtain a payments bank licence. Payment banks primarily cater to low-income households and individuals, as they are prohibited from lending money and exclusively enable deposits of up to Rs. 2 lakh.


After being widely recognised as the leader in fintech in India, Paytm has experienced a decline in its standing, which has brought attention to the regulatory obstacles and difficulties that plague the fintech sector.


In May of 2017, Paytm Payments Bank commenced its operations subsequent to the issuance of a licence. In addition to savings accounts, current accounts, digital banking, fixed deposits with associate banks, Paytm wallet, UPI, and FASTag, the financial institution provided an extensive array of products and services. It was an organic progression of Paytm's objective to penetrate the banking sector, a recurring motif throughout the company's and its founder's trajectory.


Nonetheless, everyone ought to have been concerned about the frequency of interactions with the central bank. In June 2018, the Reserve Bank of India prohibited Paytm Payments Bank from establishing new accounts or wallets on account of regulatory concerns. December 2018 marked the removal of the restrictions. The following year, the Office of Banking Ombudsman issued a show-cause notice to Paytm Payments Bank for its management of a particular account that had experienced a significant increase in daily transactions, including immediate transfers to other financial institutions.


As per the RBI's KYC (know your customer) regulations, these actions were considered unlawful. For providing inaccurate information regarding the transfer of an operating entity from One97 Communications to PPBL, the central bank issued a show-cause notice to PPBL in July 2021. As a consequence of its infringement of the Payment and Settlement Systems Act, 2007, PPBL was fined Rs. 1 crore in October of the same year.


A succession of warning signs were becoming apparent to the RBI: PPBL failed to undertake risk profiles of firms utilising its services and failed to monitor payout transactions. The regulatory threshold for client advance account end-of-day balances was exceeded on multiple occasions. Additionally, the banking regulator revealed that Paytm Payments Bank neglected to implement device-binding control mechanisms for the "SMS delivery receipt check" and was late in disclosing a cybersecurity issue. Furthermore, connections from IP addresses outside India were not hindered by the bank's video-based consumer identification system.


Following the identification of numerous instances of noncompliance by the RBI, which highlighted the bank's deficiencies in account owner identification, an additional penalty of Rs 5.93 crore was levied against the payments bank in October 2023. Paytm and its management have unequivocally disputed any breach of this nature, despite the fact that allegations have sparked concerns regarding money laundering.


Byju's Corporate Governance Case 

Byju's, a global leader in educational technology, has grown rapidly, becoming one of the world's most valuable businesses. However, concerns over financial transparency, debt levels, and governance practices have accompanied its rise. These challenges have spurred debate about the necessity for openness, particularly in privately held businesses with significant effect and reach.


The controversy surrounding Byju's has also highlighted the difficulties of managing stakeholder expectations in a fast-growing industry. As firms grow, the need to maintain high valuations can often lead to decisions that are inconsistent with best practices in corporate governance. This scenario serves as a reminder of the importance of striking a balance between aggressive growth strategies and solid governance standards.


Fractures to Chasms

Initial market success for the organisation may have been a result of its engaging teaching methods and adaptive learning technology, which appealed to an expanding demographic of technologically proficient pupils. Byju's successfully obtained substantial financial backing from notable investors, including Sequoia Capital and the Chan Zuckerberg Initiative, which facilitated the company's growth and implementation of assertive advertising initiatives. 


As a result, the company swiftly became a household name in India's education industry, with millions of customers and a billion-dollar valuation. Several corporate governance errors, compounded by a lack of accountability and transparency in financial reporting, have marred Byju's path despite its meteoric rise. Multiple reports and investigations revealed that Byju's engaged in unethical accounting techniques, such as misrepresenting its operational revenue to attract new investments. Such fraudulent operations destroyed investor trust and generated major worries about the company's credibility. 


Byju's faced claims of mishandling sensitive user information, violating privacy laws, and engaging in aggressive data mining activities. These disclosures not only harmed the company's brand but also resulted in legal action and regulatory investigations. The lack of data protection and transparency highlighted the organisation's inadequate corporate governance framework. Deloitte, Byju's auditor, left because the startup had not submitted financials for over a year. 


Additionally, three independent directors who were acting on behalf of investors and lenders voluntarily terminated their positions. Investors have initiated legal proceedings against the firm. Surprisingly, Byju's initiated counter-litigations against the creditors and lenders for breach of the financial covenants. The corporate governance mechanism has experienced a significant number of terminations and widespread disorder, both of which have shaken the business community.


Corporate Governance Issues in Start-ups 

At this point, it is critical to understand the governance issues that plague start-ups in India. Since these difficulties, if not solved, may result in the downfall of other start-ups too, such as BYJU's- 

  • Flaws in Founders and Promoters Approach: India's start-up ecosystem has become exceedingly competitive due to substantial capital inflows and the exponential growth of entrepreneurs spanning various industries. As a result, certain promoters or proprietors may be inclined to disregard governance regulations. Furthermore, novice founders lack the necessary knowledge and proficiency in the field of corporate governance. Furthermore, certain promoters downplay the significance of governance, potentially believing that it leads to an increase in operational expenses. Due to an absence of ethical principles or a general disregard for the law, founders and promoters may occasionally partake in dubious activities.

  • Exaggerated valuations: Venture capitalists' encouragement of start-ups to develop at any cost has led to an increase in company valuations beyond their fundamental values. There has been a growing tendency for individuals to prioritise company valuation over business processes. 

  • Growth at all costs: Venture capital-driven pursuit of rapid expansion is a significant factor contributing to the increase in instances of corporate misgovernance within the startup ecosystem. Start-up organisations are compelled to forsake any governance systems and procedures they may have established due to the pressure to expand at any expense. 

  • Fear of missing out: The start-up sector in India received over $131 billion in funding from 2014 to 2022. A 'fear of missing out' gripped the investors as international venture capital (VC) firms raced to invest in promising Indian companies. This diminished the value of due diligence, elevating the significance of engaging in a transaction. 

  • Overestimation of the size of the Indian market: Founders and venture capitalists have overestimated the scale of the total addressable market in India and have misrepresented the opportunity in India to their investors. India, as an emerging economy, undoubtedly has a flourishing market; however, it has not yet attained the level of development necessary to attract mergers and acquisitions of start-up companies.

Lessons in Corporate Governance

Although distinct, Paytm and Byju's narratives provide a number of teachings applicable to corporate governance as a whole: 

  • Accountability and transparency are both highly valued by stakeholders, including investors. Regarding their financials, operations, and strategic trajectory, businesses must make every effort to furnish transparent and timely data.

  • Sustainable Business Models: Rather than focusing solely on short-term gains or valuation increases, companies aiming for growth should not lose sight of developing sustainable business models that generate long-term value.

  • Adherence to regulatory compliance requirements is of the utmost importance. In order to preserve stakeholder confidence, businesses must ensure adherence to both domestic and international legal frameworks.

  • Board Oversight: Assuring that the company adheres to high governance standards, managing conflicts of interest, and making decisions in the best interest of all stakeholders are all responsibilities that a strong, independent board can fulfil in terms of providing the necessary guidance and oversight.

  • Engaging with stakeholders is critical to comprehending their concerns and proactively responding to them. This collaboration facilitates the development of a robust and reliable corporate image.

Conclusion

The accounts of Paytm and Byju serve as illustrations of the difficulties and intricacies that accompany the management of rapidly expanding enterprises in the era of digitalization. Although these individuals' narratives continue to evolve, they effectively underscore the paramount significance of corporate governance in protecting the reputation of an organisation, guaranteeing its sustainability, and augmenting the worth of its shareholders. These instances underscore the necessity for both emerging enterprises and well-established corporations to adopt a balanced strategy that harmonises aspirations for expansion with the tenets of sound governance. Given the ongoing evolution of the corporate environment, these teachings continue to hold significance, guiding organisations in their pursuit of sustainable success.


Our Directors’ Institute- World Council of Directors can help you accelerate your board journey by training you on your roles and responsibilities to be carried out in an efficient manner helping you to make a significant contribution to the board and raise corporate governance standards within the organization.


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