The Company Law Committee is considering a comprehensive structure to make larger unlisted firms comprising mature start-ups under a stringent supervisory framework. Among other rules and regulations, the committee is expected to deliberate elevated levels of guidelines on financial reporting. Obligatory submission of quarterly or biannual financial statements is among the directives being discussed for these entities, for which a permitting provision was introduced in the Companies Act in 2021. But a complete reporting frame has yet to be announced.

To ensure better adoption and stronger scrutiny of corporate governance standards, the Ministry of Corporate Affairs (MCA) is considering referring the necessity for stringent rules for larger unlisted companies functioning within business conglomerates to the Company Law Committee (CLC), which recently had its term protracted by a year. Even though publicly listed companies are subject to vigorous disclosure rules and regulations, their unlisted counterparts presently do not abide by analogous standards.

The Securities and Exchange Board of India (SEBI), in its annual report for the financial year 2022-2023, accentuated the significance of efficiently handling and supervising probable perils stemming from unlisted entities within complex conglomerates. The suggested measures intend to nurture clarity and answerability within these diversified entities.

The CLC is considering a comprehensive structure to make larger unlisted firms comprising mature start-ups under a stringent supervisory framework. Among other rules and regulations, the committee is expected to deliberate elevated levels of guidelines on financial reporting. Obligatory submission of quarterly or biannual financial statements is among the directives being discussed for these entities, for which a permitting provision was introduced in the Companies Act in 2021. But a complete reporting frame has yet to be announced.

The debate on the requirement for an advanced height of regulation for bigger unlisted companies has gained propulsion after the latest episode of Byju’s – India’s most valued start-up, bombing to meet certain compliance conditions and its statutory auditor having resigned. In June 2023, Deloitte Haskins and Sells resigned as Byju’s auditor quoting a delay on the part of the entity in presenting financial statements and the audit firm’s helplessness to begin the audit for FY22. Three directors – GV Ravishankar, Russell Dreisenstock and Vivian Wu — had also resigned from Byju’s board. MCA’s recent thinking on this matter is vital as former SEBI Chairman Ajay Tyagi had in June 2023 recommended that the Ministry must step into the panorama to establish an institutionalised appraisal method on corporate governance compliances of specific mature start-ups.

Time to Level the Playing Field

The new government strategy to explore introducing a distinctive governing system for big unlisted entities couldn’t have come a day too soon. Even as corporate governance benchmarks of listed entities have been under the scanner, there have been intensifying instances of financial anomalies in non-listed entities. Frequently regulators are obliged to handle the aftershock of an unlisted firm gone rogue either instantaneously after listing or when its gravy train of funding has suddenly stopped.

For example, in the case of Five Core Electronics whose promoters vanished immediately after its IPO only for investors to uncover that virtually all the claims the entity had made about its business were deceitful. A regulatory regime that stipulates more than once-a-year disclosures, mandated presently for unlisted entities, would be a good start to avoiding such disasters.

For too long, such entities have relished a free pass. To embolden entrepreneurship in India the government has attempted to alleviate the load on unlisted entities. Consequently, two years before it amended the rules whereby unlisted public companies whose debt instruments are listed on exchanges or are listed overseas in specified jurisdictions, are not treated as listed entities. Regrettably, while such measures have led to an upwelling in start-up activity, numerous firms have also taken it as a permit to function without any guidelines.

Several of today’s large start-ups have thrived in this indecisive region where they are compelled to make little disclosures of where their money comes from and where it goes. It is common knowledge that the relentlessly varying valuations of many unlisted entities have little relationship to financial functioning. The implicit argument has been that the funds come from a few tycoons and as such, the entities need to be answerable only to them and not to the markets and their appointed regulators.

The argument is duplicitous. The outcomes of their deeds are for the complete corporate world to tolerate. When such entities ultimately hit the public markets and are obliged to stick to more strict standards, their actual numbers are revealed. Shareholders suffer when the stock prices certainly crash, as has been observed in the case of many new-age company IPOs, as their financials did not impress or influence investors. Such collisions queer the ground for other entities planning to list. The 2021 crash in the share prices of many such start-ups dingy the atmosphere for other entities, dealing a blow to the IPO markets which did not recuperate for the succeeding eighteen months.

As a contribution to policy-making on the subject, the said committee’s purpose should go beyond simply digging out some of the troubles that have tiptoed into the functions of such entities. The aim has to be to assist them in developing their operation by looking at more translucence and readiness to circumvent window dressing and falsify their numbers. Presently, the ownership and control configurations of unlisted entities along with their performance measurement are regularly masked in mystery. It is also an outcome of the absence of professional management in many of them with founders tending to take all verdicts in collusion with their funders. Accordingly, the transparency stages are defined by the very people who need to be accountable. Any supervisory outline must also be thoughtful of the challenges and obligations of unlisted entities in their search for external capital.

It is also significant that the committee tasked with setting up the new standards supervising the disclosure prerequisites and financing of unlisted entities does not confine its scope to start-ups but looks at other large unlisted entities also comprising entities through which promoters control their holdings. After all, firms like Amul, Parle Products and Patanjali Ayurved, also come under the definition of systemically significant entities. With the increasing start-up culture in India, many more unlisted entities will be up for examination, frequently tossing up issues that will test auditors, lawyers and judiciaries in case of disputes and deception. An oversight outline will also aid in defining the role of the internal and external stakeholders of such entities, permitting the regulator to delegate accountability that presently falls between the twin seats of founders and funders.

The step is in the right direction as big unlisted entities and mature start-ups should be made more responsible, especially after the eye-openers connect with irregularities at many bigger start-ups. The change is essential as patrons must take well-timed action in case there are gaps or disputes in the financials or financial reporting of a company, primarily with the start-up ecosystem becoming bigger and many unlisted companies becoming as big as their listed peers. The compliance pressure should remain less for small companies to encourage innovation, but large unlisted companies may have the ability to meet stricter requirements.

On the whole, there can be no discussion over the fact that more disclosures would only benefit bigger unlisted companies that are judging in terms of going public to make an effortless evolution. In any case, they should embrace corporate governance customs stated for listed companies well in advance. Plentiful companies have been seen to be waking up at the last minute, projecting a hastened ticking-the-box approach, which does not stimulate confidence. After all, there is no shortcut to virtuous and transparent procedures.

About the author: Shivanand Pandit
Shivanand Pandit
He is a a tax specialist, financial adviser, guest faculty and public speaker based in Goa.

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