Startups operate differently from established corporations. They move fast, make decisions with limited information, and often develop their governance structures as they grow. The Nevin Shetty case, which involved a Seattle-based startup, illustrates how the gap between startup culture and the standards applied in criminal prosecution can create serious risk. This article examines what the case teaches founders and executives about startup governance and criminal exposure.
The case has been covered by the California Business Journal, and the governance documents at issue are part of the public court record.
How Do Startups Differ from Established Companies?
Startups differ from established companies in fundamental ways. Decision-making is faster and more centralized, with executives often wearing multiple hats. Governance structures, including investment policies, compliance procedures, and board oversight, are frequently still developing as the company scales. Resources are limited, and the focus is on growth and survival rather than on building elaborate governance systems.
This operating reality is not a flaw. It is a feature of how startups function. The speed and flexibility that come from lean governance are part of what allows startups to innovate and grow. But this same flexibility can create risk when the standards applied to evaluate the company's conduct are those of a mature corporation with fully developed governance.
What Governance Issues Arose in the Shetty Case?
In the Shetty case, the prosecution relied partly on Fabric's investment policy, arguing that Shetty's investment violated the policy the board had approved. The Board Resolution Exhibit documenting the policy became a contested piece of evidence.
The defense argued that the policy functioned as a guideline rather than a binding prohibition, reflecting the reality of how investment policies often operate at startups. At many fast-growing companies, such policies are drafted to establish general expectations, updated infrequently, and interpreted with flexibility. The defense's position was that treating a deviation from such a policy as criminal evidence applied a standard that did not fit the startup context.
Why Does the Startup Context Matter?
The startup context matters because it affects how conduct should be evaluated. A deviation from a hastily drafted, rarely updated investment policy at a fast-growing startup is a different thing from a deliberate violation of a carefully maintained compliance system at a mature corporation. When prosecutors apply the standards of a Fortune 500 compliance department to a startup's internal documents, the result can be criminal exposure for conduct that the startup's own culture treated as normal.
This mismatch between startup reality and prosecutorial standards is a source of significant risk. Founders and executives who operate according to the norms of their environment may find those same actions later characterized as criminal when judged by standards that do not reflect how startups actually function.
What Should Founders Do to Protect Themselves?
The Shetty case offers practical guidance for founders concerned about criminal risk. Formalizing governance structures early, even when it feels premature, provides protection. This includes adopting clear investment policies, documenting board approval, and establishing decision-making procedures that match the company's risk profile.
Documenting the reasoning behind significant financial decisions is equally important. A written record showing that a decision was made in good faith, based on the information available, and consistent with the executive's authority, provides a defense against later claims of wrongdoing. Disclosing potential conflicts of interest proactively and in writing protects against accusations of concealment.
How Can Startups Balance Speed and Governance?
The challenge for startups is balancing the speed and flexibility that drive growth against the governance that protects against legal risk. This balance does not require startups to adopt the elaborate compliance systems of mature corporations. It requires them to build governance appropriate to their stage and risk profile, formalizing the most important policies and decisions while preserving the agility that makes them effective.
The key is to recognize that governance is not merely bureaucratic overhead. It is a form of protection, both for the company and for the individuals who run it. The Shetty case demonstrates what can happen when the gap between startup practice and external standards becomes the basis for criminal liability.
How Should Boards Approach Governance at Startups?
Boards of directors at startups face a particular challenge in establishing appropriate governance. They must balance the need for oversight against the reality that excessive bureaucracy can slow a company down and undermine the agility that startups depend on. The right approach involves focusing governance efforts on the areas of greatest risk, including financial decisions, conflicts of interest, and regulatory compliance.
Boards should make sure that important policies, such as investment policies, are clearly drafted and properly approved, with the documentation to demonstrate that approval. They should establish clear lines of authority and decision-making processes appropriate to the company's stage. And they should revisit governance structures as the company grows, updating them to reflect the increasing complexity and risk that come with scale.
What Role Does Documentation Play?
Documentation plays a critical role in protecting both companies and executives. A clear record showing that a decision was made in good faith, based on available information, and consistent with the executive's authority provides powerful evidence against later claims of wrongdoing. Conversely, the absence of documentation can leave executives vulnerable to having their decisions mischaracterized.
In the startup context, where decisions are often made quickly and informally, the discipline of documentation can be easy to neglect. But the Shetty case demonstrates why it matters. When governance documents and decision records become the subject of legal scrutiny, their clarity and completeness can make a significant difference. Building a culture of documentation, even in a fast-moving startup, is a valuable form of protection.
What Is the Lasting Lesson?
The lasting lesson of the Shetty case for founders and executives is that startup governance matters, not just for operational reasons but for legal protection. The flexibility and speed of startup decision-making, while valuable, can create risk when judged by external standards. Building appropriate governance, documenting decisions, and understanding the legal terrain are essential steps for anyone operating in the high-stakes environment of a venture-backed company. More about the issues raised by the case is available at Nevin Shetty.