By Fernanda Arreola
While startups and SMEs are often lauded for their agility and innovation, one critical dimension is frequently overlooked: governance. This article explores the risks associated with neglecting governance innovation, emphasizing that effective governance is not merely a compliance function but a strategic enabler of growth, resilience, and ethical integrity. Drawing on recent research and global case studies, the article demonstrates how informal and stagnant governance structures expose young firms to fraud, scaling failures, and reputational risks. It argues for a proactive, dynamic approach to governance that evolves with the firm’s lifecycle, supports sound decision-making, and aligns with organizational values.
Last year, a scandal erupted in France when news broke that a large clothing retailer had lost more than 100 million euros. A 39-year-old employee had orchestrated a fraud while being a manager in the accounting department. Unfortunately, this fraud is not an exception to the rule. In Canada, frauds against Small and Medium Enterprises (SME) touch 36% of companies. In France, it is estimated that SMEs have 67% more incidence of fraud than larger firms.
The reasons for explaining this phenomenon vary, but one of the main conditions that can explain such statistics is that one crucial area is frequently overlooked, especially by startups and small to medium-sized enterprises (SMEs): governance. As Huse points out, governance in SMEs must evolve from being a tool of control to a source of strategic value creation.
Research has demonstrated that effective governance mechanisms in small and medium-sized enterprises (SMEs) positively correlate with firm performance, particularly during critical growth phases. For instance, a systematic literature review by Teixeira and Carvalho analyzed 19 studies and found a direct relationship between corporate governance mechanisms—such as board composition, ownership structure, and CEO characteristics—and various aspects of SME performance, including innovation and risk of failure.
However, for varying reasons, many founders do not consider governance while founding or managing SMEs. The fear of losing control, the budgetary limitations to hire a dedicated employee (s), and the belief that governance will develop excess bureaucracy make it difficult for leaders to engage in a rigorous and ongoing governance exercise.
What Do We Mean by Governance?
Governance is more than compliance or board meetings—it’s the system that defines how decisions are made, who holds power, how accountability is ensured, and how a firm adapts to uncertainty. In early-stage ventures, governance often emerges organically based on trust, shared vision, and founder charisma. But this informal structure rarely scales.
A study in Nigeria suggests that small and medium-sized enterprises (SMEs) that establish early governance structures are less susceptible to issues such as embezzlement. This research emphasizes the importance of proactively implementing internal control systems at the onset of business operations to mitigate employee fraud. The study suggests that a proactive approach in setting up internal controls can significantly reduce the occurrence of fraudulent activities within SMEs.
As an article published in Harvard Business Review notes, many young firms fail not because of poor products but because of poor execution and decision-making, much of which can be traced back to governance gaps. Governance should evolve alongside the startup. Unfortunately, many entrepreneurs continue to treat it as a legal formality rather than a strategic enabler.
The Innovation Imperative in Governance
As McKinsey & Company points out, governance is becoming increasingly strategic, especially in environments defined by rapid growth and uncertainty. For startups and SMEs, governance should be a dynamic framework that supports agility, scalability, and resilience.
In the early stages of a startup, governance tends to be informal and founder-driven. This can work temporarily, but as the firm grows, such informality can morph into opacity, unclear responsibilities, or even conflicts of interest. As Huse indicates, strong governance in SMEs correlates with better decision-making and improved performance, especially during periods of growth or crisis.
Innovating governance doesn’t mean replicating corporate board structures. It means designing governance mechanisms that align with the company’s vision, culture, and stage of development. Startups and SMEs that invest early in governance systems benefit from greater clarity and alignment. As Huse shows, boards and governance mechanisms can play a crucial role in value creation, especially when firms are dealing with uncertainty, complexity, and limited resources.
The Risks of Stagnant Governance
Ignoring governance innovation comes with serious risks:
- Losing Investor Confidence: Venture capitalists are no longer just looking at product-market fit; they increasingly assess how governance frameworks will support sustainable scaling. As noted by Noam Wasserman, many founders face the “control vs. growth” dilemma—and poor governance structures often make it harder to let go of control when it’s strategically necessary.
- Ethical and Legal Vulnerabilities: Without formal governance mechanisms, SMEs are more exposed to reputational and regulatory risks. For example, Elizabeth Holmes’s Theranos debacle is a stark reminder of what happens when governance is weak, boards are passive, and transparency is sacrificed.
- Scaling Failures: As Thomas Eisenmann notes in his article Why Startups Fail, many businesses’ growth stumbles not because of bad ideas but because of execution problems—including unstructured governance, chaotic decision-making, and unclear leadership transitions
- Organizational Fragility: Poor governance limits a company’s ability to adapt. Startups and SMEs without formal decision-making processes and dedicated teams are more prone to misalignment, mission drift, or ethical lapses—especially in fast-scaling environments.
- Inability to Adapt Governance also shapes how a company learns, pivots, and adapts. Dynamic governance systems as a core attribute of organizational resilience. As Ma, Xiao, and Yin, suggest an integrated concept of organizational resilience that consists of three dimensions including cognitive, behavioral and contextual resilience, and this dynamic capability should be examined from three different levels, including individual, group and organizational? to better conceptualize organizational resilience and for better applicability in management practice. Firms that rely solely on intuition and informal rules often struggle to survive crises.
Innovating Governance: Concrete Strategies
So, what does it mean to innovate governance? Some practical approaches include:
- Establishing diverse advisory boards with external experts, investors, and mission-driven leaders.
- Using agile governance frameworks with flexible decision rights and clear escalation paths.
- Implementing governance charters that reflect company purpose and stakeholder values—not just shareholder primacy.
- Developing transparent communication protocols, performance evaluation tools, and succession planning, even in early stages.
Conclusion: Don’t Wait to Innovate
As founders and business leaders, the instinct is to focus on what’s urgent—customer acquisition, product development, fundraising. However, governance is what holds these pieces together. It doesn’t have to be rigid or bureaucratic. The most innovative firms are those that treat governance as a living system—one that can grow and adapt with the organization.
In a world marked by complexity, uncertainty, and ethical challenges, innovating your governance may be the most innovative move you can make.
