Due Diligence - Essential for Start up Funding

Due diligence is now-a-days becoming a synonym to funding. Due diligence is a process by which an investor obtains information about the business in which they are seeking to invest, both from a business and legal perspective.

Due Diligence is nothing but an investigation to assess risk. So, once you have decided to raise money from outside investors, take the time to prepare due diligence. For this, first we need to know about the different stages of funding:

·         Term Sheet Negotiation

·         Business Valuation & Business Plan

·         Due Diligence

·         Agreement Signing

·         Issuance of funding instrument- Share Based and Debt Based Funding

·         Corporate Law and RBI Compliances

So, we can see that before signing of final agreement for funding, we need to clear the due diligence process. When we talk about due diligence, questions like why Due Diligence? Its process.. few tips to clear the process… are generally asked by startups. In this article, we try to clear all the queries related to due diligence for funding:

Why Due Diligence?

·         Check the Internal Control Systems are in place or not

·         To calculate the financial risk involved

·         Judge the awareness of the business owners

·         Assess the team structuring and Operational Processes in place

·         Verify the claims of the pitchers

·         Excavate undisclosed risks

Process of Due Diligence:

·         Investor appoints a team

·         Definite Mandate is set for the team

·         Confidentiality Agreements are formulated between parties

·         Due Diligence Questionnaire and checklist is prepared and circulated

·         Investigation takes place

·         Due Diligence Report is formulated and circulated

Tips to hack the due diligence investigation:

·         Ownership of Intellectual Property should reside with the Company and not the Director(s)/Shareholder (s)

·         Internal Differences of Founders should be thrashed out before pitching for investment

·         Secretarial practices should be in place

·         State Specific licenses and permits have been obtained or not

·         Proper record of all the filings with the Government department till date should be in records of the Company

·         Internal Agreements and contracts between shareholders or directors should be reduced to writing

·         Check the formulation, maintenance and renewal of contracts with service providers and vendors

·         All structural changes in company should be duly recorded with the RoC and should take place as per standard guidelines of the Companies Act, 2013

·         All the compliance related filings should be up to date.

·         State Specific licenses and permits have been obtained or not

·         Litigation issues, if any should be properly recorded and if possible sorted as early as possible.

·         Best to appoint an inspector internally to set everything in place before the due diligence check from the investor is due

Here are a few points for startups to focus on when setting their house in order:

·         Incorporation– Failure to corporatize or legalise your entity, you lose the advantage of ring-fencing yourself with an artificial-legal entity. A legal entity not only adds professionalism to the startup, but also provides a sense of confidence to the other transacting party.

·         Registrations– Failure to register under PF, ESI, VAT, Service Tax might pull you down on the edge of due diligence. So, all the registrations and filings must be in place.

·         Legal issues– Any legal issue outstanding at your door step must be tackled and if you are not capable enough then hire some lawyers and set them off.

·         Accounting– Maintain Income and Expenditure statement, P&L Accounts, other financial statements. If it is eating too much of your time, and weaning you away from core business-building activities, outsource it to someone who does it professionally.

·         Intellectual property–Ownership of Intellectual Property, including non-exclusive licenses, infringement, inappropriate use and potential action, has to be dealt and agreed upon.

·         Previous fundraising documents- If you have already raised funds, then future investors would like to know the details of fundraising, utilisation, its impact, etc. Put these in order so they can understand them thoroughly.

·         Secretarial Drafting- Secretarial practices should be in place like Board Minutes, AGM/ EGM Minutes, all the filings with MCA.