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A Guide to Start-up Fundraising Due Diligence

December 6, 2021

No investor invests money solely on the basis of the pitch that the start-up has made. Before any investor hands his money to your start-up, they want to see evidence supporting the claims that the start-up has made. Usually, this involves digging through a deep list of documents elucidating on every claim, policy, practice and history of the business. A well-managed and organized due diligence preparation will make one stand out and reduce valuable time in the fundraising process. On the other hand, a lack of knowledge and preparedness can be discouraging to potential investors.

This list of documents can largely be divided into eight sections –

  1. corporate information,
  2. permits and licenses,
  • properties and assets,
  1. liabilities and indebtedness,
  2. contracts, employment,
  3. intellectual property, and
  • legal proceedings.

Generally, a higher level of care is to be exercised for the look back period.

Corporate Information

This involves all information regarding the company itself, including its memorandum and articles of association, its corporate structure and organizational chart, list of shareholders and their percentages, and audited financial statements. The investment deck outlining all businesses and operations currently being conducted by the company should be clearly laid out, along with third parties involved, if any. Further, information regarding the company’s subsidiaries or associate companies, if any, and shareholding within them is relevant. All statutory forms and filings filed with the RoC or MCA or RBI or any other agency are relevant. FDI investments, whether inflow or outflow, as well as loans and guarantees to and from overseas entities are also important.

Permits and Licenses

General permits and licenses to conduct business in India or overseas, PAN numbers, GST registration details, start-up registration with DIPP or DPIIT, importer-exporter code, and any compliance reports filed with governmental agencies, are important.

Secondly, specific licenses to conduct business in the said industry (for example, under Central Motor Vehicles Rules), NOC by fire departments for various buildings and properties, municipal licenses and registrations, manufacturing licenses and compliance reports are important. Where the start-up is in the business of or in possession of hazardous materials, proper description and control mechanisms should be laid out. Compliance with the relevant environmental standards and licenses such as from Central Pollution Control Board, or state pollution control boards, are important.

In case the business collects, stores or processes any personal information (including financial and health information) of persons, evidence as to compliance with relevant information technology law and reasonable security practices, privacy policies should be outlined.

Lastly, any adverse documents that reflect on the restrictions of the business to operate in any manner, violations or alleged violations of permits, refusals, and any indications to amends and revocations to licenses and permits are important and should not be hidden from the investor.

Properties and Assets

Details of the following key assets, along with any copies of sale deeds, encumbrances, lease agreements, mortgages, easements, and any other evidences of titles and registration deeds –

  • self-owned assets
  • leased assets
  • licensed assets
  • all production facilities and office/business premises along with a descriptions of businesses carried out at every such premises.
  • investments and interests of the business

Any insurance policies undertaken for these properties, as well as any claims filed therefrom should also be included.

Liabilities and Indebtedness

All documents evidencing any debt secured by the company along with copies of the financial arrangements, debt agreements, term loan agreements, as well as documents evidencing any creation of charges, sale, pledges and any guarantees furnished by the business should be clearly detailed. Any defaults, delays and non-performance, as well as any terminated/suspended/revised agreements are vital. Further, any clauses in agreements or documents that evidence limits or restrictions on the business’ ability to intake debt or investment are key, since they may limit an investor’s ability to invest in the business.

Contracts

Each of the following material contracts by the business are essential –

  • any agreements between itself and its shareholders, directors, third parties, board of directors, subsidiaries and associate companies;
  • any non-competition agreements;
  • any consulting agreements;
  • any profit-sharing agreements;
  • any joint ventures; and
  • partnership agreements.

Moreover, material contracts relating to top suppliers and customers, retailers, logistics services providers, manufacturers and distributors, as well as any marketing or publication agreements are important.

Employment

Employment contracts of KMPs including any director service agreements, employment agreements along with a list of names and designations should be prepared. Details of employees at each location, including all temporary and contractual labour and workers is important.

Additionally, details of personnel policies including POSH compliances and internal complaints committee, gratuity schemes, bonus schemes, ESOP schemes, registrations under EPF Act and ESI Act, as well as details of contributions therein should be clearly described. Lay-off and retrenchments undertaken, along with details of any compensation thereof should be included.

Intellectual Property

Any non-confidential information relating to the business’ intellectual property, including trademarks, patents, designs, copyrights, etc. should be provided along with details as to their registrations, disputes, conflicts, litigations, and joint ownerships of IP should be detailed. Details as to IPs used by the business, however owned by a KMP or employee or director should be included here as well. Any information that would limit the business from expanding or using or transferring its IP is very important, as it may form the basis of the investor’s decision.

Legal Proceedings

Details of all complaints, legal notices, legal proceedings, pleadings filed, government orders, administrative orders, tax litigation and liquidator notices, and all correspondence relating to any of the aforementioned, if any, are of utmost importance.

Best Practices

Due diligence is inevitable. Preparing these documents and having everything ready before there’s an offer on the table will save both legal teams a lot of hassle, while also providing complete information to the start-up for their investment pitches.

It is almost necessary to start with a due diligence checklist, allowing for better organisation of documents. Responding to due diligence requests promptly and providing information proactively will allow the business to gain credibility. On the other hand, delays and limiting information may potentially kill a deal if the investor is suspicious of unscrupulous items.

Hence, transparency is paramount. It is best practice to always drill down into the lowest level of detail available. Second, consistency is vital, for it inspires confidence in the investor. While some differences in information is natural, these should ideally be explained through schedules and notes. Holding the hand of the investor through the entire process is key for a potential investor to hold a relationship with the start-up.

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Suyash Bajpai, Intern at S.S. Rana & Co. has assisted in research of this article.

For more information please contact us at : info@ssrana.com