What is due diligence for startups in India?

Abstract

In recent years, India has been elevated to the status of a successful target for global
investment. The Indian economy is being fuelled by its enormous labour force, powerful
wealth, and unexplored resources. Since India opened the gates to the world market, many
foreign based enterprises have been aggressively eager to make investments into the Indian
market, and vice versa. Nonetheless, a lack of awareness of a variety of variable such as the
process for establishing an Indian company, the simplicity of running enterprise, accessibility
to consumer choices, and the cultural backdrop has proven to be an impediment to foreign
firms’ open investment.

There are distinct categories of priority in the due diligence process. The due diligence fields
have been selected in accordance with standard due diligence methods. There are already
specific rules in the disciplines of due diligence, such as law and tax, that are defined by the
nation's or territory's competition laws. As a result, they are not covered as thoroughly in
previous research, which tend to rely heavily on specific domains of due diligence that are
commonly disregarded. A complete examination is required to create the key principles of
due diligence. Due diligence is multiple disciplines in nature; hence a wide range of literature
has been researched in order to achieve a holistic understanding of the process.

The author intends to form the foundation of a philosophical structure that describes the main
domains of due diligence, the process of due diligence, and the notions of due diligence. This
article goes into the multifaceted nature of due diligence and its compliance with Indian laws
in order to offer Indian companies with a comprehensive perspective of the complete
procedure.

Keywords

Due diligence, importance’s, types, procedure involved in due diligence process, documents
required for conducting due diligence, why Is Due Diligence for Startups Is Important in
India, benefits of due diligence.

Introduction
Due diligence is a preliminary investigation or audit performed before to a transaction, such
as a purchase, investments, business partnership, or bank loan, to verify that it follows legal,
accounting, and environmental requirements in order to establish a company in India. All of
the findings from these investigations and audits will be compiled into a Due Diligence
document. During the funding stage, completing due diligence on the firm is critical for
startups in India. To ensure compliance, we have compiled a list of corporate due diligence
needs for Indian startups.1

Research methodology

This paper is of descriptive nature and the research is based on secondary sources for the
deep analysis of the what is due diligence for startups in India. secondary source of
information like journals and websites are used for the research.

What is due diligence:

Due diligence is often conducted by a corporation prior to a company sale, a private

investment in equity, the granting of a loan from the bank, and various other transactions.
Throughout the procedure for due diligence, the company's legal, financial, and compliance
concerns are frequently evaluated and recorded. In generally, business due diligence is
performed prior to an investor or acquirer purchasing an entity or investing in a firm. The
buyer must get from the vendor of the business or shares the records and data needed to
conduct due diligence on the business.2

Importance:

The primary necessity for a corporation when investigating any business opportunity is to
examine and analyze the potential and risk connected with such enterprise. Due diligence
includes pre-transaction, transaction, and post-transaction operations including all important
parts of a company's history, present, and predictable future.

Following the completion of due diligence, a report on due diligence is prepared to provide
data and perspective on various aspects such as transaction risks, the value at which an
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agreement should be conducted, the assurances and compensation that must be acquired from
the vendor, and so on.

In every transaction, the seller investigates the prospective purchaser to make sure the
purchaser has sufficient funds to finish the purchase, along with other business aspects such
as technical as well as human resources, cultural, taxation, and so on that will affect the
company after the transaction is completed. There are numerous sorts of due diligence
undertaken by the corporation before entering into any commercial transaction or taking any
corporate action such as a merger, de-merger, amalgamation, takeover, joint venture, and so
on.3

Types of due diligence:

Due diligence for startups in India includes the following types:

1. Tax Compliance:
The taxation sections of the firm must be properly evaluated during the due diligence
stage to ensure that a company does not face any unexpected tax issues down the
road. The following aspects of a company's taxation must be considered:
 ITR Submission
 TDS Return
 GST Return Submission
 PF Returns and ESI Payment4
2. Functional components:
Throughout the due diligence process, it is critical to gain a thorough grasp of the
company's strategy, company activities, and operational information. All up and
running elements, including employee interviews and inspections of the premises,
must be thoroughly investigated. The operational aspects review must include and
document the following:
 Number of Customers
 Company Organization
 Information about the seller Services Information about production

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  the number of employees
 Specifications for machinery and equipment
3. Human Resource (HR) due diligence
HR due diligence includes understanding the country's system of employment
contracts, labor laws, labor relations, rules and regulations, workplace culture, and
industry standards. The staff, or the people side of a firm, has both value and cost in
monetary terms.
Payroll preparation checklist
HR policy
schedule for ESOPs
Employee contact information and other details5
4. Legal due diligence
Legal due diligence is an essential part of any transaction and a mandatory consideration
before entering into any merger or acquisition. It is an exercise in risk assessment to
investigate any potential liabilities of the target company that could impact a successful
transaction.

Examples of legal due diligence are careful examination of all material contracts, including
partnership agreements, licensing agreements, guarantees, and loan and bank financing
agreements.6
5. Compliance with Startup Accounting:

The Companies Act of 2013 requires every company to keep a book of accounts and accurate
transaction data. As a result, precise financial transaction data must be audited and verified in
contrast to the company's financial reports. Consider the following points while conducting
financial due diligence on a company:

 Financial statement validation

 Every asset and liability must be assessed and verified.
 Cash flow information must be verified.
 Every statement of accounts is scrutinized in light of transactional data.7
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Procedure involved in the due diligence process:

There are 3 stages in the due diligence process –

1. Pre- diligence process

2. diligence process
3. post- diligence

Pre- diligence process:

The pre-diligence process is the first step in due diligence, and it emphasizes preparing for a
thorough inspection of the target organization. The following major activities are included at this
stage:

1. Non-Disclosure Agreement and Letter of Intent:

To set the structure and secrecy of the due diligence, the investor commences the process by
signing a LOI and an NDA with the target firm.

2. Document management:

Collecting and organizing relevant papers from the target company, such as financial data, legal
agreements, and other significant information.

3. Issue Identification:

During the diligence phase, identifying potential concerns or areas of concern that require careful
study.

4. Preparation of Documents:

Putting together the relevant documents and materials for the due diligence assessment.

5. Establishment of a Data Room:

Creating a private data room to promote document sharing and review among the stakeholders
participating in due diligence.

Due Diligence Procedure

The due diligence procedure entails a thorough assessment of the target company's operations and
financial condition. It concludes with the creation of a due diligence report. This level includes the
following elements:

1. Report on Due Diligence:

Professional specialists perform the due diligence and create a report in a variety of formats:

2. Outcome Categories: Summary Report Detailed Report:

The due diligence report's findings are divided into several categories:

Deal Breakers: serious problems that could jeopardize the transaction, such as legal infractions or
major liabilities.

Deal Diluters: Recognizing infractions that could result in measurable penalties and lower the value
of the enterprise.

Deal Cautioners: Findings that may not have a financial impact but need cautious handling owing
to non-compliances.

Deal Makers: Reports that show no violations or severe violations.

Post-Diligence:

The post-diligence stage is critical for correcting any found non-compliances and negotiating the
deal's conditions. This stage's key actions include:

1. Non-Compliance Correction:

Identifying and addressing non-compliance issues uncovered during the due diligence process.

2. Legal Procedural Procedures:

To fix identified difficulties, initiate legal steps such as applying for compounding of charges or
negotiating shareholder agreements.

3. Deal Negotiation:

Using the results of the due diligence to negotiate the terms of the transaction with the target
company. This step aids in risk mitigation and obtaining mutually agreeable conditions.
Due diligence in India entails careful planning, a thorough investigation, and post-dilligence steps
to guarantee that all parts of a possible corporate deal are thoroughly reviewed and any difficulties
are addressed.8

Documents required for conducting due diligence:

 The following are the documents that the company must supply for the due diligence
procedure. Association Memorandum
 Intellectual Property Registration or Application Documents
 Articles of Association
 Shareholding Pattern
 Certificate of Incorporation
 Financial Reports
 Receipts for Tax Payments
 Registers of Statutes
 Property Records
 Bills for utilities
 Employment Records
 Operational Records
 Account Statements
 Certificates of Tax Registration
 Individual Income Tax Returns

Below is a Company Due Diligence checklist with a set of papers to be evaluated. MCA
documents:

The data from the Ministry of Corporate Affairs is utilized to start the due diligence procedure.
MCA publishes all of the companies' master data. With the payment of a nominal charge, all
documents registered with the registrar of companies (ROC) will be made public to anybody. The
following documents are available for review on the MCA website:

Information About the Company

 Authorised Capital
 Paid-up Capital
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 Date of Incorporation
 Date of the Most Recent Annual General Meeting
 Date of the Company's Most Recent Balance Sheet Status
Director Information:
 Directors of the Company
 Date of Appointment of Directors
Charges Registered
 Details of Secured Lenders of the Company
 Quantum of Secured Loans
Documents
 Certificate of Incorporation Memorandum of Association
 Articles of Association
In addition to the documents mentioned above, other documents such as financial
documents and many other compliance certificates can be downloaded for inspection.
Articles of Association:
The articles of association will describe the class of shares and the investors' voting
rights. A company's articles of incorporation may provide that its shares are not
transferable. Check that the shares are transferable.
The following are the company's statutory registers:
The Companies Act,2013 requires a private limited company to keep certain
documents pertaining to share transfers, share allotments, the board of directors, and
so on.To ensure shareholding and directors, statutory registries must be reviewed.
Book of Accounts and Financial Statements:
All of the company's financial statements are checked and validated with supporting
papers.
The following are some due diligence considerations:
 Account statements
 Liabilities and assets
 Data on cash flow
 All financial statements are compared against transactional data.

Tax review:
 All of the company's tax liabilities must be evaluated in order to avoid future
errors.

The following elements are taken into account during the tax review:

 Income tax returns have been filed

 Income tax has been paid
 The company's income tax liability is calculated.
 Returns on ESI and PF ESI / PF Payments Filed
 Calculation of ESI and PF Payments Returns on Service Tax / VAT Filed
Service
 Tax / VAT Payments Basis for Calculating Service
 Tax / VAT Payments
 TDS Refunds
 Payments of TDS
 Calculating TDS

Legal Aspects:

The company's legal due diligence includes a review of any liabilities and
appeals to lawsuits/cases/charges. A lawyer is normally in charge of this.

 All the company's real estate properties are legally compliant.

 There is no opposition from the Secured Creditor regarding the transfer
of the corporation.
 Court records and filings are verified.

Operational Aspects:

A thorough understanding of the company concept and its operation is

achieved at this level. It could also include corporate visits, staff interviews,
meetings with board directors, and so on. The following requirements must be
met and documented.

 Business Plan
 Number of Clients
 Employees' Count
  Utilities
 Production Information
 Machinery Information
 Vendor Information.9

Why Is Due Diligence for Startups Is Important in India?

1.To evaluate the business model's viability:

The first step in due diligence is determining the viability of the company plan. Entrepreneurs
must undertake market research to establish whether their product or service is in demand.
They must comprehend the target market, competitors, and industry developments. This will
assist them in validating their business concept and refining their marketing strategy.

2. Identifying and Managing Risks in Due Diligence

Entrepreneurs can use due diligence to uncover potential hazards in their company plans.
Legal, financial, operational, and market risks are all included. Entrepreneurs must be alert of
these dangers and devise measures to mitigate them. For instance, they may require licenses,
permits, and insurance to safeguard their company from legal liabilities.

3.To Secure Funding for Due Diligence:

Startups in India requires substantial money to get started. Due diligence is essential for
obtaining investor finance. Investors must comprehend the investment's possible dangers and
opportunities. This covers a market analysis, competition, and financial estimates for the
startup. It assists investors in making informed investment selections and negotiating
investment terms.

4.To Comply with Due Diligence Regulations

In India, startups must adhere to a variety of government rules, including tax laws, labor
laws, and environmental laws. Due diligence assists entrepreneurs in understanding their
company's legal needs and ensuring compliance. This will assist them in avoiding legal
penalties and protecting their company from liability.10

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Benefits of due diligence:

Aids in the negotiation of a better agreement:

By investigating the target company's financial status, you can haggle for a better price
throughout the due diligence process. If you are aware of the other company's performance
and financial status, you can negotiate a better bargain.

Increase your chances of success:

Before any transaction can be completed, you must verify all essential information from the
other company, including financials and legal documentation. As a result, deals that go
through the due diligence process have a higher chance of success. A thorough due diligence
method might help you because it offers you with broad coverage and a better understanding
of the firm.

Transparency is ensured:

Many firms try to hide facts that could harm their reputation, operations, or bottom line. Due
diligence promotes communication between both parties, allowing both parties to reach an
agreement without fear of unpleasant surprises.

Identify shortfalls:

You can only establish a profitable business if you understand where a company is failing
and succeeding. Due diligence assists you in identifying the target company's weaknesses and
strengths. You must have this information before signing a contract in order to make sound
business judgments. Before purchasing a business or getting into a contract with one, you
must know this information.

Resolve any unforeseen difficulties:

Doing business is difficult; there are new challenges to face every day. In today's competitive
industry, you must be prepared to deal with any unforeseen challenges. Businesses frequently
wait too long to resolve difficulties, causing them to lose money or stagnate. Due diligence is
required to investigate current and predicted future issues. Prior to signing an agreement,
thorough due diligence searches for unforeseen problems that can be resolved.

Reduce hazards:

Business transactions are frequently very broad in scope, and one faulty contract can cost you
a lot of money. A wise businessman will thoroughly investigate the firm with which they are
doing business. As a result, they frequently hire experts to properly study the company with
which they intend to do business.

If the due diligence step is missed, the buyer may be exposed to higher risk in a merger or
acquisition. Due diligence will supply you with all of the company information, both good
and negative, minimizing the risk of engaging into a business transaction greatly.11

Challenges in conducting due diligence:

Due diligence effort is viewed as overly time-consuming -

According to interviewees in the Forrester insight research, their methods for performing due
diligence and preventing fraud demand excessive employee labor. Many employees' manual
processes and legacy solutions have become inefficient and unsustainable, especially as a
firm grows. And it takes an increasing amount of time to teach new team members—a
difficult task.

The available info is untrustworthy -

Employees frequently lack trust in the data to which they have access. Data may be out of
date, duplicated, or wrong. Needless to say, this reduces the precision of their work and
undermines the team's trust in their employment, which can further hinder the due diligence
process.

Meeting evolving compliance and reporting obligations -

Every company wants to decrease the risk of noncompliance. However, maintaining

compliance standards might be difficult. Backlogs, which consume a significant amount of
compliance personnel' time, are one major factor. These employees may also have a lot of

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other work on their plates, which pulls their attention away from remaining up to date on
regulations and requirements.12

Case laws:

Chander Kanta Bansal vs. Rajinder Singh Anand: In this case the supreme court held that
the applicants' case in this case would come under clause 1(aa) of rule 27 because the
applicants want to record some old papers that they only got their hands on in 2008 and 2011.
The Supreme Court has stated in several decisions that petitioners under this section must
prove that the evidence was not within his knowledge or could not be supplied by him despite
exercising due diligence at the time of passing the decree appealed against. As a result, the
onus is plainly on the petitioners to demonstrate to this court that, despite exercising due
diligence, they could not have produced the aforementioned papers. Now the question is
whether the parties have behaved. whether due diligence was used is a matter for the court to
decide based on the facts and circumstances of each case. It is important to refer to the
Supreme Court's decision in the case of Chander Kanta Bansal v. Rajinder Singh Anand,
(2008) 5 SCC 117, where the court described the idea of due diligence as follows: The term
"due diligence" is not defined in the Code. The word diligence, according to the Oxford
Dictionary (Edn. 2006), denotes "careful and persistent application or effort." Diligent
denotes careful and consistent in one's approach to one's work and tasks, demonstrating care
and effort. According to Black's Law Dictionary (18th Edn. ), diligence is defined as
"constant effort to accomplish something, care; caution; the attention and care required from
a person in a specific situation. Due diligence refers to the diligence that is properly expected
of, and usually undertaken by, a person seeking to satisfy a legal requirement or discharge an
obligation. According to Drain-Dyspnea's Words and Phrases (Permanent Edn. 13-A), in law,
due diligence is doing everything reasonable, not everything possible. Due diligence is
defined as reasonable diligence; it is the diligence that a prudent individual would use in the
management of his own business.

Conclusion:

Due diligence is an important stage for companies to ensure their success. It assists
entrepreneurs in determining the sustainability of their company concept, identifying and
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managing risks, obtaining capital, and complying with regulations. Due diligence allows
startups to make informed investment decisions and avoid potential problems.

Market, financial, legal, and operational due diligence are all important aspects of due
diligence. To ensure the success of their startups, entrepreneurs should undertake due
diligence and seek expert guidance as needed.