INTRODUCTION
Start-Ups market in Indian Economy is growing in magnificent pace and there is lot of involvement of stakeholder ranging from lower to higher profile. Every start-up at the initial stage struggles with lot of challenges, one of which is gaining the financial assistance from Angle Investors, Private Equity Funds, and other investors. It is to be acknowledged that every start-up may not become successful, therefore, while investing in start-up the investor always keep the success rate of it in mind. Though, it is a speculation prima-facie, but proper analysis of the idea behind the start-up and future projection is always scrutinized by the investors before making any sort of investment in the start-up company. Apart from that, one more step is generally followed by the investors i.e., the Due-Diligence. In general parlance, investors before investing in Start-ups prefers to have three (3) types of due-diligences, i.e. (i) Legal Due Diligence, (ii) Secretarial Due-Diligence, and (iii) Financial Due Diligence.
In this article, we will be understanding the concept behind the above-mentioned due-diligences and will also understand the relevance of due-diligence for start-ups and the consequences if due-diligence is not properly concluded.
TYPES OF DUE-DILIGENCE
Under Financial Due-diligence, the prime objective of the investor is to analyse the actual financial condition of the company and to minutely ascertain if there are any discrepancies and latches between the actual figures shown in various books of accounts and trail documents substantiating the financial transaction done by the company.
It is important to have this due-diligence because, window-dressing has been a very common practice being followed by the Start-ups for impressing the investors with good figures and to close the deal.
2. Legal Due-Diligence
Under legal due-diligence, investors prefer to analyse the compliance and litigation status of all applicable laws on the company. It has been an admissible fact that in the initial stage of incorporation, till the time Start-ups fixes their feet in market to walk with little balance, they do not nourish their legal and compliance department and do not take them seriously. They prefer to do the compliances as the last-minute requirement only and that too in a casual manner. Also, sometimes it has been observed that there is a lack of back-up of legal documents. Further, in legal due diligence, the scope covers to ascertain if any sort of prosecution is pending against the company and its top level management and also if any adverse order has been filed against them. Also, at the same time if its scope is broadened, it may cover the findings of such things for the vendors associated with the company.
3. Secretarial Due-Diligence
Under Secretarial Due diligence the major part of review relates to the documents under the Companies Act, 2013. In this part of due-diligence, the key point to analyse is the level of governance being followed by the management of the company in taking any decision and to check if all compliances has been adhered in the right and true spirit. It is true that the procedure prescribed under the Companies Act, 2013 for performing any task is somewhere bit lengthy and may be not much interesting for the Start-ups but the same is required to be adhered properly because there is huge penal provision if the same gets non-complied.
Also, compliance shows the legal nature of the company but the governance level shows the intent and ethics the Start-up follows. At global level, it is the governance which matters and not only the compliance. Further, it is also the mindset of investors that if company is having good governance, then compliance naturally becomes its ingredient. Also, it has been seen sometimes that the investor may forgive non-compliance but not the non-governance.
BENEFITS OF DUE-DILIGENCE
A. Timely steps for cure of non-compliance
By due-diligence, the company gets to know about the non-compliance or other things, if any in timely manner and they may take effective steps to cure the same which may be done by way of compounding, adjudication or any other way. This helps the company to gain the trust of the investors while pitching for investment and it also expedite the process of completion of due-diligence, which eventually speed ups the investment.
B. Cost & Time Saving
Generally, it has been observed that compliance and due-diligence has been taken as a cost factor by the Start-ups but it is very important to be made clear that effective due-diligence saves the cost of the company which may be imposed by various authorities or which may incur due to prosecution, if gets started by any authority. It saves both cost and time. Also, it has been seen many a times that the investors back away to invest in the entities where either the entity or its stake-holders are facing prosecution. It is seen many a times that big companies are sinking due to huge cost of prosecution.
C. Risk Mitigation for Investors
As already mentioned earlier, investment in Start-ups is majorly a game of speculation, but the same is done only after proper study of the future projection and due-diligence. Proper and timely due-diligence allows the risk mitigation for the investors, and investor get assured that no litigation and other cost is going to suck the investment. Also, specifically due to financial due-diligence, the investor ascertains the stakes of third party which may be in terms of loan, financial debt, operation debt, etc. existing in the company and the credit worthiness of the company, which makes the investor understands the risk factor of unnecessary and contingent claims which may arise in future and plan accordingly.
D. Speediness in investment
If all things go in smoothly, and due-diligence gets completed in timely manner and effective steps has been taken to cure minor glitches, if any comes after due-diligence, the same increases the chances of speedy disbursal of the funds and eventually helps the Start-up to grow.
Conclusion
Though due-diligence is not a mandatory requirement but the same is done prior to every investment round by any investor, due to the reasons and benefits quoted above. It simultaneously brings the importance of compliance and governance also in front and every due-diligence will be easily successful only when the start-ups are following compliance and governance.
It is also pertinent to note here that major start-ups fail to get the investment due to failure in the due diligence and consequently, both the idea and the start-up gets defeated. It is always preferable for the start-ups to have internal due-diligence at proper intervals so as to have timely analysis of lacking, if any.
At last, to conclude, it can be said that an effective compliance, governance and due-diligence leads to speedy funding.
CS Santosh Pandey is a Company Secretary Practicing in New Delhi. He can be reached at info@spcounsels.com
Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates
