What is Due Diligence?
Due diligence (DD) is the investigation and verification process that investors conduct before finalizing an investment. It is the process of confirming that what the founders have represented about their company is accurate and identifying any potential risks or issues that could affect the investment.
In the Indian startup ecosystem, due diligence typically occurs after the term sheet is signed but before the final investment documents are executed. The depth and scope of DD varies based on the funding round, investment amount, and investor type. Seed rounds may have light DD, while Series A and beyond involve comprehensive scrutiny.
Why Due Diligence Matters
- • Risk Assessment: Identifies legal, financial, and operational risks
- • Valuation Validation: Confirms metrics and projections presented by founders
- • Investment Decision: Information gathered informs final investment decision
- • Price Adjustment: Issues discovered may lead to adjusted valuation or terms
- • Protection: Reps and warranties in final agreements based on DD findings
- • Post-Investment Planning: Helps investors understand areas needing attention
Due Diligence vs Audit
Due Diligence
- • Forward-looking assessment
- • Focuses on risks and opportunities
- • Broader scope (legal, business, tech)
- • Conducted by investor or advisors
- • Goal: Investment decision
Audit
- • Historical verification
- • Focuses on accuracy of records
- • Primarily financial focus
- • Conducted by statutory auditors
- • Goal: Opinion on financial statements
Types of Due Diligence
A comprehensive due diligence process covers multiple dimensions of the business. Understanding each type helps you prepare appropriate documentation.
1. Legal Due Diligence
Reviews corporate structure, contracts, litigation, compliance, intellectual property ownership, and governance documents. Usually the most extensive part of DD.
2. Financial Due Diligence
Examines financial statements, revenue recognition, burn rate, unit economics, financial projections, and working capital requirements.
3. Tax Due Diligence
Reviews tax compliance, filings, assessments, disputes, transfer pricing, and potential tax exposures under Income Tax, GST, and other laws.
4. Technical Due Diligence
Assesses technology architecture, code quality, scalability, security, tech team capabilities, and product roadmap for tech-enabled startups.
5. Business/Commercial DD
Analyzes market size, competitive landscape, business model viability, customer metrics, growth strategies, and unit economics.
6. HR/Team Due Diligence
Reviews organizational structure, key personnel, employment contracts, ESOPs, and cultural fit with the founding team.
DD Timeline and Process
Understanding the typical DD timeline helps you prepare and manage expectations. The process varies based on funding stage and company complexity.
Typical Timeline by Stage
| Stage | Timeline | Focus Areas |
|---|---|---|
| Angel/Pre-Seed | 3-7 days | Basic legal, team, product demo |
| Seed Round | 1-2 weeks | Legal docs, financials, basic tech review |
| Series A | 3-4 weeks | Full legal, financial, tax, tech DD |
| Series B+ | 4-8 weeks | Comprehensive all-area DD |
The DD Process Flow
Phase 1: Information Request
Investor sends DD checklist/request list. Company begins gathering documents and populating data room.
Phase 2: Document Review
Investor and advisors review uploaded documents. Follow-up questions and additional requests are made.
Phase 3: Management Interviews
Calls/meetings with founders and key team members to discuss business, technology, and clarify questions.
Phase 4: Site Visit (if applicable)
For manufacturing or asset-heavy businesses, physical inspection of facilities.
Phase 5: DD Report
Investor prepares internal DD report summarizing findings, risks, and recommendations.
Phase 6: Issue Resolution
Discussion of issues found, remediation plans, potential price adjustments, and reps/warranties.
Setting Up Your Data Room
A well-organized data room demonstrates professionalism and accelerates the DD process. Prepare your data room before starting fundraising.
Data Room Tools
For Early Stage
- • Google Drive
- • Dropbox
- • OneDrive
- • Notion
For Growth Stage
- • Digify
- • FirmRoom
- • iDeals
- • Intralinks
Security Features
- • Access controls
- • Watermarking
- • Download restrictions
- • Activity tracking
Recommended Folder Structure
📁 Data Room
├── 📁 01_Corporate
│ ├── Incorporation Documents
│ ├── Shareholding Pattern
│ ├── Board Minutes
│ └── SH-7/CHG-1 Filings
├── 📁 02_Financial
│ ├── Audited Financials
│ ├── Management Accounts
│ ├── Projections
│ └── Banking Documents
├── 📁 03_Legal_Contracts
│ ├── Customer Agreements
│ ├── Vendor Contracts
│ ├── Employee Contracts
│ └── NDAs
├── 📁 04_IP_Technology
│ ├── IP Assignments
│ ├── Trademark Certificates
│ ├── Patent Documents
│ └── Tech Architecture
├── 📁 05_Tax_Compliance
│ ├── Income Tax Returns
│ ├── GST Returns
│ ├── TDS Returns
│ └── Assessment Orders
├── 📁 06_HR_ESOP
│ ├── ESOP Plan
│ ├── Key Employee Contracts
│ └── Organization Chart
└── 📁 07_Regulatory
├── Licenses and Permits
└── Compliance Certificates
Document Preparation Tips
- • Scan quality: Use clear, legible scans (300 DPI minimum)
- • File naming: Use descriptive names (e.g., "MOTION_Pic_AOA_Executed.pdf")
- • Version control: Include dates in filenames for updated documents
- • Index document: Create a master index listing all documents
- • Translation: Provide English translations for vernacular documents
- • Completeness: Include all pages (don't skip blank pages)
Legal Due Diligence Checklist
Legal DD is typically the most extensive part of the process. Ensure these documents are organized and readily available.
Corporate Documents
- ✓ Certificate of Incorporation
- ✓ Memorandum of Association (MOA)
- ✓ Articles of Association (AOA)
- ✓ PAN Card of the company
- ✓ TAN allotment letter
- ✓ Certificate of Commencement of Business (if applicable)
- ✓ ROC filings (AOC-4, MGT-7) for last 3 years
- ✓ Active compliance status on MCA portal
Share Capital and Funding
- ✓ Current shareholding pattern
- ✓ Cap table (fully diluted)
- ✓ Share certificates issued
- ✓ Past investment agreements and SHA
- ✓ Share application forms
- ✓ Valuation certificates (FEMA compliance)
- ✓ FIRC/FIRCAs for foreign investment
- ✓ FC-GPR and FC-TRS filings
- ✓ Board resolutions for allotments
Board and Governance
- ✓ Board meeting minutes (last 2 years)
- ✓ Shareholder meeting minutes
- ✓ Board resolutions for major decisions
- ✓ Director appointment letters
- ✓ DIR-8 declarations from directors
- ✓ DIN allotment letters
Material Contracts
- ✓ Customer agreements (top 10 by value)
- ✓ Vendor/supplier agreements (major)
- ✓ Lease agreements for office premises
- ✓ Loan agreements and debt documents
- ✓ Guarantee or security documents
- ✓ Partnership/JV agreements
- ✓ Non-disclosure agreements
Litigation and Disputes
- ✓ List of pending litigation (company and directors)
- ✓ Court notices and summons
- ✓ Arbitration proceedings
- ✓ Regulatory show-cause notices
- ✓ Threatened claims or disputes
- ✓ Tax demands and appeals
- ✓ Employment-related disputes
Financial Due Diligence Checklist
Financial DD validates the company's financial health, revenue recognition practices, and burn rate. Investors scrutinize these numbers carefully.
Financial Statements
- ✓ Audited financial statements (last 3 years)
- ✓ Management accounts (monthly/quarterly)
- ✓ Balance sheet, P&L, Cash flow statements
- ✓ Notes to accounts with significant accounting policies
- ✓ Auditor reports and management letters
- ✓ Consolidated statements (if subsidiaries)
Revenue and Customers
- ✓ Revenue breakdown by product/service line
- ✓ Customer concentration analysis
- ✓ Monthly recurring revenue (MRR) trends
- ✓ Customer acquisition cost (CAC) calculations
- ✓ Lifetime value (LTV) analysis
- ✓ Churn rate and retention metrics
- ✓ Revenue recognition policy
- ✓ Deferred revenue schedule
Expenses and Costs
- ✓ Detailed expense breakdown by category
- ✓ Employee cost analysis
- ✓ Marketing and customer acquisition spend
- ✓ Infrastructure and technology costs
- ✓ Office and administrative expenses
- ✓ Related party transactions
- ✓ Founder compensation and drawings
Cash and Banking
- ✓ Bank statements (all accounts, 12+ months)
- ✓ Fixed deposit receipts
- ✓ Cash flow projections
- ✓ Burn rate analysis
- ✓ Runway calculation
- ✓ Bank reconciliation statements
Projections and Assumptions
- ✓ Financial projections (3-5 years)
- ✓ Detailed assumptions behind projections
- ✓ Sensitivity analysis
- ✓ Use of funds from current round
- ✓ Milestones tied to fund deployment
- ✓ Path to profitability analysis
Tax Due Diligence Checklist
Tax DD identifies potential tax exposures and compliance status. This is critical as tax issues can result in significant liabilities.
Income Tax
- ✓ Income Tax Returns (last 3-5 years)
- ✓ Tax computation statements
- ✓ Form 16/16A (TDS certificates)
- ✓ Tax audit reports (if applicable)
- ✓ Assessment orders and appeals
- ✓ Transfer pricing documentation (if applicable)
- ✓ Advance tax payment challans
- ✓ Form 26AS (tax credit statements)
GST
- ✓ GST registration certificate
- ✓ GST returns (GSTR-1, GSTR-3B, GSTR-9)
- ✓ GST payment challans
- ✓ Input tax credit reconciliation
- ✓ E-way bills (if applicable)
- ✓ GST assessment/audit reports
- ✓ Show cause notices and demands
TDS and Other Taxes
- ✓ TDS returns (24Q, 26Q, 27Q)
- ✓ TDS payment challans
- ✓ Form 16A issuance records
- ✓ Professional tax registration and payments
- ✓ Advance tax payments for directors
Common Tax Red Flags
- • Pending tax assessments or disputes
- • Mismatch in GSTR-2A/2B vs books
- • TDS defaults or late deposits
- • Unexplained cash deposits
- • Aggressive tax positions without documentation
Technical Due Diligence Checklist
For tech-enabled startups, technical DD assesses the technology's scalability, security, and competitive advantage. This is especially important for Series A and beyond.
Architecture and Infrastructure
- ✓ System architecture diagrams
- ✓ Technology stack documentation
- ✓ Cloud infrastructure setup (AWS/Azure/GCP)
- ✓ Scalability assessment
- ✓ Disaster recovery and backup procedures
- ✓ Load balancing and auto-scaling setup
- ✓ CDN and caching strategy
Code and Development
- ✓ Code repository access (GitHub/GitLab)
- ✓ Code quality metrics
- ✓ Documentation quality
- ✓ Test coverage reports
- ✓ CI/CD pipeline setup
- ✓ Deployment procedures
- ✓ Technical debt assessment
Security
- ✓ Security audit reports (if any)
- ✓ Vulnerability assessments
- ✓ Penetration test reports
- ✓ Data encryption practices
- ✓ Access control and authentication
- ✓ Incident response procedures
- ✓ Third-party security certifications
Product and Data
- ✓ Product roadmap
- ✓ Feature documentation
- ✓ API documentation
- ✓ Data models and schemas
- ✓ Data retention policies
- ✓ Third-party integrations
- ✓ Open source license compliance
Business Due Diligence
Business DD assesses the market opportunity, competitive position, and sustainability of the business model.
Market and Competition
- ✓ Market size analysis (TAM, SAM, SOM)
- ✓ Competitive landscape mapping
- ✓ Competitive advantage analysis
- ✓ Industry trends and forecasts
- ✓ Regulatory environment
- ✓ Market entry barriers
Business Model
- ✓ Revenue model documentation
- ✓ Unit economics analysis
- ✓ Pricing strategy
- ✓ Customer segments
- ✓ Go-to-market strategy
- ✓ Partnership strategy
Customer Validation
- ✓ Customer testimonials/references
- ✓ Case studies
- ✓ Net Promoter Score (NPS)
- ✓ Customer satisfaction surveys
- ✓ Usage metrics and engagement
- ✓ Pipeline and funnel metrics
HR and Team Due Diligence
Investors invest in teams as much as ideas. HR DD assesses the quality and stability of the team.
Organizational Structure
- ✓ Organization chart
- ✓ Headcount by function
- ✓ Key employee profiles
- ✓ Hiring plan and roadmap
- ✓ Employee turnover analysis
Employment Documentation
- ✓ Employment contracts (key employees)
- ✓ Non-disclosure agreements
- ✓ Non-compete agreements
- ✓ IP assignment agreements
- ✓ Offer letters and appointment terms
- ✓ Consultant/freelancer agreements
ESOP and Compensation
- ✓ ESOP scheme document
- ✓ ESOP grant letters
- ✓ ESOP pool and allocations
- ✓ Vesting schedules
- ✓ Salary structure
- ✓ Bonus and incentive plans
Intellectual Property Due Diligence
IP DD ensures that the company's intellectual property is properly protected and owned, which is crucial for valuation and defensibility.
IP Ownership
- ✓ IP assignment agreements from founders
- ✓ IP assignment from employees
- ✓ IP assignment from contractors
- ✓ List of all company IP assets
- ✓ Confirmation no third-party IP in core product
Trademarks
- ✓ Trademark registration certificates
- ✓ Pending trademark applications
- ✓ Trademark search reports
- ✓ Domain name registrations
- ✓ Social media handle registrations
Patents and Copyrights
- ✓ Patent applications and grants
- ✓ Patent search reports
- ✓ Copyright registrations (if any)
- ✓ Software copyright documentation
- ✓ Invention disclosure records
Third-Party IP
- ✓ List of open source components used
- ✓ Open source license compliance
- ✓ Third-party software licenses
- ✓ Font and content licenses
- ✓ No infringement claims or disputes
Regulatory Compliance Checklist
Compliance DD verifies that the company meets all applicable regulatory requirements for its industry and operations.
General Compliance
- ✓ Shop and Establishment Act registration
- ✓ Professional tax registration
- ✓ EPF and ESI registrations (if applicable)
- ✓ Labour law compliance
- ✓ POSH (Prevention of Sexual Harassment) compliance
- ✓ Maternity benefit compliance
Industry-Specific Compliance
Depending on your industry, additional compliance may be required:
- ✓ FSSAI license (food businesses)
- ✓ Drug license (pharma/healthcare)
- ✓ NBFC/RBI registration (fintech)
- ✓ IRDAI registration (insurance)
- ✓ SEBI registration (investment services)
- ✓ DOT license (telecom)
- ✓ BIS certification (manufacturing)
Data Protection
- ✓ Privacy policy
- ✓ Terms of service
- ✓ Data processing agreements
- ✓ Consent mechanisms
- ✓ Data localization compliance (if applicable)
- ✓ Incident response plan
Common Red Flags
Being aware of common red flags helps you address issues proactively before they become deal-breakers.
Legal Red Flags
- • Missing incorporation documents or filings
- • Outstanding litigation against founders
- • IP owned by individuals, not the company
- • Material contracts without proper documentation
- • Pending regulatory actions
- • Non-compliance with FEMA for foreign investment
Financial Red Flags
- • Significant revenue recognition issues
- • Unexplained related-party transactions
- • Missing audited financials
- • Unrealistic financial projections
- • High customer concentration risk
- • Poor unit economics
Operational Red Flags
- • Key person dependency (company too tied to one founder)
- • High employee turnover
- • Missing key employee contracts
- • Outdated technology or security vulnerabilities
- • Customer complaints or reputation issues
Tips for a Smooth DD Process
Following these tips can help you navigate due diligence efficiently and maintain investor confidence.
Preparation Phase
- • Start preparing your data room before fundraising
- • Conduct a self-audit to identify potential issues
- • Engage a lawyer familiar with startup funding
- • Organize all documents systematically
- • Prepare clear explanations for any anomalies
During DD Phase
- • Respond promptly to information requests
- • Be transparent about issues - disclose proactively
- • Provide context for complex matters
- • Don't hide problems - explain mitigation plans
- • Keep communication channels open
Professional Support
- • Engage experienced startup lawyers
- • Consider a financial advisor for financial DD
- • Work with chartered accountants for tax matters
- • Assign a dedicated internal DD coordinator
- • Set up regular update calls with the investor
Key Success Factor: Honesty
Full disclosure is always better than surprises. If there are issues, explain them upfront along with your mitigation plans. Investors appreciate transparency and are often willing to work through issues if they're disclosed early and handled professionally.