Startups often grow rapidly, but documentation and compliance don’t always keep up. As a result, during due diligence—whether for funding, acquisition, or compliance checks—several issues routinely surface. These problems are usually avoidable but continue to persist due to lack of formal systems in place.
Below are some of the common issues observed across early-stage and growth-stage startups during due diligence reviews:
1. Absence of Founder Agreements or Clear Shareholding Records
Many Startups operate for years without a written agreement between the founders. Equity splits, decision-making roles, IP ownership, and exit terms are either undocumented or unclear. This becomes a major red flag when investors seek clarity on control, rights, or ownership of the product/IP.
Even in companies with multiple investors, cap tables are often maintained in excel without formal share certificates or updated Registers of Members.
2. Delayed or Missed Regulatory Filings
Statutory filings under the Companies Act or FEMA are often missed. For example:
- Form DPT-3 for outstanding loans is frequently overlooked.
- FLA Return (for companies receiving foreign investment) is either delayed or not filed.
- MSME disclosures and director KYC updates are sometimes pending for multiple years.
Such lapses create compliance risk and delay deal closure when investors conduct background checks.
3. Informal Contracts with Vendors and Developers
In the early stages, Startups rely on freelance developers or agencies to build their product. In many cases, no agreement is signed. Later, when the company is being valued or the IP is being transferred, there is no legal proof of ownership. This becomes a critical issue during technology due diligence.
The same issue is seen in marketing, content creation, and vendor contracts—where payments are made but no scope or deliverables are documented.
4. Gaps in Financial Records and Accounting Hygiene
Many startups delay appointing accountants or auditors. TDS returns are not filed on time, GST returns may reflect mismatches, and payments may be made in cash without proper documentation. Personal expenses of founders are sometimes routed through the company account.
These issues impact valuation, especially if the financial statements cannot be reconciled with bank statements or ledger records.
5. Lack of KYC/AML Checks for Clients and Vendors
This is particularly relevant in sectors dealing with finance, crypto, or international clients. Many Startups onboard vendors or customers without PAN, GSTIN, or contract copies. In some cases, startups have issued large payments or received funds from unknown sources—without appropriate documentation.
With increasing focus on AML compliance, such lapses can raise concerns during funding or statutory audit.
Conclusion:
Due diligence is not just a checklist—it is a reflection of how organized a business is. Startups should treat documentation, filings, and accounting practices as foundational, not optional. A quarterly internal review with the help of professionals can help identify and plug these gaps early.
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thanks for sharing, very helpful.!!
Insightful