What Is Due Diligence In A Start-Up
In the world of business and start-ups today, with the sheer quantity of business coming up, it’s become increasingly important for venture capitalists, angel investors, buyers etc. to be extremely vigilant about the business they are wanting to be a part of or invest in. There have been numerous instances where well-trusted and large multi-national as well as start-up companies have compromised the trust and integrity of the business as well as its customers and investors. This could happen in many ways. The prime ways this occurs is by money laundering, tax evasion, etc.
Now, this is where due diligence comes into play. So, what exactly is due diligence? According to the Oxford Languages Dictionary, “due diligence is reasonable steps taken by a person to avoid committing a tort or offence. It is a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.”
Due diligence is important because an angel investor or buyer must know what sort of business they are getting involved in. It becomes a vital tool to help them assess whether investing in a company will provide them with the gains and profits they so desire. Due diligence is somewhat of an ‘investigative procedure’ that helps provide angel investors with adequate data and knowledge to make an informed decision.
How does the act of due diligence play into the industry of start-ups?
Start-ups require huge amounts of capital to get their feet off the ground. To help establish a constant growth rate that has good returns a large capital is needed. What’s important to note is that start-ups are entering a market where there is already some form of a well-established business before them. So entering as a new player in the niche market becomes harder. This culmination of uncertainty that exists makes it all the more important for angel investors and buyers to conduct their due diligence.
Types of Due Diligence
Under the umbrella term of due diligence, there exist numerous types of the same. Due diligence includes reviewing the assets, liabilities, operations, business plans etc. of the company or start-up. As such we must look at the types of due diligence that exists.
Tax and financial due diligence
Here investors must look at a myriad of things concerning the business. This includes analysing the funding requirement of the business. The scalability of the company. Reviewing the tax audits, tax liabilities, profit or loss that the business has gone through etc. After reviewing the financials of the company the questions that angel investors and buyers must ask themselves is will there be a steady growth of the business with enough profits because only then should you consider investing.
Intellectual property and technical due diligence
This type of due diligence is where there is a thorough investigation of the technical aspects of the service or product that the start-up is marketing and selling. This type of due diligence is especially important for tech start-ups. What angel investors and buyers do here is that they will hire an industry expert to conduct this investigation into the start-up and help them better understand the liabilities or short fallings the start-up may have.
Legal due diligence
Now when you start a business there are numerous legal aspects that one has to take care of. Acquiring basic business licenses, creating contracts, making sure any original products have a patent etc. All this comes under the legal aspect of the business. Legal due diligence is by far one of the most tedious of them. This is because a legal team has to make sure that the company is following not the legal but ethical rules set in place as president. The start-up must comply with the rules and regulations of the Ministry of Corporate Affairs.
To Sum Up
Due diligence has become a very important step in the investment process of a business and as such should be taken seriously. It helps angel investors and buyers make informed decisions which in turn will also help keep the trust. Due diligence also helps investors have greater trust in the company as you have now displayed all your cards and are not hiding anything.
About Devansh Lakhani
Director of Lakhani Financial Services, and a Chartered Accountant, he helps start-ups raise funds from his network of investors. He guides and advises start-ups to scale up by providing efficient sales, marketing, team building, and business management strategies. He has executed fundraising by block deals on the stock exchange and conducted IPOs and right issues on the SME platform to the tune of over Rs. 50 Crore. He is currently working with start-ups from various sectors to help them channelize their business models and investments.