Due diligence (DD) is a systematic process of verifying, analyzing the records, agreements, contracts of a business and ascertaining the protentional risks, non-compliance or hidden liabilities. The growing prevalence of due diligence in businesses is being driven by increased fundraising, acquisitions, and mergers and acquisitions (M&A) activity, as organizations prioritize risk assessment and transparency in today’s dynamic corporate landscape.

The DD report issued subsequent to completion of the DD typically contains the following:

• Scope and period of DD
• General Information
• Shareholding of the company
• Reg flags with its implication and recommendations on how to mitigate
• Documents relied upon
• Pending requisitions
• Limitation of the scope
• Disclosure of litigations- summary of the pending litigations based on the information provided by the Company representatives

Documents/information evaluated in the DD:

• Shareholding/Directorship history– Frequently, it is observed that certain founders who are no longer actively involved with a company continue to hold significant shareholding and remain listed as directors. To facilitate smoother operations and enable further capital infusion, it is advisable to dilute such founders’ shareholding to a minimum. There have been instances where an earlier founder becomes unreachable or untraceable, making it impossible to file their resignation as director without a signed resignation letter. In such situations, Section 167 of the Companies Act may be invoked to vacate the director’s office, allowing the company to move forward effectively.

• Any prior term sheet/investment agreement or MOU– It is crucial to review specific terms such anti-dilution or right of first refusal to ensure no potential deadlocks while fund raising, sale or merger transactions. Thorough scrutiny of these clauses ensures smooth execution and protects the interests of all parties involved.

• Share certificates- Share certificates serve as legal evidence of ownership in a company, and any anomalies or discrepancies in these certificates can jeopardize the entire transaction. It is essential that share certificates are properly stamped in accordance with the applicable state Stamp Act; otherwise, they may be deemed invalid under the law.

• Employment agreement with the Founder, appointment letter for other employees- Non-compete, non-solicitation provision is essential in founder agreement.

• Financing documents- Bank sanction letters, personal guarantee of promoters/founders. In some sanction letters, prior consent of lenders is a mandate for any change in capital structure.

• Various Licenses- Depending on the nature of the business, certain licenses are legally required. During the due diligence process, these required licenses are identified and cross-checked against those currently held by the company to ensure full compliance.

• Intellectual Property rights- A trademark application should be filed to protect the mark, brand, or logo used by the company. Often, it is observed that at the inception stage, founders register the business domain name/trademark under their personal names. When the founder subsequently exits, the intellectual property rights may not be assigned to the company, leading to potential complications.

• Labour law and Prevention of Sexual Harassment at workplace compliance

• Business Contracts

• Property documents

• Corporate documents such as related party transactions, ESOPs

Founders should proactively complete due diligence before pursuing fund raising so that founders can anticipate investor questions, address risks, and improve transparency, which significantly enhances their chances of securing investment and prevents delays or deal failures risk mitigation. Ultimately, a well-executed due diligence process is instrumental in fostering transparency, mitigating risks, and driving successful business outcomes.

Akansha Rathi and Associates (ARACS), Company Secretary Firm in Navi Mumbai is engaged into compliance related services. We have a team of experts who not only possess required skills and experience but also have worked in complex business environment and were engaged in providing complex solutions in terms of providing related Compliance services to our clients.