Due Diligence: What Indian Start-Ups Must Know Before Closing a Deal

In today's fast-paced and dynamic business landscape, start-ups in India are on the rise, driven by innovative ideas, entrepreneurial spirit and a supportive ecosystem. According to a NASSCOM analysis, there has been a consistent 10 per cent increase in the number of start-ups annually. 

As these start-ups grow and seek investment to scale their operations, founders must thoroughly understand the due diligence process. Due diligence is a comprehensive investigation conducted by potential investors to assess the start-up's viability, risks and potential returns. 

Due diligence is a critical step in the investment process for both investors and start-ups. It allows investors to evaluate the start-up's financial, legal and operational aspects to mitigate risks and make informed investment decisions. 

For start-ups, it is an opportunity to showcase their strengths, address any concerns and build trust with potential investors. A thorough due diligence process can help establish transparency, align expectations and pave the way for a successful partnership.

Navigating the Due Diligence Maze

There are many aspects to due diligence and it is quite possible that first-time entrepreneurs might miss some of the following: 

Financial Due Diligence Investors closely scrutinise a start-up's financial statements, revenue models, profitability and cash-flow projections. They assess the compliance of the business model with relevant laws and regulations. 

To instil trust and confidence in investors, start-ups must prioritise maintaining well-organised books of accounts, adhering to proper accounting practices, and providing reliable projections. 

Legal Due Diligence Legal due diligence involves assessing a start-up's legal documentation, such as incorporation documents, contracts, licenses and intellectual property rights. 

Investors verify compliance with applicable laws, potential litigation risks, and pending legal issues. Start-ups must maintain proper legal records and protect their intellectual property.

Market Due Diligence Investors spend enough time to analyse the target customers, market size and competitive landscape to gaze at the start-up's product-market fit. They also assess the start-up's unique value proposition, market traction and growth prospects. 

Operational Due Diligence Operational due diligence focuses on the start-up's internal operations, including management team capabilities, execution strength and scalability. Investors evaluate the start-up's organisational structure, key personnel and operational efficiency. Founders must assemble a robust management team, fix realistic milestones and prepare scalability plans to instil confidence in investors.

Mastering the Due Diligence Game

Founders can draw up some key strategies to stick to the straight and narrow path while traversing the road of success. The most important part is to be well prepared.

Start-ups must proactively organise their financial, legal and operational documents within time. Being well-prepared enables smooth due diligence and reflects positively on the start-up's professionalism.

Founders should also be transparent about their achievements, challenges and risks. Investors appreciate honesty and will be more inclined to support a start-up that acknowledges its limitations and has plans to address them.

When in doubt, it is best to engage expert advisors. Seeking guidance from experienced advisors, such as lawyers and accountants, can help start-ups navigate the complexities of due diligence. These professionals can ensure compliance, identify potential issues and provide valuable insights.

Building a strong network and obtaining positive references from industry experts, mentors or existing investors can enhance a start-up's credibility during due diligence. It demonstrates a track record of successful collaborations and validates the start-up's credibility.

The Due Diligence Lacunae 

The start-up landscape in India has experienced impressive growth in recent years, benefiting from increased support from various stakeholders such as the government, investors, and accelerators. This growth, however, has faced some recent setbacks. 

According to data from Venture Intelligence, this year has seen a significant decline in both the number and value of deals compared to the previous year. So far, only 227 deals have been recorded in India, a notable drop from the 540 transactions during the same period in 2022. 

Similarly, this year's total investment amount stands at a mere $9.8 billion, a substantial decrease from the impressive $22.3 billion invested in the corresponding period last year.

To navigate the evolving start-up ecosystem in India, entrepreneurs must be mindful of their industry's specific regulatory and compliance requirements. Staying abreast of sector-specific nuances, policy changes, taxation, and intellectual property rights is essential. A comprehensive understanding of these aspects will ensure compliance and contribute to a competitive advantage in the market.

Despite the recent decline in funding, Indian start-ups have displayed remarkable resilience. According to a PWC India report, they managed to raise nearly $24 billion in 2022, even with a 33 per cent drop in funding compared to the previous year. 
This accomplishment surpasses the total funds raised in both 2020 and 2019 combined. It reflects the enduring appeal of Indian start-ups and the confidence investors have in them, even amidst challenging circumstances. 

However, the intensification of due diligence activities within the ecosystem indicates a growing demand for transparency and accountability. Investors now prioritise start-ups with sustainable business models, strong governance practices, and a clear path to profitability. 

While due diligence is critical for securing investment, it is a stepping stone towards long-term success. Indian start-ups can leverage the momentum gained during due diligence by executing strategic business plans, nurturing investor relationships, and staying informed about industry developments. By doing so, they can position themselves for sustainable growth and significantly impact the evolving start-up ecosystem in India.
-        Prasad Vanga, CEO and Founder, Anthill Ventures