Diligence does not fail rounds often. What it does, routinely, is cost time and money — an extra six weeks, an indemnity, a holdback, or a revised price. Almost all of that cost comes from housekeeping that could have been done cheaply, two years earlier, when nobody was watching.
1. The cap table, and whether it agrees with the Registry
The first document requested is the capitalisation table. The first thing done with it is a comparison against the company's filings with the Registrar of Companies.
Every allotment of securities requires a return in Form PAS-3 within thirty days. Every issue at a price requires the price to be supportable. Where the cap table shows an allotment the Registry does not, or shows a shareholding the register of members does not, the round stops until it is reconciled — and reconciliation of a three-year-old allotment is far harder than filing it on time was.
- Register of members and share transfer records maintained and current
- PAS-3 filed for every allotment, with the valuation report where required
- Share certificates issued, stamped and delivered
- Convertible instruments — their terms recorded, and the conversion mechanics consistent between the agreement and the cap table
- Founder vesting agreements executed, not merely discussed
2. The ESOP pool, and the tax that attaches to it
Employee stock options are examined on three axes: whether the scheme was validly approved, whether grants were made in accordance with it, and whether the tax treatment has been applied.
The taxable event on exercise is a perquisite under Section 17(2)(vi) — the difference between the fair market value on the date of exercise and the amount paid by the employee — on which the employer is required to withhold. Eligible start-ups meeting the conditions in Section 80-IAC may defer the withholding under the mechanism in Section 192(1C), but the deferral is conditional and does not remove the obligation.
3. Revenue — the number that gets tested hardest
Investors do not test revenue against the accounts alone. They test it against the goods and services tax returns, the bank statements and the customer contracts, in that order.
- Revenue recognised where the performance obligation has been satisfied, not where the invoice was raised
- Deferred revenue carried as a liability, particularly for annual subscriptions billed upfront
- Turnover reconciling to the GST returns, with the difference explained line by line
- Related-party revenue identified separately, because it will be excluded from the multiple
- Collection history and receivable ageing consistent with the revenue claimed
A gap between accounted revenue and GST turnover is not by itself a problem — there are legitimate reasons for it. An unexplained gap is a problem, because the reviewer must assume the least favourable explanation.
Diligence rarely uncovers dishonesty. It uncovers ambiguity, and prices it.The AKV working rule
4. Statutory compliance — the quiet list
| Area | What is checked |
|---|---|
| Income tax | Returns filed, tax deducted and deposited, quarterly statements furnished, no outstanding demands on the portal |
| GST | Returns filed to date, credit reconciled, no notices pending, registration particulars current |
| Companies Act | Annual filings, board and general meeting minutes, statutory registers, ADT-1, INC-20A |
| Labour | Provident fund and employees' state insurance registration where thresholds are crossed, and contributions deposited on time |
| Contracts | Employment agreements, intellectual property assignment from founders and contractors, customer terms |
Intellectual property assignment deserves particular attention. Where the product was built partly by contractors, and the contracts do not assign the intellectual property to the company, the company does not own what the investor is buying. This is discovered late and is expensive to cure.
5. Valuation and the pricing of the issue
An issue of shares to a resident investor above face value engages the valuation requirements under the Companies Act read with Rule 11UA of the Income-tax Rules, 1962. An issue to a person resident outside India additionally engages the pricing guidelines under the exchange control framework, where the price may not be less than the fair value determined under an internationally accepted methodology.
On the income-tax side, the position for closely held companies has changed: the charge under Section 56(2)(viib) — commonly described as angel tax — was withdrawn by the Finance (No. 2) Act, 2024 with effect from assessment year 2025-26. Rounds priced before that change may still carry historical exposure, and diligence will look at them.
6. The benefits worth securing before the round, not after
Recognition by the Department for Promotion of Industry and Internal Trade is the gateway to the deduction under Section 80-IAC for eligible start-ups — one hundred per cent of profits for three consecutive assessment years out of the first ten, subject to conditions including the incorporation window prescribed in that section. Separately, Section 79 relaxes, for eligible start-ups, the restriction on carry-forward of losses where shareholding changes — which is precisely what a funding round does.
Both need to be in place before the shareholding moves. Applying afterwards is, at best, an argument.
7. The twelve-week version
If a round is expected within a year, the sequence that removes most diligence friction is: reconcile the cap table to the Registry and file what is missing; formalise the ESOP scheme and value it; reconcile revenue to the GST returns for every quarter and document the differences; close out open tax and GST notices; complete the statutory registers and minutes; and obtain assignment of intellectual property from every person who wrote code or created a mark. None of it is difficult. All of it is slow if left until a term sheet is signed.
Scope of advice. This firm advises on the Indian tax, exchange-control and regulatory position. Where a matter also turns on the law of the country in which you are resident or in which an entity is incorporated, we set out the Indian position and coordinate with your adviser in that jurisdiction; we do not render advice on foreign law.
Discussing your position. If any part of this affects a transaction you are contemplating, the useful conversation is the one that happens before it is executed. A scoping call is the appropriate first step.
This article is general commentary on the law as it stands and is not advice on any specific facts. Positions in tax, corporate and exchange-control law change with amendments, notifications and judicial decisions; please confirm the current position with the firm before acting.