Due Diligence for Fundraising (Not M&A): What VCs Check in Tax, GST, Labour, and ROC Before Signing the Term Sheet

Due Diligence for Fundraising (Not M&A): What VCs Check in Tax, GST, Labour, and ROC Before Signing the Term Sheet

Why fundraising diligence feels sudden (and why it kills timelines)

In fundraising, founders often assume diligence starts after the term sheet. In reality, many investors do a “pre-term-sheet scan” and then a deeper review right after signing. If basics are missing, you get:

  • Delayed signing or renegotiated terms
  • Larger escrow/indemnity asks (even in VC-style deals)
  • Conditions precedent that take weeks to close
  • Reputation risk with the next investor in the syndicate

The good news: most diligence issues are predictable and preventable with a simple compliance + documentation system.

Fundraising diligence vs M&A diligence (what is different)

Fundraising diligence

  • Goal: confirm the company is investable and risks are manageable
  • Focus: corporate hygiene, statutory compliance, tax/GST exposure, employment and IP basics
  • Output: a short risk memo + conditions precedent + representations and warranties

M&A diligence

  • Goal: price the business and allocate risk for acquisition
  • Focus: deeper historical review, customer contracts, litigation, title, assets, long lookback
  • Output: detailed diligence report, price adjustments, indemnities, escrow

For founders, the key is to prepare for the fundraising version: fast, structured, and “red-flag driven.”

The diligence mindset: what investors are really asking

Across categories, VCs are trying to answer:

  1. Is the company legally in good standing?
  2. Are there hidden liabilities that can blow up post-investment?
  3. Are financials and taxes consistent with the story?
  4. Is the cap table clean and defensible?
  5. Can we close quickly without surprises?

The “minimum viable data room” (MVDR) you should have ready

Create a data room with consistent naming and a single index. Suggested structure:

  • 01 Corporate and ROC
  • 02 Capitalization and ESOP
  • 03 Financials and MIS
  • 04 Direct tax
  • 05 GST and indirect tax
  • 06 Labour and payroll
  • 07 Key contracts
  • 08 Litigation and notices
  • 09 IP and technology
  • 10 Related party transactions

If you want help setting up a repeatable compliance system, our Corporate Secretarial team can support the ROC and governance side: https://perfectaccounting.in/our-services/dallas-experts-manage-bank-account-operations-and-asset-valuation-seamlessly/

1) ROC and corporate compliance checks (the first filter)

This is usually the fastest way for an investor to spot hygiene issues.

What they check

  • Annual filings completed on time (AOC-4, MGT-7/MGT-7A, ADT-1)
  • Director KYC compliance (DIR-3 KYC)
  • Registered office correctness and proof
  • Statutory registers maintained (members, directors, charges, transfers)
  • Board and shareholder approvals for key actions
  • Charges and borrowings (CHG forms, loan documentation)

Common red flags

  • Missed ROC filings or late filings without explanation
  • Board minutes missing for share allotments or major contracts
  • Share certificates not issued or not properly stamped
  • Charges created but not filed, or filed but not satisfied

Quick fixes that work

  • Prepare a “ROC compliance gap note” with a closure plan and dates
  • File pending forms with additional fees and keep challans
  • Reconstruct minutes/resolutions with professional support where legally permissible

For ongoing compliance and filings support, our Accounting and Compliance services can help maintain a clean monthly process: https://perfectaccounting.in/our-services/europes-top-firms-trust-our-tax-management-services-for-accurate-tax-returns-and-bank-reconciliations/

2) Cap table, share issuances, and ESOP hygiene

Even early-stage rounds can get stuck here.

What they check

  • Cap table matches ROC filings and share certificates
  • Allotment documentation (Board/SH approvals, PAS-3, valuation where required)
  • ESOP plan approvals, grant letters, vesting schedules
  • Any side letters or special rights

Common red flags

  • Informal promises of equity without documentation
  • Missing PAS-3 filings or incorrect allotment dates
  • ESOP pool created but not properly approved

Quick fixes

  • Reconcile cap table to MCA and statutory registers
  • Document past issuances properly and align dates
  • Prepare an ESOP register and grant documentation pack

3) Direct tax checks (Income Tax, TDS, assessments)

Investors want to know if there is a silent tax bomb.

What they check

  • ITR filed on time and acknowledgements available
  • Tax audit report (if applicable)
  • TDS compliance: returns, challans, Form 26AS alignment
  • Outstanding demands, notices, assessments
  • Related party payments and disallowance risk

Common red flags

  • TDS deducted but not deposited on time
  • Mismatch between books and ITR schedules
  • Unreconciled 26AS/TIS items

Quick fixes

  • Build a “Tax Compliance Summary” (FY-wise) with filings, challans, and status
  • Close TDS gaps and keep a tracker of corrections
  • Document positions on disputed items

Our Tax Advisory and Compliance team can support direct tax and TDS clean-up: https://perfectaccounting.in/our-services/atlantas-financial-services-team-handles-gst-and-income-tax-with-exceptional-accuracy/

4) GST checks (returns, reconciliations, and exposure)

GST is a diligence hotspot because it is data-heavy and mismatch-driven.

What they check

  • GSTR-1 and GSTR-3B filing status
  • E-invoicing applicability and compliance (if triggered)
  • Input tax credit (ITC) eligibility and reversals
  • Reconciliation: books vs returns vs GSTR-2B
  • GST notices, audits, and demands

Common red flags

  • Sales in books not matching GSTR-1
  • ITC claimed without 2B support
  • Wrong place of supply or RCM gaps

Quick fixes

  • Prepare a monthly GST reconciliation pack
  • Identify top mismatch reasons and fix process (invoice discipline, vendor follow-up)
  • Maintain a “GST exposure note” with estimated liability and mitigation

5) Labour, payroll, and employment compliance

Investors look for hidden liabilities and employee disputes.

What they check

  • PF and ESIC registrations and monthly compliance
  • PT and Shops & Establishment compliance (state-wise)
  • Payroll registers, salary structures, and reimbursements
  • Employment agreements, offer letters, HR policies
  • Contractor vs employee classification risk

Common red flags

  • PF/ESIC not applied to eligible employees
  • Contractor payments that look like employment
  • Missing signed employment documents

Quick fixes

  • Run a payroll compliance audit and close gaps
  • Standardize employment documentation
  • Create a contractor compliance checklist (TDS, GST, agreements)

Our Payroll Processing and Employment Laws practice can help set up a compliant multi-state payroll system: https://perfectaccounting.in/our-services/france-offers-extensive-support-for-payroll-processing-and-salary-structure-optimization/

6) Key contracts and commercial risk

VC diligence is not as deep as M&A, but they still check the basics.

What they check

  • Top customer contracts and revenue concentration
  • Vendor contracts with lock-ins or penalties
  • IP assignment clauses (especially for tech startups)
  • Data protection and confidentiality clauses
  • Change of control clauses (rare in early stage, but important)

Common red flags

  • No written contracts with major customers
  • IP created by founders/employees not assigned to the company
  • One-sided indemnities or unlimited liability

Quick fixes

  • Execute missing contracts and add basic protections
  • Create an IP assignment pack for founders and key employees
  • Summarize key terms in a one-page contract matrix

7) Related party transactions and founder arrangements

Investors want transparency and clean governance.

What they check

  • Related party transactions disclosed and approved
  • Founder loans, advances, reimbursements documented
  • Rent agreements for founder-owned premises
  • Any personal expenses in company books

Common red flags

  • Material related party payments without agreements
  • Founder reimbursements without policy

Quick fixes

  • Create agreements and pricing notes
  • Clean up books and implement an expense policy

The “Red Flag to Fix Plan” (what to send investors)

If you have issues, don’t hide them. Package them.

A simple format:

  • Issue summary
  • Root cause
  • Financial exposure estimate (range)
  • Corrective action
  • Target closure date
  • Owner
  • Evidence of progress (filings, challans, revised policies)

This builds confidence and often prevents term-sheet renegotiation.

Best Takeaway

Fundraising diligence rewards companies that are boring on compliance. If your ROC filings are current, GST and TDS are reconciled, and your employment and cap table documentation is clean, you close faster and negotiate from strength.

If you want, we can help you set up a diligence-ready data room and a monthly compliance rhythm so every future round gets easier.