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

Fundraising diligence is different from M&A diligence (and thats good news)

In M&A, diligence can be exhaustive and adversarial. In fundraising, diligence is usually:

  • Time-bound: investors want speed.
  • Risk-focused: they look for deal-breakers and price/structure drivers.
  • Governance-driven: they want confidence the company can scale without compliance surprises.

The goal is not to prove youve never made a mistake. The goal is to show you:

  • track compliance,
  • disclose issues early,
  • and fix problems with a clear plan.

The VC diligence lens: what theyre really trying to answer

Most diligence questions map to four outcomes:

  1. Is the cap table clean and enforceable?
  2. Are there hidden statutory liabilities (tax/GST/labour) that will explode later?
  3. Is governance strong enough for institutional capital?
  4. Will this round face closing delays due to missing filings or approvals?

The 4 core diligence buckets (and what to prepare)

1) ROC and corporate compliance: Is the company legally tidy?

This is often the first scan because its easy to verify and signals discipline.

What VCs commonly check:

  • Incorporation documents (COI, MOA, AOA)
  • Share capital history: allotments, transfers, ESOPs
  • Annual filings: AOC-4, MGT-7/MGT-7A, ADT-1
  • DIR-12 history (director appointments/resignations)
  • Charges (if any) and satisfaction filings
  • Board and shareholder approvals for key actions

Common red flags:

  • Missed annual filings or long delays
  • Share allotments without proper PAS-3 and supporting resolutions
  • ESOP grants without compliant approvals and documentation
  • Missing signed minutes or poorly maintained statutory registers

How to fix fast:

  • Create a ROC Diligence Folder with SRNs, challans, and final PDFs
  • Run a compliance gap check and prepare a rectification plan with timelines
  • Standardize minutes and registers going forward

2) Tax and TDS: Are there hidden direct tax exposures?

Investors worry about tax exposures because they can become personal liability issues for directors and can block future exits.

What VCs commonly check:

  • Income tax returns filed on time
  • Tax assessments/notices and status of litigation
  • TDS compliance: deductions, deposits, returns, and reconciliations
  • Related party transactions and transfer pricing (where applicable)
  • Section 43B-type exposures (statutory dues not paid on time)

Common red flags:

  • TDS deducted but not deposited (or deposited late)
  • Repeated mismatches in 26AS/TDS returns
  • Unresolved notices or unclear responses
  • Aggressive expense positions without documentation

How to fix fast:

  • Prepare a Tax Position Memo: issues, amounts, status, next steps
  • Reconcile TDS ledgers with returns and challans
  • Document related party pricing and approvals

3) GST: Is indirect tax compliance scalable?

GST diligence is often sharper than founders expect because GST issues can create immediate cash outflows.

What VCs commonly check:

  • GST registrations (state-wise) and returns filing status
  • Output vs input reconciliation (GSTR-1, GSTR-3B, 2B/2A)
  • E-invoicing applicability and compliance
  • ITC eligibility and reversals
  • Vendor compliance risk (blocked credits due to vendor defaults)

Common red flags:

  • Large unreconciled differences between GSTR-1 and 3B
  • ITC claimed without 2B support
  • Export/SEZ documentation gaps (if applicable)
  • Notices for mismatch, late filing, or classification disputes

How to fix fast:

  • Run a month-wise GST reconciliation and keep it in the data room
  • Create an ITC policy note (eligibility, approvals, documentation)
  • Maintain a vendor compliance tracker for high-value vendors

4) Labour and payroll compliance: Will employee issues become liabilities?

Investors look for labour compliance because it affects brand risk, attrition, and statutory liabilities.

What VCs commonly check:

  • PF/ESI registrations and monthly compliance
  • Professional tax, labour welfare fund (state-specific)
  • Shops & Establishment registration
  • Employee contracts, offer letters, HR policies
  • Contractor arrangements and classification risk

Common red flags:

  • PF/ESI not applied correctly or delayed deposits
  • Heavy contractor usage without proper agreements
  • Missing employment documentation and policy gaps
  • Gratuity provisioning not considered where applicable

How to fix fast:

  • Prepare a Payroll Compliance Pack: registrations, challans, returns
  • Standardize employment templates and contractor agreements
  • Document classification rationale (employee vs consultant)

The diligence data room: a practical folder structure

A clean data room accelerates closing. Suggested structure:

  • 01 Corporate & ROC
    • COI/MOA/AOA
    • Share capital and ESOP documents
    • Annual filings (AOC-4, MGT-7/7A, ADT-1)
    • Minutes and registers
  • 02 Tax & TDS
    • ITRs, computation, notices
    • TDS returns and challans
    • Tax position memo
  • 03 GST
    • Registrations
    • Returns + reconciliations
    • Notices and responses
  • 04 Labour & Payroll
    • PF/ESI/PT compliance
    • Employment templates and policies
    • Contractor agreements
  • 05 Key Contracts
    • Customer/vendor contracts
    • IP assignments, NDAs
    • Leases and related party agreements

The Founders diligence narrative: how to present issues without panic

If you have gaps (most companies do), present them like this:

  • What happened (fact-based)
  • Impact range (estimated exposure)
  • Current status (filed/paid/responded)
  • Fix plan (timeline + owner)

This approach builds trust and reduces last-minute renegotiation.

Common deal delays (and how to avoid them)

  1. Cap table inconsistencies (share allotments not properly filed)
  2. Missing Board/shareholder approvals for ESOPs or related party items
  3. Unreconciled GST leading to uncertain liabilities
  4. TDS non-compliance creating immediate exposure
  5. Employment documentation gaps causing HR risk flags

How Perfect Accounting can help

We support fundraising readiness and diligence response so your round doesnt stall:

  • Pre-diligence compliance health check (ROC, tax, GST, payroll)
  • Data room setup with a clean index and document checklist
  • Diligence Q&A support and issue tracker management
  • Fix plan execution support (filings, reconciliations, documentation)

Explore our Accounting and Compliance support: https://perfectaccounting.in/our-services/europes-top-firms-trust-our-tax-management-services-for-accurate-tax-returns-and-bank-reconciliations/

And our Corporate Secretarial Services for ROC and governance hygiene: https://perfectaccounting.in/our-services/dallas-experts-manage-bank-account-operations-and-asset-valuation-seamlessly/

 

Final Tip

Fundraising diligence rewards preparedness, not perfection. If your filings are organized, reconciliations are ready, and issues are disclosed with a fix plan, youll move faster, negotiate from strength, and reduce the risk of term sheet surprises.