8. Due Diligence Process - What Investors Actually Check¶

8.1 Executive Summary¶

Due diligence is mutual validation, not interrogation: Investors verify claims and assess risks; founders evaluate investor capability and cultural fit. Both parties are making multi-year partnership decisions.
Preparation reduces timeline by 50%: Clean data rooms with organized documentation cut DD from 6-8 weeks to 3-4 weeks. Speed creates competitive advantage in fundraising.
Legal and financial DD dominate Indian transactions: 60% of DD effort focuses on compliance (ROC filings, tax returns, FEMA, contracts) vs 40% on product/market in US deals. Indian regulatory complexity drives this.
Customer references matter more than founders expect: 70% of investors conduct customer calls; negative references kill 15-20% of deals in late stages. Prepare customers in advance.
Red flags in DD are negotiation leverage: Findings become post-term-sheet negotiating points for price adjustments, earnouts, or escrows. Clean DD reduces investor ability to renegotiate terms.
Founder due diligence on investors is equally critical: Check reference calls with 3-5 portfolio founders; ask hard questions about board dynamics, down-round behavior, and value-add claims.

Due diligence typically spans 3-6 weeks and covers six domains: financial, legal/compliance, product/technology, commercial/market, team/HR, and tax. This chapter provides detailed checklists and preparation strategies for each domain, with Indian regulatory context throughout.

8.2 Due Diligence Overview: Purpose and Timeline¶

What Is Due Diligence?¶

Due diligence (DD) is the comprehensive investigation investors conduct between term sheet signing and final documentation/closing. The term sheet establishes binding exclusivity (no-shop period) during which investors validate all claims made in pitch materials and assess risks that could impact valuation or deal structure.

Primary Objectives:

Verification: Confirm accuracy of financials, metrics, and representations made during fundraising
Risk Assessment: Identify legal, financial, operational, or regulatory risks that could impact company value
Deal Structuring: Uncover issues requiring special provisions in Shareholders' Agreement (escrows, earnouts, indemnities)
Partnership Evaluation: Assess founder competence, team quality, and cultural fit for long-term collaboration

Common Misconception: DD is NOT final decision on whether to invest (that decision was made at term sheet stage). DD is confirmatory validation and risk quantification. Material adverse findings can kill deals, but most DD results in price adjustments or protective provisions rather than deal termination.

Typical Timeline and Phases¶

Phase 1: Data Room Access (Week 1)

Founder uploads comprehensive documents to secure virtual data room (Google Drive, Dropbox, or specialized platforms like Carta, Capshare, or DealRoom)
Investor reviews initial documents and generates question list
Preliminary customer reference list provided

Phase 2: Document Review and Q&A (Weeks 1-3)

Investor reviews financials, contracts, corporate records, compliance documents
Email Q&A exchanges on specific findings or gaps
Specialized DD teams engaged (legal counsel, tax advisor, technical consultant)

Phase 3: Management Meetings and Deep Dives (Weeks 2-4)

Management presentations on product, technology, sales, operations
Customer reference calls (5-10 customers)
Technical/product demo and architecture review
Employee interviews (optional, more common at later stages)

Phase 4: Third-Party Verification (Weeks 2-4, parallel)

Financial audit (if not already completed)
Legal counsel review of contracts, compliance, IP
Background checks on founders and key executives
Technical due diligence by investor's CTO or external consultant

Phase 5: Issue Resolution and SHA Drafting (Weeks 3-6)

Red flags and findings presented to founders
Negotiation on material issues (price adjustments, escrows, representations/warranties)
Shareholders' Agreement drafting begins based on term sheet
Final board approvals secured

Total Timeline:

Fast track (prepared company): 3-4 weeks
Standard: 4-6 weeks
Complex (regulatory issues, cross-border, distressed): 6-10 weeks

India vs US Comparison: Indian DD takes 25-40% longer than US equivalents due to:

FEMA compliance verification for foreign investment
Tax and ROC filing review (higher penalty risk for non-compliance)
Multiple entity structures (holding companies, subsidiaries) more common
Less standardized document practices requiring custom review

What Investors Actually Care About¶

Investor Priority Ranking (Based on Survey of 50+ Indian VCs):

Financial Accuracy (30% weight): Are revenue and burn numbers accurate? Do unit economics hold up under scrutiny?
Legal Compliance and IP (25% weight): Are all filings current? Is IP properly assigned? Any litigation risk?
Customer Validation (20% weight): Do customer references confirm product value and founder credibility?
Market Position (15% weight): Is competitive positioning accurate? Can market size claims be substantiated?
Team and Culture (10% weight): Are key hires competent? Any founder/co-founder conflicts? Cultural red flags?

What Kills Deals in DD (Ranked by Frequency):

Financial misrepresentation (35%): Revenue recognition errors, overstated metrics, hidden liabilities
Legal/IP issues (25%): IP not assigned to company, pending litigation, incomplete contracts
Customer dissatisfaction (15%): References reveal churn risk, product quality issues, or founder integrity concerns
Founder conflicts (10%): Co-founder equity disputes, key employee departures, cultural toxicity
Regulatory non-compliance (10%): Missing ROC filings, tax defaults, FEMA violations
Market size inflation (5%): Unsupportable TAM claims, competitive positioning inaccurate

Note: Most DD findings result in negotiated remedies (price reduction, escrows, earnouts) rather than deal termination. Only material misrepresentation or fraud typically kills deals outright.

8.3 Domain 1: Financial Due Diligence¶

Core Financial Documents Required¶

Mandatory Documents:

Audited Financial Statements (Last 2-3 Years)
Profit & Loss Statement
Balance Sheet
Cash Flow Statement
Auditor's Report and Notes
India Requirement: Mandatory for companies with revenue >Rs 1 crore or raising FDI
Management Accounts (Monthly, Last 12-24 Months)
Monthly P&L by business unit/product line
Monthly cash flow actuals vs plan
Month-by-month burn rate and runway
Investor Focus: Month-to-month trends, seasonal patterns, acceleration/deceleration
Cap Table and Option Ledger
Complete capitalization table showing all shareholders
Share class details (common, CCPS, preferences)
Option pool: grants outstanding, vesting schedules, strikes
Convertible notes or SAFEs (if applicable)
Critical: Cap table must reconcile with ROC filings and share register
Financial Model and Projections
3-5 year revenue and expense projections
Detailed assumptions by line item
Scenario analysis (base, upside, downside)
India Context: RBI valuation certificate must align with projections
Revenue Documentation
Customer contracts or purchase orders
Invoices for last 12 months (at minimum top 20 customers)
Payment terms and collection patterns
For SaaS: ARR/MRR reconciliation, churn analysis, cohort retention
Banking and Debt
12 months bank statements (all accounts)
Loan agreements and debt schedules
Outstanding payables and receivables aging
For Venture Debt: Existing debt covenants and warrant coverage

Key Financial Metrics Investors Verify¶

Revenue Metrics (SaaS):

Annual Recurring Revenue (ARR) and Monthly Recurring Revenue (MRR)
Net Revenue Retention (NRR) or Net Dollar Retention
Gross Churn and Net Churn by cohort
Average Revenue Per User (ARPU)
Customer Acquisition Cost (CAC) and Lifetime Value (LTV)

Verification Process:

Investor Request: "Please provide MRR reconciliation for last 12 months showing:
- Beginning MRR
- New MRR (new customers)
- Expansion MRR (upsells/cross-sells)
- Contraction MRR (downgrades)
- Churn MRR (cancellations)
- Ending MRR

Plus: Supporting invoices for top 20 customers and Stripe/payment gateway export."

What Investor Is Checking:
1. Does MRR reconciliation math add up?
2. Are all new customers in MRR actually paying (or just trials/pilots)?
3. Is churn rate consistent with pitch deck claims?
4. Do payment gateway totals match claimed MRR?

Marketplace/E-Commerce Metrics:

Gross Merchandise Value (GMV)
Take rate (revenue as % of GMV)
Order frequency and repeat purchase rate
Contribution margin (revenue - variable costs) per order

Verification: Investors will request transactional data extracts from databases, payment gateways (Razorpay, Stripe), and logistics partners to independently verify GMV claims.

Unit Economics:

Customer Acquisition Cost (CAC) by channel
CAC Payback Period (months to recover CAC from customer revenue)
LTV:CAC ratio (target: 3:1 or better)
Gross Margin and Contribution Margin per customer/order

Common Red Flags:

🔴 CAC payback >18 months without path to improvement
🔴 LTV:CAC ratio <1.5:1 (customer value less than acquisition cost)
🔴 Gross margins <40% for SaaS, <20% for e-commerce
🔴 Improving metrics solely through unsustainable discounting

Financial Red Flags That Kill Deals¶

Material Misrepresentation (Deal Killers):

Revenue Recognition Fraud:
Recording pilots/trials as paid revenue
Recognizing full contract value upfront instead of ratably
Round-tripping (selling to entity you control to inflate revenue)

Case Study: Indian edtech startup claimed Rs 15 crore ARR to raise Series A. DD revealed Rs 8 crore was from pilots with no signed contracts and Rs 3 crore from distributor who hadn't actually sold to end customers. Investor withdrew term sheet citing material misrepresentation.

Hidden Liabilities:
Undisclosed debt or guarantees
Pending litigation not mentioned in pitch
Outstanding tax liabilities or penalties
Vendor payables >90 days significantly understated
Fake Customers or Inflated Metrics:
Customer references who are friends/family, not real users
Paid user counts including free/inactive accounts
GMV inflated by test orders or promotional give-aways

Negotiable Issues (Price Adjustments or Protective Provisions):

Working Capital Deficits:
Negative working capital (liabilities > assets) requiring immediate cash infusion
Solution: Reduce valuation or structure investment as working capital tranche + growth tranche
Customer Concentration Risk:
30% revenue from single customer or >50% from top 3 customers
Solution: Earnouts tied to customer diversification or revenue concentration provisions
Burn Rate Higher Than Represented:
Actual burn 20-30% higher than pitch deck projections
Solution: Reduce post-money valuation to account for shorter runway

How to Prepare: Financial DD Checklist¶

Pre-DD Preparation (4-6 Weeks Before Term Sheet):

✅ Get Financial Audit Completed

Engage reputable CA firm for statutory audit if revenue >Rs 1 crore
Cost: Rs 50,000-Rs 3 lakh depending on complexity
Timeline: 2-4 weeks
Ensure audited financials match management accounts (reconcile discrepancies before investor sees)

✅ Create Revenue Reconciliation

Build Excel reconciling MRR/ARR claims to invoices and payment gateway reports
Document revenue recognition policies (when do you recognize revenue?)
For SaaS: Reconcile deferred revenue on balance sheet to contracted ARR

✅ Organize Financial Model

Ensure projections match pitch deck numbers
Document all assumptions with footnotes and sources
Build sensitivity analysis (what if revenue 20% lower?)
Maintain version control (investors will compare latest model to pitch deck model)

✅ Clean Up Cap Table

Verify cap table matches ROC filings (Form PAS-3) and share register
Reconcile all option grants to employment agreements
Update vesting schedules to current date
Use Carta, Capshare, or Eqvista for professional cap table management

✅ Prepare Unit Economics Documentation

Calculate CAC by channel with supporting data (ad spend, headcount allocation)
Calculate LTV with cohort analysis (not just ARPU × assumed lifetime)
Build customer cohort retention curves (% of customers active after 1 mo, 3 mo, 6 mo, 12 mo, 24 mo)

8.4 Domain 2: Legal and Compliance Due Diligence¶

Indian Corporate Compliance Documentation¶

Mandatory ROC Filings (Companies Act 2013):

Certificate of Incorporation and Amended AoA
Form PAS-3 (Return of Allotment) for every funding round with 15-day timeline
Form MGT-14 (Special Resolution filings) for capital raises, AoA amendments
Form AOC-4 (Annual Financial Statements) - due 30 days after AGM
Form MGT-7 / MGT-7A (Annual Return) - due 60 days after AGM
Board and Shareholder Meeting Minutes - all meetings since incorporation

Investor Verification Process:

Investor requests MCA login credentials or extract from MCA21 portal showing:
- Complete filing history with dates
- Any pending or delayed filings
- Penalties paid for late filings
- Changes in directors, registered office, authorized capital

Investor is checking:
1. Are all required filings current and timely?
2. Any pattern of non-compliance or late filings?
3. Do filed financials match management accounts provided?
4. Any undisclosed related party transactions in filed documents?

FEMA Compliance (Foreign Investment):

Form FC-GPR (filed within 30 days of each foreign investment)
Form FC-TRS (filed for any share transfers to/from non-residents)
Form FLA (Annual Return on foreign assets/liabilities - due July 15)
RBI Valuation Certificates (for each foreign investment round)
Press Note 3 Clearances (if applicable for land-bordering country investors)

Common FEMA Violations Found in DD:

🔴 Late FC-GPR filing (most common - found in 30-40% of startups)
🔴 Missing FLA annual returns (penalty Rs 7,500 + potential 3x investment amount)
🔴 Down round without proper RBI valuation justification
🔴 Using investment funds before FC-GPR filing completed (2024 Section 42 amendment violation)

Investor Action if FEMA Violations Found:

Require compounding application to RBI before closing (adds 2-3 months)
Escrow portion of investment until violations resolved
Representations and warranties in SHA holding founders liable for penalties
In severe cases: Withdraw term sheet if government approval required but unlikely

Tax Compliance:

Income Tax Returns (last 3 years) - Form ITR-6 for companies
TDS Returns (Form 24Q, 26Q, 27Q) - quarterly filings
GST Returns (GSTR-1, GSTR-3B) - monthly filings
TDS Certificates (Form 16A) for all employee and contractor payments
Angel Tax Compliance (Section 56(2)(viib) exemption documentation if applicable pre-2025)

DPIIT Recognition and Tax Benefits:

If company is DPIIT-recognized:

DPIIT Certificate of Recognition
Section 80-IAC Certificate from Inter-Ministerial Board (if applicable)
Documentation of tax benefit utilization
Compliance with DPIIT eligibility requirements (turnover <Rs 100 crore, <10 years old)

Intellectual Property Due Diligence¶

Critical IP Documentation:

IP Assignment Agreements - All founders, employees, contractors assign IP to company
Patent Applications and Grants (if any)
Trademark Registrations (company name, brand, logo)
Copyright Registrations (software, creative works)
Domain Name Registrations (who owns company domains?)
Open Source License Compliance (list of all OSS used and license types)

Most Common IP Red Flag (Found in 60%+ of Seed-Stage Startups):

🔴 Founder/Employee IP Not Properly Assigned

Scenario:

Founders built initial product before incorporating company. Code developed on
personal GitHub accounts. Company incorporated later. No IP assignment agreement
executed transferring pre-incorporation work to company.

Legal Risk:
- Founders technically own IP personally, not company
- If founder leaves, could claim ownership of codebase/technology
- Acquirer won't buy company without clean IP title
- Investors won't fund without IP clarity

Solution Required:
- Execute backdated IP assignment agreements with all founders
- Includes all work product from inception, not just post-incorporation
- Filed with company records
- Lawyer Review: Essential (cost Rs 25,000-Rs 1 lakh)

Open Source Compliance:

Investors increasingly scrutinize open source usage:

GPL-licensed code requires making derivative works open source (toxic for proprietary software)
AGPL extends GPL to SaaS (more restrictive)
MIT/Apache licenses are permissive (generally acceptable)
Undeclared GPL usage found in DD can kill enterprise SaaS deals

Preparation: Run open source scanning tools (Black Duck, WhiteSource, Snyk) to identify all OSS dependencies and flag GPL/copyleft licenses. Budget Rs 50,000-Rs 2 lakh for OSS audit by specialized firm if product is complex.

Material Contracts Review¶

Contracts Investors Always Request:

Customer Contracts (top 10-20 by revenue)
Payment terms, cancellation clauses, SLAs, liability caps
Any unusual obligations or terms?
Auto-renewal provisions
Vendor/Supplier Contracts (material vendors >Rs 5 lakh annual spend)
Cloud infrastructure (AWS, GCP, Azure) agreements
Critical SaaS tools (Salesforce, analytics, etc.)
Payment processors, logistics partners
Partnership and Channel Agreements
Revenue share terms
Exclusivity clauses
Territory restrictions
Lease Agreements (office space, equipment)
Termination clauses, security deposits
Any personal guarantees by founders? (red flag)
Loan Agreements and Debt Instruments
Venture debt terms, covenants, warrants
Bank credit facilities
Director loans (related party transactions)

What Investors Are Checking:

✅ Customer contracts are standard form without unusual liabilities
✅ No "change of control" provisions allowing customers to terminate upon funding or acquisition
✅ No personal guarantees by founders creating liability
✅ Vendor contracts can be terminated with reasonable notice (not locked into 5-year non-cancellable)
✅ No IP ownership claims by customers in contracts

Litigation and Disputes¶

Complete Disclosure Required:

Pending Litigation - Any lawsuits filed by or against company
Regulatory Notices - Tax notices, ROC notices, labor department notices
Arbitration or Mediation - Ongoing disputes even if not in court
Threatened Litigation - Demand letters, cease-and-desist notices received
Former Employee/Founder Disputes - Equity disputes, IP claims

Even Small Claims Matter:

Investors view litigation as distraction and risk. A Rs 5 lakh vendor dispute may seem trivial to founders but signals poor contract management or relationship issues to investors.

Disclosure Strategy: Proactively disclose all litigation/disputes in data room with:

Current status and timeline
Financial exposure (maximum liability)
Management's assessment of likelihood of adverse outcome
Legal opinions if material dispute

Hidden litigation discovered in DD destroys founder credibility and often kills deals.

8.5 Domain 3: Product and Technology Due Diligence¶

Product Demo and Architecture Review¶

Standard Product DD Process:

Step 1: Investor Demo (1-2 Hours)

Founders demonstrate product live (not just slides/video)
Walk through key user journeys and features
Show admin/backend dashboards with real data
Demonstrate mobile app and web responsiveness

Step 2: Investor Self-Service Trial

Investor receives demo account with real (or realistic synthetic) data
Investor tests product independently over 1-2 weeks
Investor identifies bugs, UX issues, performance problems
Investor compares product claims to actual functionality

Step 3: Technical Architecture Review (Series A and beyond)

Technology stack documentation (languages, frameworks, databases, cloud infrastructure)
System architecture diagram (how components interact)
Scalability plan (can system handle 10x users? 100x?)
Security architecture (authentication, encryption, data protection)

Step 4: Code Review (Series B+ or technical investors)

Access to Git repository (GitHub, GitLab, Bitbucket)
Code quality assessment (automated tools like SonarQube)
Technical debt evaluation
Development practices (CI/CD, testing coverage, code review process)

What Investors Assess:

✅ Product-Market Fit Signals:

Is product solving real problem? (validated through customer calls)
Is UX intuitive and polished or rough prototype?
Do customers use product regularly or occasionally?
Are features aligned with customer requests or founder assumptions?

✅ Technical Quality:

Is codebase maintainable or spaghetti code?
Is architecture scalable or will it break at 10x growth?
Is security adequate for enterprise customers?
Is technical team size appropriate for product complexity?

🔴 Red Flags:

Product demo requires extensive "explaining" (UX is confusing)
Significant bugs or crashes during investor testing
Product doesn't match pitch deck claims or screenshots
Technical architecture is "MVP prototype" with no path to production-grade
Entire codebase written by outsourced agency with no in-house technical ownership

Technical Due Diligence Case Study: SaaS Platform¶

Background: HR-tech SaaS startup raising Rs 24 crore Series A. Pitch deck claimed 150 paying customers, Rs 2.4 crore ARR, enterprise-grade security.

DD Process:

Product Demo:
Investor tested platform over 1 week
Found significant UX issues (multi-step workflows taking 10+ clicks)
Performance problems (page loads >5 seconds)
Mobile app non-functional (crashes on Android)
Architecture Review:
Single monolithic application (no microservices)
Single database instance (no redundancy or failover)
No auto-scaling (manual server provisioning required for growth)
Hosted on single AWS region (no geographic redundancy)
Security Audit:
No SOC 2 compliance or ISO 27001 certification
Basic password authentication (no 2FA/MFA)
Customer data not encrypted at rest
No regular security audits or penetration testing

Investor Findings:

✅ Positive:

Core functionality worked and delivered value to customers
Customer references validated that despite UX issues, product solved real problem
Technical team was competent, just under-resourced

🔴 Concerns:

Technical debt would require 6-12 months to address before scaling
Enterprise customers required security certifications startup didn't have
Mobile app needed complete rebuild (significant cost)

Outcome:

Investor didn't walk away but negotiated:

Price Reduction: 15% lower valuation to account for technical debt remediation costs
Milestones: 50% of funding released upfront; 50% released after SOC 2 audit completed and mobile app rebuilt (6-month milestone)
Technical Leadership: Required hiring VP Engineering as condition of funding
Revised Use of Funds: Allocated Rs 4 crore specifically to technical infrastructure and security (investor oversight)

Lesson: Technical DD findings created negotiation leverage for investor. Clean technical foundation prevents these issues.

How to Prepare: Product/Technical DD¶

4-6 Weeks Before Term Sheet:

✅ Professional Product Demo Environment:

Create polished demo account with realistic sample data (not "Test User 123" and "ABCD Corp")
Fix known bugs and UX issues in demo environment
Optimize performance (page load times, responsiveness)
Test on multiple devices and browsers
Prepare demo script highlighting key features and differentiators

✅ Document Technical Architecture:

Create system architecture diagram (use tools like Lucidchart, Draw.io)
Document technology stack with versions
Prepare scalability plan (how system will handle 10x, 100x growth)
Document security practices (authentication, authorization, data encryption)
If applicable: SOC 2, ISO 27001, GDPR compliance documentation

✅ Code Quality Improvements:

Run automated code quality tools (SonarQube, CodeClimate)
Address critical bugs and security vulnerabilities
Improve test coverage (aim for >60% for core modules)
Document development practices (code review, CI/CD, deployment process)

✅ Address Technical Debt Proactively:

Identify known technical debt items
Create remediation plan with timeline and cost estimates
Disclose in data room rather than hiding (investors will find it)

8.6 Domain 4: Commercial and Market Due Diligence¶

Customer Reference Calls¶

Standard Process: Investor requests 5-10 customer references representing different segments, use cases, and deal sizes. Investor schedules 20-30 minute calls with each reference.

What Investors Ask Customers:

Problem and Solution Validation:
"What problem were you trying to solve when you bought [Company]'s product?"
"What alternatives did you evaluate?"
"Why did you choose [Company] over competitors?"
Product Value and Satisfaction:
"On a scale of 1-10, how satisfied are you with the product?"
"What do you love about it? What frustrates you?"
"How frequently do you use it? What's adoption like across your organization?"
Founder and Team Assessment:
"What's it like working with the [Company] team?"
"How responsive are they to feedback and support requests?"
"Would you describe the founders as trustworthy and competent?"
Retention and Growth Signals:
"What's the likelihood you'll renew your contract? (1-10)"
"Would you increase your usage/spend if [feature] was available?"
"Would you recommend [Company] to a peer in your industry?"
Competitive Positioning:
"How does [Company] compare to [Competitor X] and [Competitor Y]?"
"What would make you switch to a competitor?"

What Kills Deals in Customer Calls:

🔴 Churn Risk Signals:

"We're evaluating alternatives" or "Probably won't renew"
"Product hasn't delivered expected ROI"
"We don't use it much anymore"

🔴 Founder Integrity Concerns:

"They over-promised and under-delivered"
"Support has been unresponsive"
"Felt misled during sales process"

🔴 Product Quality Issues:

"Lots of bugs and crashes"
"Features promised 6 months ago still not delivered"
"UX is terrible; users resist adopting it"

Positive Signals Investors Love:

✅ "We'd be lost without it; it's mission-critical"
✅ "Founders are incredibly responsive and customer-obsessed"
✅ "We're planning to expand usage to other departments"
✅ "We've recommended them to 3-4 other companies already"

How to Prepare Customer References¶

8 Weeks Before Fundraising:

Identify Reference Candidates:
Choose 8-12 customers (investor will select 5-7 from list)
Mix of segments: enterprise, mid-market, SMB
Mix of tenure: recent customers + long-term customers
Include at least 1-2 "lighthouse" customers (impressive brand names)
Pre-Call with Customers:
"We're raising Series A and investors will likely call you as a reference"
"Would you be comfortable speaking with them?"
"Here's what they typically ask..." (share sample questions)
"Please be honest—they want authentic feedback, not a sales pitch"
Prep Call Talking Points:
Remind customer of results they've achieved with your product (quantify: "You mentioned we saved you 20 hours per week")
If customer has concerns, address proactively before investor calls
Provide Reference List to Investor:
Customer name, title, company
Contact information (email, LinkedIn)
Brief context: "Sarah leads HR at TechCorp. They've been using our platform for 18 months across 200 employees. Use case: automated onboarding."

Red Flags to Avoid:

🔴 NEVER provide only "friendly" references (friends/family/investors as customers) Investors will ask for references beyond your provided list. If you resist, it signals you're hiding dissatisfied customers.

🔴 NEVER coach customers to give scripted answers Investors can tell when references are rehearsed. Authentic enthusiasm is more convincing than sales pitches.

🔴 NEVER hide churned customers Investors will ask: "Have any customers churned? Can we speak with 1-2?" Transparency builds trust.

Market Sizing and Competitive Analysis Verification¶

Investors Verify TAM/SAM/SOM Claims:

Pitch Deck Claim: "We're addressing a $50 billion TAM in the Indian HR-tech market, with a $5 billion SAM for our SMB segment."

Investor Verification:

Requests source for $50B claim (Gartner, McKinsey, etc.)
Checks if source actually says $50B for India (often founders use global TAM)
Analyzes whether $5B SAM is reachable (do you have distribution to reach entire SMB market?)
Compares to competitive funding and market share (if 10 competitors raised $500M combined, is there really $5B available?)

Common Inflations Investors Catch:

🔴 Using global TAM when only operating in India
🔴 Including adjacent markets not actually served (claiming "HR-tech" TAM when only doing payroll)
🔴 Top-down calculations without bottom-up validation ("$50B TAM" / "We'll capture 2%" is lazy)

Competitive Analysis Deep Dive:

Investors independently research competitors:

Check competitors' websites, pricing, features
Request competitive battle cards or loss analysis ("Why do you lose to Competitor X?")
Conduct market calls with industry experts, analysts, or customers using competitors
Compare your claims about differentiation to actual feature comparison

If Competitive Positioning Is Inaccurate:

Investors will call out discrepancies:

"You claimed to be only solution with X feature, but Competitor Y's website shows they offer it"
"Your pricing is 40% higher than competitors—how do you justify premium?"
"Customers mentioned they prefer Competitor Z for enterprise deals—why?"

Best Practice: Honest, nuanced competitive assessment wins more credibility than claiming superiority in all dimensions. Acknowledge competitor strengths and articulate specific positioning:

✅ "Competitor X has better brand and larger sales team, but we have superior product for SMB segment and faster time-to-value"

8.7 Domain 5: Team and HR Due Diligence¶

Founder Background Verification¶

Standard Checks:

Employment History Verification:
LinkedIn profile accuracy
References from former employers (sometimes checked for senior hires)
Verification of claimed titles and responsibilities
Education Verification:
Degree authenticity (especially for IIT/IIM claims)
Graduation year, major, honors
Legal Background Checks:
Criminal record check
Civil litigation history
Bankruptcy filings
Regulatory violations or sanctions
Social Media and Reputation:
Google search for negative news articles
Twitter/LinkedIn for controversial statements
Glassdoor for employee reviews (if applicable)

Red Flags:

🔴 Resume Fraud: Claiming degrees not earned, embellishing titles, overstating achievements. Even small dishonesty discovered in DD kills deal immediately.

🔴 Undisclosed Legal Issues: Pending litigation, regulatory violations, or criminal history not disclosed. Investors expect complete transparency.

🔴 Reputation Concerns: Pattern of burning bridges with former employers, investors, or co-founders. Industry reputation matters.

Employee and Advisor Due Diligence¶

Documents Requested:

Complete Employee List:
Name, title, start date, salary, equity grants
Employment status (full-time, contractor, intern)
Department and reporting structure
Employment Agreements:
All founders, executives, and key employees (sample for others)
Verify IP assignment clauses present
Verify non-compete and non-solicitation provisions (if applicable)
Verify at-will employment or notice periods
Option Grant Documentation:
Grant letters for all option holders
Vesting schedules current
Option pool utilization (how much granted vs remaining)
Advisor Agreements:
Who are advisors and what equity have they received?
Are they actively contributing or "zombie advisors" (equity with no value-add)?
Verify advisor equity is reasonable (<0.5% for most advisors)

What Investors Assess:

✅ Team Quality:

Are key roles filled by competent people?
Is there domain expertise in critical functions (product, sales, engineering)?
Has team stayed stable or high turnover?

✅ Compensation Benchmarking:

Are salaries competitive for market? (Not underpaying to inflate runway)
Is equity distribution reasonable? (Not >10% granted to early non-critical employees)

🔴 Red Flags:

High employee turnover (>30% annual attrition signals cultural problems)
Key employees without equity incentives (flight risk)
Over-generous early grants (advisor with 2% for minimal contribution)
Undisclosed related party hiring (spouse, family members on payroll)

Founder Relationship and Co-Founder Dynamics¶

Investor Assessment Through Informal Observation:

During DD, investors observe founder team dynamics:

Do founders finish each other's sentences or contradict each other?
Is there clear division of responsibilities or overlap/conflict?
Do founders have mutual respect or subtle tension?
Is decision-making collaborative or dominated by one founder?

Explicit Questions Investors Ask:

"How do you and your co-founders make major decisions? What happens if you disagree?"
"Have you had any serious conflicts? How did you resolve them?"
"What would happen if one co-founder wanted to leave?"
"Is there a formal founder agreement addressing departures?"

Red Flags That Kill Deals:

🔴 Unresolved Co-Founder Equity Disputes:

Founders disagree on equity split
One founder feels under-compensated
No founder vesting agreements (creates departure risk)

🔴 Toxic Founder Relationships:

Visible tension or disrespect
Communication breakdowns
Inability to make decisions collaboratively

Investor Action: If co-founder conflict is evident, investor may:

Require founder mediation or counseling before close
Demand founder vesting agreements with acceleration
In severe cases: Walk away entirely (team risk too high)

8.8 Domain 6: Reverse Due Diligence - Founders Evaluating Investors¶

Why Founder DD on Investors Matters¶

Venture capital is a 7-10 year partnership. Choosing the wrong investor is worse than raising at a slightly lower valuation from the right investor. Poor investors:

Micromanage operations and slow decision-making
Fight founders during down rounds (squeeze with harsh terms)
Provide no value-add beyond capital
Damage company reputation through association

Founder DD is equally important as investor DD on you.

Investor Reference Checks (MANDATORY)¶

Request 3-5 Portfolio Founder References:

Ask investor: "Can you connect me with 3-5 founders in your portfolio? I'd love to learn about their experience working with you."

What to Ask Portfolio Founders (20-30 Minute Call):

Value-Add Assessment:
"What value has [Investor] provided beyond capital?"
"Have they opened doors to customers, hires, or follow-on investors?"
"How engaged are they? Monthly calls? Quarterly? Only show up for board meetings?"
Board Dynamics:
"What are board meetings like? Collaborative or contentious?"
"Does [Investor] support your strategic decisions or frequently push back?"
"How do they handle disagreements?"
Down Round Behavior:
"If you've had challenges or down rounds, how did [Investor] respond?"
"Were they supportive or punitive?"
"Did they provide bridge capital or force harsh terms?"
Founder-Friendliness:
"On a scale of 1-10, how founder-friendly is [Investor]?"
"Would you take money from them again in your next company?"
"Any red flags or concerns I should know about?"
Responsiveness and Support:
"When you need help, how quickly does [Investor] respond?"
"Have they been helpful during crises (COVID, funding winter, product issues)?"

Ask for Both Successful and Struggling Company References:

"Can you connect me with one company that's doing great and one that's faced challenges? I want to understand how you support founders in both scenarios."

Investors who only provide successful references may be hiding their behavior in difficult situations.

Questions to Ask Investors Directly¶

Partner Background and Expertise:

"What's your background before venture capital? Operating experience?"
"What value do you personally bring beyond capital?"
"How many boards are you currently on? How much time can you dedicate to us?"

Fund and Firm Dynamics:

"What's your fund size and how much dry powder remains?"
"What's your ownership target for investments at our stage?"
"Do you lead rounds or prefer to follow? Will you lead our next round?"
"How do investment decisions work? Is it consensus or individual partner discretion?"

Follow-On Capital:

"What percentage of your fund is reserved for follow-on investments?"
"In what scenarios would you lead our Series B?"
"Have you ever declined to participate in a portfolio company's follow-on round? Why?"

Down Round Scenarios:

"What happens if we need to raise at a lower valuation than this round?"
"Would you provide bridge capital or participate in a down round?"
"How do you typically approach anti-dilution and other protections in down rounds?"

Exit Philosophy:

"What's your typical hold period before exiting?"
"Do you have a preference for IPO vs M&A exits?"
"Have you ever blocked an exit one founder wanted to pursue? Why?"

Red Flags in Reverse DD¶

🔴 Investor Refuses to Provide References: Any investor not willing to connect you with 3-5 portfolio founders is hiding something.

🔴 Negative Portfolio Founder Feedback: If references describe investor as "hands-off and unhelpful" or "micromanaging and difficult," believe them.

🔴 Partner Has Zero Operating Experience: Career VCs without startup operating experience may lack empathy for founder challenges and provide less relevant guidance.

🔴 Fund is Late in Its Life: If investor's fund raised 7-8 years ago with limited dry powder remaining, they may not have capital for your follow-on rounds and may pressure for premature exit.

🔴 Investor Pushes for Extreme Terms: Full ratchet anti-dilution, participating preferred uncapped, or investor board control at seed stage signals aggressive investor likely to fight in future.

8.9 Action Items¶

Create comprehensive data room 4-6 weeks before term sheet: Organize Google Drive or Dropbox with folders for: Corporate (ROC filings, AoA, board minutes), Financial (audited statements, management accounts, cap table), Legal (contracts, IP agreements, litigation), Product (architecture docs, security policies), HR (org chart, employment agreements, option ledger). Grant investor access incrementally as DD progresses.
Complete financial audit if revenue >Rs 1 crore: Engage CA firm for statutory audit; timeline 2-4 weeks; cost Rs 50,000-Rs 3 lakh. Ensure audited financials match management accounts and reconcile discrepancies before investor review.
Fix corporate compliance gaps: Audit all ROC filings (PAS-3, MGT-14, AOC-4, MGT-7); file any missing or late filings immediately; pay penalties proactively. Review FEMA compliance (FC-GPR, FLA) for foreign investments and compound violations if needed.
Execute IP assignment agreements with all founders and employees: Ensure all IP developed for company (including pre-incorporation work) is assigned to company; use lawyer-reviewed agreements; cost Rs 25,000-Rs 1 lakh for comprehensive IP cleanup.
Prepare 8-12 customer references: Identify mix of customer segments and tenures; conduct pre-calls explaining reference process; prep customers on sample questions but emphasize honest feedback over sales pitch.
Build professional product demo environment: Create polished demo account with realistic data; fix known bugs; optimize performance; test across devices/browsers; prepare demo script highlighting differentiation.
Document technical architecture: Create system diagram; document tech stack; prepare scalability plan; address security practices; run code quality tools (SonarQube) and remediate critical issues.
Conduct investor reference checks: Request 3-5 portfolio founder contacts from investor; schedule 20-30 minute calls; ask about value-add, board dynamics, down-round behavior, and founder-friendliness; request both successful and struggling company references.
Prepare FAQ document addressing likely DD findings: Proactively document known issues (technical debt, delayed ROC filings, customer concerns) with remediation plans; disclose in data room rather than hiding; demonstrates transparency and competence.
Engage legal counsel for DD support: Budget Rs 1 lakh-Rs 3 lakh for lawyer to review investor DD requests, coordinate document production, and handle specialized areas (FEMA compliance, IP audit, contract review).

8.10 Key Takeaways¶

Preparation cuts DD timeline by 50%: Organized data rooms with clean financials, current compliance, and proactive disclosure reduce DD from 6-8 weeks to 3-4 weeks. Speed is competitive advantage in fundraising.
Financial accuracy is non-negotiable: Revenue misrepresentation, inflated metrics, or hidden liabilities kill deals outright. Investor will independently verify claims through payment gateways, customer invoices, and transaction data.
Legal compliance matters more in India: FEMA violations (late FC-GPR, missing FLA), ROC filing gaps, and tax non-compliance found in 40%+ of startups during DD. Fix proactively or face price reductions and escrows.
IP assignment is #1 legal issue: 60%+ of seed-stage startups lack proper IP assignment from founders and employees. Execute agreements immediately covering all work from company inception, not just post-incorporation.
Customer references determine 15-20% of deal outcomes: Negative customer feedback (churn risk, product quality, founder integrity concerns) kills deals even after term sheet signed. Prepare customers but emphasize authentic feedback.
Reverse DD protects founders: Check 3-5 portfolio founder references asking about value-add, board dynamics, and down-round behavior. Choosing wrong investor worse than accepting slightly lower valuation from right investor.
Disclosure builds trust; hiding creates crises: Proactively disclose known issues (technical debt, compliance gaps, customer concerns) with remediation plans. Hidden problems discovered in DD destroy credibility and negotiation leverage.

8.11 References¶

Feld, Brad, and Jason Mendelson. Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist. 4^th ed., Wiley, 2019.
Ministry of Corporate Affairs. (2024). The Companies Act, 2013. Retrieved from https://www.mca.gov.in/
Reserve Bank of India. (2025). Master Direction on Foreign Investment in India. Retrieved from https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11200
Cooley GO. Due Diligence Checklist for Startups. Retrieved from https://www.cooleygo.com/
Carta. Due Diligence Checklist and Best Practices. Retrieved from https://carta.com/learn/cap-tables/due-diligence-checklist/
Inc42. (2024). Guide to Startup Due Diligence in India. Retrieved from https://inc42.com/resources/startup-due-diligence-guide-india/
Y Combinator. Preparing for Due Diligence. Retrieved from https://www.ycombinator.com/library

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Disclaimer¶

This chapter provides educational information about startup funding and is not legal, financial, or investment advice. Every startup situation is unique. Consult qualified professionals (lawyers, accountants, financial advisors) before making any funding decisions.

Last Updated: November 2025