4 Things Startups Must Tidy Up Before Due Diligence
At Transition Level Investments, we have four staff members conducting due diligence on startups we are looking to invest in. We’ve spotted four issues which often come up in due diligence.
If you’re planning on approaching investors in the near future, tidy up these four things before embarking on the capital raising process.
WATCH THE VIDEO —> Common Problems in Due Diligence…
Unpaid loans from founders or shareholders:
When starting a business founders often loan money to the company. Before we invest, we will usually request that the loans either be repaid, ‘forgiven’, or more commonly, converted into equity, usually on the same terms as incoming investors.
Incoming investors want to see their funds going towards growth and not necessarily repaying loans to founders.
Messy shareholdings after a founder has left:
As investors, we prefer that the majority of your shareholdings are owned by founders still working in the business.
Problems can arise when a chunk of equity is held by a founder who has left the business. In this situation, ideally the exiting founders would sell their shares back to the remaining founding team.
Prospective investors do not want to buy equity in a company where the founding team is in the position where they end up too heavily diluted down the track. This can be the case when an ex-founder has left but, retained a substantial stake in the business.
If this is the case in your startup, it is important to disclose this up front before we embark on the DD process.
Unpaid Superannuation Contributions:
Unpaid superannuation contributions are often uncovered in DD. Founders get so busy growing their business they might overlook paying their own Superannuation creating outstanding superannuation liabilities.
Before we invest, we will make sure that all outstanding superannuation liabilities are paid and/or allocated with current funds.
As prospective investors, we don’t want to be investing in a company only to have a portion of our funds go towards paying down the company’s debts.
Employees or Contractors?
Finally, another issue might arise where staff are incorrectly categorised as contractors when they are in fact employees.
Companies that do this are:
– not meeting their tax and super obligations
– denying workers their employee entitlements
– illegally reducing their labour costs and gaining an unfair advantage over their competitors.
The most important thing…
Finally, the most important thing when going in to the due diligence process is to be honest and upfront about any potential issues. Don’t wait for the issue to be discovered because it will, and it will look bad on you. Bring it to the table early so it can be resolved.