Post-investment due diligence in India is crucial
Deepak Bhawnani

Over the past few decades, India’s business landscape has witnessed a steady rise in fundraising via private equity (PE) transactions. Startups, across verticals, have immensely benefited from the increased inflow of funds, with some having attained unicorn status.  Even in the post-pandemic era, the startup ecosystem in India received over $17 billion from venture capital (VC) firms in the first half of 2021. 

 In this competitive, yet volatile, business environment, PE and VC firms know that sustaining a competitive edge begins once the business investment or acquisition is concluded, as the name of the fund is constantly linked to the investee entity and its promoters. Due diligence is not forensic science and is never perfect, but is probably the primary way to assess the reality of an investee company and its promoters. Even with nominee director representation, investees may not provide all relevant details once the investment is in place. 

 While promoters of a portfolio company may have been subject to pre-investment due diligence, the situation could change. Proactive post-investment due diligence is still not a norm, so any regulatory issues, litigation, fraud and other fall-outs, including inter-personal issues between promoters, impact the reputation of the investor as well. 

 Companies should assess risks based on the level of technology investment, cyber-security protocols, and environmental, social and governance (ESG) commitment. The 'G' for governance covers an array of domestic and international regulatory compliance regulations, politically-exposed persons (PEP), and sanctions cheques, filings and declarations, which are mandatory. 

 Various documents are updated or amended post investment. Contracts, including but not limited to, client agreements/ service level agreement (SLAs); loans, liens, mortgages; insurance policies; employment letters and business development commitments need to be revisited periodically. The provisions, benefits, and policies pertaining to employees require reassessment. In terms of financial reporting, quarterly MIS, annual reports, auditor reports and director reports should be reviewed. Intellectual Property like trademarks, copyrights, patents, whether in the name of the promoter or entity, must be looked into. The status of existing litigation and new notices should be assessed to ensure effective legal recourse and liability. Company licenses and registration requirements help in maintaining regulatory compliance. Any changes in shareholder agreements and board resolutions call for a review. 

 We have seen that some promoters change focus after receiving the investment funds. Overconfidence, pressure to deliver, rapid hiring for expansion (without proper protocols and checks being followed), and various other factors reduce regulatory and compliance adherence. In addition, wasteful spending and new or undisclosed related party transactions may facilitate leakage. This is where consistent monitoring becomes relevant. 

 If strategised and executed well, periodic and targeted rescreening in the form of due diligence and risk monitoring, would give confidence to investors that their investee is operating with integrity. Let’s deep dive into some critical elements that ought to be a part of post-investment strategic due diligence. 

 Only a handful of PE firms in India initiate an update to their integrity due diligence process. Scheduling post-investment integrity due diligence as a proactive measure can be set on a specific timeline, for example, once every two or three years, or prior to releasing an additional round of investment, or planning a strategic sale or an Initial Public Offering (IPO). These early warning programmes help detect, alert and manage potential adverse events. Maintaining oversight of the ongoing monitoring of portfolio companies and ensuring agreed compliance standards with a risk-based approach increases success rates. 

 Additionally, due diligence monitoring reports aptly support VC and PE funds by providing relevant information on governance standards. These reports would highlight any leakage of funds, conflict issues, parallel or competitive ventures by the promoters, litigation, enforcement, regulatory compliance checks, and various other flags. Moreover, such strategic intelligence reports are cost-effective with a short turnaround time. 

 Post-investment, an entity is empowered to expand with new service lines, additional offices, multiple jurisdictions, and a ramp-up of senior professionals to augment the team. Together, these add to business risk and hence, monitoring malfeasance, attrition, litigation and market perception becomes critical. 

 None of these elements can be treated with laxity or a mindset of ‘let's grow fast and clean up later’.  In addition, identifying red flags pertaining to credit exposure of the investee company, and developing processes help respond in preventive situations. 

 Post-investment due diligence provides an early warning regarding the status of the portfolio entity, helping investors keep their investments safer and profitable, with reputational repercussions mitigated. 

Deepak Bhawnani is the Founder and CEO of Alea Consulting, which works in risk mitigation and fraud investigations. Bhawnani is available at deepak@alea.asia 

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