Preparing for diligence before you need to

Founders imagine diligence as a test to pass. It is closer to a negotiation input. Every issue found becomes either a price reduction, an indemnity, a holdback, or a condition, and every one of those comes out of the founders' side.

The timing problem

Diligence begins after a term sheet. The valuation is agreed. From that moment, every finding can only move the number downwards.

The same issue found six months earlier costs the price of fixing it. Found during diligence, it costs the price of fixing it plus whatever the other side extracts for having found it, plus the credibility cost of not having known.

This asymmetry is the entire argument for preparing early.

What actually gets found

The list is repetitive across transactions.

Cap table problems

Share transfers not properly recorded. Promises of equity made informally to early employees or advisers and never documented. ESOP grants without a scheme, or a scheme without approvals. Founder shares without vesting.

These are the worst to find late, because fixing them requires the cooperation of people whose leverage has just increased.

Statutory registers and filings

Registers not maintained. Board minutes written retrospectively in one sitting, which is visible. Filings made late.

Tax and GST

Unreconciled input tax credit. TDS not deducted on a category of payment. Positions taken without documented reasoning.

Contracts

Major customers on expired terms or no written contract. Key employees without proper agreements. Intellectual property developed by contractors with no assignment clause, a finding that can stop a technology deal outright.

Related party transactions

Money moving between the company and entities the founders control, without documentation, approval or commercial rationale.

What "ready" means

Being diligence-ready is not having perfect records. It is being able to answer any question in the list above within a day, from documents that already exist, with any known issue already identified and disclosed by you rather than discovered by them.

The second half matters as much as the first. An issue you disclose is a known quantity. The same issue discovered by the other side raises a question about what else was not disclosed, and that question is expensive.

A twelve-month preparation

Months one to three. Reconstruct the cap table from first principles and reconcile it to the statutory registers. Document every equity promise ever made, including informal ones. Fix the gaps while the people involved are still friendly.

Months four to six. Bring statutory records current. Contracts with every material customer, supplier and employee, signed and filed. IP assignments from every contractor who wrote code or made designs.

Months seven to nine. Tax and GST review across the open years. Reconcile credits. Identify any position that would need explaining, and document the reasoning now rather than reconstructing it under questioning.

Months ten to twelve. Build the data room. Run a mock diligence, have someone who has not been involved ask the questions cold.

The data room

A folder structure holding, at minimum: incorporation documents and registers, the cap table and all equity documentation, three years of financials with the audit files, tax and GST returns with reconciliations, material contracts, employment documents, IP assignments, licences, and a schedule of related party transactions.

Maintaining it continuously costs an hour a month. Assembling it from nothing takes weeks, at the worst possible time.

The founders who do best

They treat diligence as something they run on themselves annually, whether or not a transaction is in prospect. The by-product is a business whose records are in order, which is useful for a loan, a large customer, a succession, or simply for knowing where you stand.