Financial and Tax Due Diligence (FTDD), a subset of the broader financial due diligence process, is an essential process for start-ups, particularly during investment rounds, mergers, or acquisitions. For start-ups founders, the FTDD process might seem overwhelming, yet it is crucial for securing investors, ensuring growth, and gaining credibility.
Protemus Capital will explore the key FTDD challenges start-ups face and provide practical tips for preparing your start-ups for a smooth financial due diligence process.What is Financial and Tax Due Diligence (FTDD) for Start-ups?
FTDD refers to a comprehensive review of a company’s financial and tax status to ensure transparency and compliance.
For start-ups, FTDD is critical during investment rounds or when attracting investors, venture capital, or angel investors. This process involves analyzing financial statements, reviewing balance sheets, and assessing tax compliance. It also covers legal due diligence, where aspects such as intellectual property, equity contributions, and regulatory compliance are reviewed.
The FTDD process helps potential investors evaluate a start-ups’ market potential, revenue streams, and growth potential. Thus, when it comes to start-ups, preparing thoroughly for FTDD can make or break a deal. It not only enhances trust but also sets the foundation for sustainable growth.
How does M&A valuation influence your business decisions? Read more: Understanding M&A Valuation: Key Methods and Why They Matter7 Key Challenges Start-ups Face During Due Diligence
FTDD for start-ups have their own challenges. Below are some common issues start-ups encounter, particularly in Indonesia, as noted by the Protemus Capital team:1. Accounting and Bookkeeping
Many start-ups still manage accounting manually without the help of proper accounting software, resulting in disorganized records and financial mismatches.
Often, these start-ups only manage basic financial statements such as profit and loss and rely on cash-based accounting instead of accrual. This can lead to significant unrecorded expenses and an inaccurate picture of the company's financial health.
Tips: Start-ups may consider utilizing simple accounting software that enables accurate record-keeping and accrual accounting to avoid any unforeseen expenses during the financial due diligence process.2. Lack of Clear Accounting Policies
When a start-ups lacks clear accounting policies, it often leads to inconsistent financial reporting. For example, revenue calculations and recordings can vary, which may result in revenue being overstated or understated.
A common issue is the premature recognition of revenue—such as when payments are received upfront, but services have not yet been delivered. In such cases, this revenue should be recorded as unearned revenue rather than recognized as actual income. These inconsistencies can raise red flags during a financial due diligence assessment.
Tips: Implement clear and consistent accounting policies early on. Accurate revenue recording is critical to presenting reliable financial information to potential investors.3. Related Party Transactions
Many start-ups often conduct transactions on a single account with owners or related parties, which can complicate financial transparency.
Such transactions often raise concerns about whether funds are being used for corporate purposes or personal interests. It is important to review bank statements and track the movement of funds to ensure compliance.
Tips: Maintain a clear separation between personal and business transactions, and ensure all transactions with related parties are documented and justified.4. Inadequate Inventory System
Start-ups that do not have an established inventory system or that rarely perform stock checks face difficulties matching actual stock levels with recorded quantities. The lack of a proper documentation system can hinder the ability to trace inventory data back to a specific period, making the FTDD process impractical.
Tips: Establish an inventory management system early on and conduct regular stock checks to ensure transparency and accuracy in reporting.5. Normalization of Expenses
During FTDD, normalizing expenses such as salaries, rent, and other operating costs ensures a more accurate reflection of the company's financial health.
Start-ups often have unique cost structures early on—for example, founders may serve as C-level executives without drawing a salary, or office rent may be subsidized at below-market rates by the founders.
These factors are important for investors to consider, as these costs will need to be normalized when an investor steps in, meaning C-level salaries and rent will eventually align with market rates.
Tips: Adjust expenses for normalization, including salary adjustments for C-level executives and other operating expenses such as accounting software subscriptions, office rent, etc.6. Equity and Shareholder Issues
FTDDs often reveal mismatches in equity and shareholder contributions. In some cases, shareholders may not pay the full required capital, or they may use personal assets as equity contributions without proper documentation.
Tips: Verify and document all equity contributions thoroughly, and cross-check these records with bank statements to ensure accuracy. Additionally, consult with a legal advisor to confirm the validity of the company’s documents, particularly regarding capital contributions.7. Legal Entity and Tax Compliance
Start-ups, especially those newly established and often lacking personnel with expertise in tax matters, frequently encounter tax compliance issues. Common challenges include compliance with withholding taxes such as Income Tax (PPH) 21, 23/26, and 4(2). Additionally, start-ups with revenue under IDR 4.8 billion can opt for the Final Income Tax for MSME (PPH Final UMKM) scheme, but must still ensure they adhere to all applicable regulations.
Tips: If your company is in Indonesia, incorporate the start-ups as a PT (Perseroan Terbatas) and ensure full compliance with tax regulations. This not only streamlines operations but also builds credibility with investors.
Learn about navigating divestiture processes: Divestment Done Right: Essential Insights for StakeholdersHow Start-ups Can Prepare for Financial Due Diligence
Preparation is key to overcoming the challenges mentioned above. Start-ups should take the following steps to streamline their FTDD process:1. Organize Financial Records and Statements
Invest in professional accounting software or services to keep financial records accurate and up-to-date. Maintain consistent financial reporting practices to avoid discrepancies. Ensure all financial statements, including balance sheets and revenue statements, are properly documented.2. Establish Clear Accounting Policies
Create and implement a set of accounting policies that define how revenue, expenses, and equity contributions should be recorded. Consistency is crucial to avoid FTDD issues such as overstated revenue.3. Prepare for Tax Compliance
Start-ups should familiarize themselves with applicable tax regulations and ensure compliance, especially if they are not yet incorporated as a PT. This includes proper tax withholdings (PPH 21, PPH 23/26) and regular tax filings. Professional assistance from financial advisors like Protemus Capital can help navigate these complexities.4. Document Equity Contributions and Shareholder Arrangements
To avoid discrepancies during FTDD, start-ups must document shareholder contributions accurately and verify these records against bank statements. Establish clear agreements and record any use of assets as equity with appropriate documentation.
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Financial and Tax Due Diligence (FTDD) is a vital process for both investors and start-ups, especially during fundraising or mergers and acquisitions (M&A). Whether you're a venture capital (VC) firm, an angel investor, or a start-up founder, Protemus Capital offers expert solutions to make the FTDD process smooth and efficient.
VCs and angel investors can rely on Protemus Capital for comprehensive due diligence services to assess start-ups before making investment decisions. Our team ensures all financial, legal, and tax documentation aligns with investment criteria, reducing risks and enhancing decision-making.
For start-ups founders, Protemus Capital can assist in conducting Vendor Due Diligence (VDD) before starting their fundraising journey. This proactive approach helps founders prepare well-organized financial reports, establish transparent accounting policies, and ensure tax compliance—giving them an edge when presenting their business to investors.
Protemus Capital provides not only FTDD and VDD services but also ongoing advisory support to optimize business plans, assess growth opportunities, and align operational structures with investor expectations. With Protemus Capital as your partner, you can confidently navigate investment rounds or acquisitions, ensuring a well-prepared, credible case to attract investors.
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