A founder signs a term sheet for a ₹12 crore Series A in September. The investor's counsel opens the data room and asks three questions: where is the PAS-3 for the 2023 seed allotment, why does the ESOP pool in the cap table differ from the ordinary resolution passed in 2024, and why has DIR-3 KYC not been filed for one of the two directors. Three weeks later the round closes at a reduced valuation with ₹1.4 crore parked in an indemnity escrow. Nothing about the business changed. The filings did.
This is the most expensive compliance failure in Indian startup fundraising, and it is entirely avoidable. Due diligence is not an audit of your ambition. It is a reconciliation exercise: the investor's counsel compares what you say happened against what the MCA, the GST portal, and the Income Tax Department say happened. Every gap between those two records becomes a negotiating lever.
What the law actually requires
There is no section of the Companies Act 2013 titled "due diligence." What exists instead is a body of filing and record-keeping obligations that, taken together, constitute the paper trail an investor's counsel will reconstruct. Understanding which sections generate which documents is what separates a two-week diligence from a ten-week one.
Statutory registers under Section 88. Every company must maintain a register of members (Form MGT-1), a register of debenture holders, and a register of any other security holders. Rule 3 of the Companies (Management and Administration) Rules 2014 prescribes the format. These registers — not your cap table spreadsheet, not your Carta account — are the legally authoritative record of who owns your company. Section 88(5) imposes a penalty of ₹3,00,000 on the company and ₹50,000 on every officer in default for failure to maintain them. In diligence, a register of members that does not tie exactly to the PAS-3 filings and the share certificates issued is treated as a title defect.
Allotment filings under Section 42 and Section 62. Any private placement of securities requires a special resolution, a private placement offer letter in Form PAS-4, a record of the offer in Form PAS-5, and a return of allotment in Form PAS-3 filed within fifteen days of allotment. Section 42(8) makes late PAS-3 filing punishable with a penalty of ₹1,000 per day of default, capped at ₹25,00,000 for the company and the same for each promoter and director. Critically, Section 42(6) requires that share application money be kept in a separate bank account and not utilised until allotment is complete and PAS-3 is filed. Investor counsel checks the bank statement against the allotment date. Money spent before allotment is a Section 42 violation that cannot be cured retrospectively.
Charge registration under Section 77. Every charge created on company assets — including hypothecation under a working capital facility, or a lien granted in a venture debt agreement — must be registered in Form CHG-1 within thirty days of creation. Section 77(3) is the sharp edge: an unregistered charge is not taken into account by a liquidator or creditor in insolvency. An unregistered charge in your books signals to an investor that your security position with lenders is unclear, which directly affects how they model downside recovery.
Board and shareholder records under Section 118. Minutes of every board meeting and general meeting must be recorded within thirty days and entered in a bound minute book with consecutively numbered pages. Section 118(11) attaches a ₹25,000 penalty on the company and ₹5,000 on each defaulting officer. Section 118(8) makes minutes recorded in the prescribed manner evidence of the proceedings. A resolution approving an ESOP grant, a related party transaction, or a director appointment that does not appear in a properly maintained minute book is, for diligence purposes, a resolution that did not happen.
Related party transactions under Section 188 and Section 189. Every contract with a related party requires board approval, and where thresholds under Rule 15 of the Companies (Meetings of Board and its Powers) Rules 2014 are crossed, a shareholder resolution as well. Section 189 requires a register of contracts in Form MBP-4. Section 188(5) allows the company to recover any loss from a director who entered into a related party transaction without approval. Founder-owned vendor entities, family-owned premises leased to the company, and director loans are the three categories that surface in almost every Indian diligence.
Annual filings and MCA21 v3. AOC-4 (financial statements) and MGT-7 or MGT-7A (annual return) are due within thirty days and sixty days of the AGM respectively. For FY 2025-26, with the AGM deadline falling on 30 September 2026, AOC-4 is due by 29 October 2026 and MGT-7 by 28 November 2026. Section 137(3) imposes ₹10,000 plus ₹100 per day of continuing default, capped at ₹2,00,000 for the company. DIR-3 KYC is due 30 September each year for every director holding a DIN, and failure deactivates the DIN with a ₹5,000 reactivation fee under Rule 12A of the Companies (Appointment and Qualification of Directors) Rules 2014.
Practical implications
The MCA21 v3 portal has changed what "clean" means. Under the earlier system, a founder could reasonably tell an investor that a delay was a portal issue. Under v3, every form carries a straight-through-processing status, an SRN, and a timestamp visible on public view. Investor counsel does not ask you for your filing history — they download it. Discrepancies between what you represent in the disclosure schedule and what the portal shows are treated as misrepresentation, which flows directly into the indemnity clause.
Three specific consequences follow from a weak paper trail:
Valuation discount. Where cap table history cannot be reconstructed from PAS-3 filings and the register of members, counsel will insist on a title indemnity. Indemnity caps in Indian venture deals typically run between ten and twenty percent of the investment amount, and the escrow is real money withheld for twelve to twenty-four months. On a ₹12 crore round, a fifteen percent escrow is ₹1.8 crore you do not get to deploy.
Conditions precedent that delay close. Missing filings become CPs. A CP requiring you to file three years of overdue AOC-4 forms, obtain a fresh valuation report under Rule 11UA, and reconstitute your minute book adds four to eight weeks to close — during which your term sheet exclusivity may lapse and your runway shortens.
Section 164 disqualification risk. Under Section 164(2)(a), a director of a company that has not filed financial statements or annual returns for three consecutive financial years is disqualified for five years and cannot be reappointed to any company. MCA21 flags this automatically. If diligence uncovers that a founder-director is disqualified, the board composition contemplated by the SHA becomes impossible to execute, and the deal structure has to be redrawn.
Angel tax and valuation exposure. Under Section 56(2)(viib) of the Income Tax Act, consideration received for shares in excess of fair market value is taxable in the hands of the company. A DPIIT-recognised startup that has filed Form 2 is exempt, but the exemption is conditional on the recognition being valid on the date of allotment. Investor counsel checks the DPIIT certificate date against the proposed allotment date. Where a prior round was closed without a Rule 11UA valuation report, the new investor will require an indemnity for the historic exposure.
Step-by-step: what to do
1. Run an MCA public-view audit on your own company. Go to the MCA21 v3 portal, use View Company/LLP Master Data and View Public Documents for your CIN, and download every form filed since incorporation. Build a spreadsheet with form type, SRN, event date, filing date, and days of delay. This is the same document investor counsel will build. Building it first means you control the narrative.
2. Reconcile the cap table three ways. Take your register of members under Section 88, every PAS-3 filed, and your working cap table spreadsheet. They must produce identical shareholding at every historical date. Where they diverge, the register of members governs — and where the register itself is defective, you need a rectification under Section 59 before diligence, not during it.
3. Reconstruct the minute book. Every allotment, ESOP grant, director appointment, borrowing under Section 179(3)(d), and related party transaction must have a corresponding board resolution with a date that precedes the action. Bound, page-numbered, signed by the chairman. Where a meeting genuinely happened but was never minuted, minute it now with the correct date and a note of when it was recorded — do not backdate a signature.
4. Close the ESOP loop. Reconcile the pool size approved by ordinary resolution under Rule 12 of the Companies (Share Capital and Debentures) Rules 2014 against grants actually made, options vested, options exercised, and options lapsed. The most common defect is a company that has granted more options than the approved pool. Fix this with a fresh shareholder resolution ratifying and expanding the pool before the data room opens.
5. Register or satisfy every charge. Pull your CHG-1 and CHG-4 filings against your actual loan and lease documentation. Where a charge was created and never registered, apply for condonation of delay under Section 87 — the Central Government can condone, but it takes time, which is why this must start eight weeks before close.
6. Reconcile GST, TDS, and books. Investor counsel and the financial DD team will compare revenue in your audited financials against GSTR-1 and GSTR-3B turnover, and expense heads against Form 26AS and TDS returns. Mismatches are not automatically fatal, but unexplained mismatches are. Prepare a written reconciliation for every variance above one percent.
7. Structure the data room by workstream. Use folders that mirror how the diligence team is organised: Corporate (incorporation documents, MOA/AOA, all resolutions, statutory registers), Capital (all PAS-3s, share certificates, SHAs, ESOP documents, valuation reports), Financial (three years of audited financials, monthly MIS, bank statements, debtor and creditor ageing), Tax (ITR-6 acknowledgements, GST returns, TDS certificates, any assessment or notice correspondence), Contracts (customer, vendor, employment, and all related party agreements), and Regulatory (any sector licence, FEMA filings including FC-GPR, IP registrations). Index every document. A well-indexed data room measurably shortens diligence.
8. Draft the disclosure schedule honestly. Every known defect goes in the disclosure schedule. A disclosed defect is a negotiated risk; an undisclosed defect discovered in diligence is a breach of warranty and a trust problem that reprices the round.
FAQ
How long before a fundraise should due diligence preparation start?
Ninety days minimum. Charge condonation under Section 87, register rectification under Section 59, and clearing overdue ROC filings each have their own timelines that cannot be compressed. Companies that begin at term sheet stage routinely add six weeks to close.
Can we file overdue AOC-4 and MGT-7 forms now, or does that flag us?
File them. The additional fee under Section 403 is ₹100 per day per form, and it is far cheaper than an indemnity escrow. Filing late is visible on MCA21; not filing at all triggers Section 164(2) disqualification and strike-off proceedings under Section 248. A late-but-filed record is a routine disclosure item.
Who prepares the data room — the CA or the company secretary?
Both, on different workstreams. The company secretary owns the corporate and capital sections (registers, resolutions, PAS-3, CHG filings, MCA reconciliation). The CA owns the financial and tax sections (restated financials, GST and TDS reconciliation, debtor ageing, revenue recognition memos). The founder owns contracts and commercial. One person coordinating the index is essential.
What is the single most common defect found in Indian startup diligence?
Share application money utilised before allotment and before PAS-3 filing, in breach of Section 42(6). It is common because the money is in the account and the runway is short. It is serious because it cannot be cured after the fact — only disclosed, quantified, and indemnified.
---
For a compliance audit of your company, visit pvtltd.co
---
See Also
- "BRSR is only for the top 100 companies": What SEBI's assurance glide path actually requires in FY 2026-27
- "Our internal auditor already covers it": what RBI's concurrent audit mandate for NBFCs actually requires
- "We're private, so Ind AS doesn't apply to us": What the ₹250 crore net worth threshold actually triggers
Ready to incorporate or sort your compliance?
Our team handles every filing. You focus on building.