Pre Due Diligence Review

When entering into a due diligence there are some key areas investors or purchasers tend to look at, often with a view of finding holes so that they can reduce your company valuation. Being aware of these aspects and ensuring you have robust answers in place to all of these questions will help you protect your company valuation in a negotiation. 
1. Director expenses - are all directors expenses above board and within reasonable expectations and are all benefits being recognised and taxed correctly? In early stage startups company directors are often also the founders of the company, and can have a lot of control as often there isn't an official board in place to monitor things. Investors will want to know whether directors have taken advantage of their position by favouring themselves with generous expenses or WFH allowances, with the risk that perhaps not all of this has been taxed correctly or reported as a benefit to HMRC. 
2. Permanent establishment - Does the company operate internationally, and if so are there any potential unpaid taxes that overseas governments could claim? A key risk here is the inadvertent creation of a ‘permanent establishment’ in another country, i.e. a taxable presence elsewhere, which may occur if you have a sales team or an office in that country.
3. Off payroll working – are there contractors or consultants on the books who really should be employees, but instead of being on the payroll have been invoicing the company on a regular basis? This is often the case (and understandable) for startups who prefer the ease of hiring contractors rather than taking on full employees (with employee contracts, benefits, pensions etc.). The rules to consider ( IR35) can be quite complex and in some cases vague, but the risk is that the company has been under-declaring its PAYE bill to HMRC.  
4. Poor record keeping - how good are your books and records? Are there many items for which you have lost the receipt or invoice? Have signed board minutes been kept for key business decisions? Are signed share certificates held on file?
5. Company register s and shareholder history - have all share dealings being properly documented at Companies House? Have there been any complicated or unusual transactions, such as share buy-backs or share transfers/gifts, and have then been dealt with and documented correctly?
6. Company option scheme - if the company has an option scheme in place, is all of the paperwork in order, have HMRC filings been made on time and are all signed option agreements held on file?
7. Revenue recognition - for some companies recognising their revenue is a simple process, but for others it can be more complicated. For example, if you are selling software licences do you need to recognise the income over the duration of the licence agreement? This might mean deferring the revenue to a later period if, for example, the software licence is for one year but you invoice your customers upfront. 
8. Loans to directors - there are some complicated rules when it comes to loans to directors, especially when the loans are overdrawn, i.e. when the director owes money to the company. If this is the case investors will pore over the loans to assess whether all filings and taxes have been made correctly and on time, and will analyse any director loan agreements in place. You can get a flavour of the rules around director loans here.
9. VAT risks - generally, the VAT rules if your customers are all UK based are simple and there is little risk of things going wrong. However, if your customers are based outside of the UK, the VAT rules differ between B2B and B2C sales and also between sale of services (i.e. software) versus sale of goods. Furthermore, there are specific rules when you are selling to consumers in the EU, per the VAT OSS rules here (formerly 'VAT MOSS'). 
10. R&D risks - is your R&D claim rock solid or a little dubious? Have you reached the end of the 12 month 'enquiry window' where HMRC can still look at a claim, or do you have any claims still 'in play' that could potentially be assessed by HMRC? Have your R&D claims been properly documented and reported to HMRC by a specialist (like us) or have you used a third party who has perhaps cut some corners?  
Barnes & Scott can help with conducting a detailed review of your business before you undergo a due diligence from a potential investor or acquirer. We will use our experience to analyse your finance systems, processes and transactions to identify and resolve any issues before they become a problem!  Our experienced team have worked on deals of all shapes and sizes, from small mergers to big acquisitions. 

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