For startups or businesses seeking institutional funding, the Due Diligence (DD) process is a critical gatekeeper. Investors examine the quality of your company’s internal controls in addition to evaluating market potential.
Internal controls are the systems and procedures designed to protect corporate assets, ensure the reliability of financial data, and drive compliance. Here are five key areas investors focus on during due diligence:
1. 📈 Financial Reporting Integrity
Investors need assurance that the financial data they use for valuation is accurate and consistent.
- GAAP/IFRS Compliance: Are the accounting policies strictly adhering to applicable standards? Deviations can trigger significant re-statements and valuation adjustments.
- Monthly Close Procedure: The promptness and thoroughness of the monthly financial close will be evaluated. Maturity is indicated by evidence of consistent bank account and key ledger reconciliation as well as a low number of significant post-close adjustments.
2. 🛡️ Duty Segregation (SoD)
The most basic anti-fraud measure is this. Investors have to make sure that no employee has complete control over a transaction cycle.
Key Separations: They seek evidence that the person who starts a transaction (making a purchase order, for example) is not the manager who approves it or the accountant who records the payment.
Cash Access: Strict oversight of bank accounts, authorization of wire transfers, and payments. They confirm that dual signatures or approvals are necessary for important transactions.
3. System and IT Access Controls
Systems are where modern financial data is kept. The security of those systems is essential to data integrity.
Access Management: In the ERP, CRM, and payroll systems, who is authorized to post journals, modify prices, or access private information? Investors seek proof that access is role-based and promptly terminated when an employee leaves.
Change Management: They examine how modifications to crucial financial system configurations (such as account codes or discount rules) are handled; is independent testing and approval required prior to implementation?
4. Policy and Documentation If compliance controls are not consistently implemented and documented, they are useless.
Process Narratives: Written records of important business cycles, such as Order-to-Cash and Procure-to-Pay, are requested by investors.
Evidence of Review: They look for sign-offs, initials, or electronic audit trails that demonstrate managers are actively examining and approving expense reports, large journal entries, and reconciliations.
Whistleblower Policy: One of the most important signs of effective governance is the existence of documented, private channels for staff members to report unethical behavior without fear of reprisal.
5. 💰 Revenue Cycle Management
Investors pay close attention to revenue since it is frequently the most important factor in valuation.
Contract Review and Revenue Recognition: Ensures that, prior to finalization, all contracts are examined by Finance/Legal to ensure that the terms are in line with the appropriate revenue recognition policy.
Sales Commission Calculations: Verification that commission calculations are accurate per the contract and strictly controlled to prevent commission fraud or the recognition of fictitious revenue.
In conclusion:
Strong internal controls show that management is committed to risk management and fiscal responsibility in addition to growth. This gives investors the assurance that the underlying data is trustworthy and their money will be used securely.
