Early companies often have informal accounting. Diligence separates harmless untidiness from problems that matter: unpaid taxes, related-party transactions, commingled spending and unrecorded obligations.
10 min read · Level 3
I am rarely worried by a founder who says the books are a bit of a mess. I am worried by one who says everything is fine and cannot show a reconciliation to the bank. Untidiness is a stage of company life; an unexplained gap between the accounts and the cash is a different kind of problem.
Most early companies do not have audited accounts, and many keep simple books. That is normal. Diligence looks for problems that are not.
Usually manageable Needs investigation Cash-basis bookkeeping unpaid payroll or sales taxes Late month-end closes founders' personal spending through the company Simple spreadsheets transactions with founders' other businesses No formal budget revenue recorded on invoice before delivery loans or advances not in the accounts grants with repayment conditions
A practical sequence:
Because liabilities discovered after investment become the new investors' problem. Unpaid taxes can carry penalties and interest, and in some jurisdictions directors can be personally liable.
How a company keeps its books also reflects how carefully it is run.
This is educational information, not tax or accounting advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Sources: U.S. IRS - Trust Fund Recovery Penalty; UK HMRC - GOV.UK tax guidance
Diligence finds payroll tax arrears.
Payroll taxes due over 9 months 180,000 Paid 0 Estimated penalties and interest 25,000 Liability 205,000
The company's 2,400,000 of cash effectively becomes about 2,195,000 once this is paid (2,400,000 - 205,000). At 200,000 of net burn, runway falls from 12 months to about 11. More importantly, the investor now asks why taxes were not paid and what else has been deferred.
Treating all informal accounting as equally harmless, or equally alarming, instead of looking specifically for hidden liabilities.
Confirm the accounts match actual cash movements.
Check filings and payments for payroll, sales and corporate taxes.
Identify dealings with founders and their connected businesses.
Ask for off-balance-sheet obligations to be disclosed in writing.
During diligence on any company, especially those without audited accounts.
Do not demand audit-grade accounts from very early companies; focus on material risks rather than formality.
Tax authorities in several jurisdictions can in certain circumstances hold company directors personally liable for unpaid payroll or withholding taxes, which is why unpaid payroll taxes are treated as a serious issue in diligence rather than an ordinary creditor balance.
Some unpaid obligations follow the people running the company, not only the company.
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