Due diligence for startups: check that cheque | SeedLegals

It sounds like stating the obvious but it’s essential you know where your funding is coming from. When you’re very busy, minimising the risk of financial crime might seem like a lower priority but if your company is left vulnerable to financial crime, the cost – in terms of penalties and reputation damage – could be very high.

Why are startups a target? Because criminals try to hide money via investments or gain an air of legitimacy by associating themselves with legitimate companies. You could be exposed to financial crime by receiving investment linked to crime or to sanctions, as well as through investors or shareholders who behave in ways that could damage your company’s reputation. For example:

• Money laundering – You could be targeted by criminals aiming to launder proceeds of crime or corruption by investing in your business, including by using shell companies or offshore accounts to disguise the source of the funds.
• Fraud and economic espionage – You could be vulnerable to fraudulent activities including data or trade secrets theft, and other forms of ‘economic espionage’ via investors gaining access to your company.
• Corruption and sanctions – You must check investors don’t have a history of corruption, and that they and their associates aren’t sanctioned in jurisdictions in which your business operates.
• Predicate crimes – You risk being linked to crimes such as modern slavery and human trafficking, environmental crimes and trade-based money laundering if you accept money from investors implicated in these crimes or networks.

Even if you think you can trust a potential investor, get into the habit of checking every investor and doing more than just a cursory Google search. When you’re carrying out your due diligence on investors, here are red flags to look for:

• Criminal or litigation history
• Bad reputation
• Disreputable or dubious network
• Use of proxies – Be wary of any investor who won’t conduct business face to face. Look out for proxies such as shell companies or lawyers, as well as relying on family or close associates to carry out business activities.
• Unethical business practices – Are their business practices or goals compatible with your startup’s mission or ethical standards? If not, your reputation could be at risk or your ESG governance could be undermined.
• Financial instability – If the investor has a history of financial instability or won’t confirm they have the funds, or explain the sources of their funds, you risk leaving your startup with financial problems in future.

The team at Themis have seen first hand how criminals try to exploit weaknesses in startups:

The invisible investor
In one case, a Themis client was offered a large but unsolicited investment. When Themis investigated the potential investor, they found they had no online presence – a massive red flag. The ‘investor’ turned out to be an insurance fraudster.

The shady exploiter
In another case, Themis found evidence that a potential investor for a client was running a fraud scheme taking advantage of young people looking to build a new life abroad. Under the scheme, individuals were charged €1,000 ‘deposits’ for trips that never happened – and the victims didn’t get back their money. Themis also discovered that the investor had been sentenced by a French court to 18 months in prison for fraud and breach of trust. Yikes. Clearly, the client didn’t go ahead to work with this investor.

The dodgy politician
Another Themis client was approached by someone who appeared to be wealthy and claimed to have served in the cabinet of the government of their country. The behaviour of the ‘investor’ became increasingly strange, including asking the company to pay a ‘legalisation’ process fee. The ‘investor’ turned out to be a scammer.

Everyone knows it’s foolish to rush into something simply because it looks good on paper. But as a cash-strapped startup, it can be tempting. Fortunately, these Themis clients were vigilant and did their due diligence properly. To protect the business you’ve built, it’s always worth taking the time to carry out thorough checks.

Case study 1 The fintech startup and the Russian billionaire
Case study 2: The private equity firm misappropriating funds

Due diligence shouldn’t be a blocker. Done right, it helps your business succeed and grow. Here are the top tips from Themis for integrating due diligence in your operating processes and team mindset:

• Embed due diligence as a habit
  Always establish and verify the identity of investors, companies they own and their business associates. Build accurate risk profiles and spot potential red flags or suspicious activities.
• Monitor regularly
  It isn’t enough to just check people once. Continuously monitor the business activity, relationships and risk profiles of people and companies you’re working with to make sure you detect unusual behaviour or changes.
• Screen for sanctions and PEPs
  Check investors against lists of sanctions and PEPs from all jurisdictions in which you do business, as well as those produced by the UN.
• Check for litigation and adverse media
  Check people and companies you’re working with to identify adverse media, reputational damage, and criminal or civil litigation history.

No-one should have their hard work undone by criminals or illegal behaviour. That’s why we’ve partnered with Themis. With our legaltech services and the powerful Themis Search & Monitoring platform, you can speed up investment deals and protect your company. With experts taking care of your legals and due diligence, you can maintain your focus on growing your business and achieving your goals.

Coming soon: listen to our CEO Anthony Rose and Dickon Johnstone, CEO of Themis, discuss financial crime and due diligence.