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Why Do Related Party Transactions Matter in Financial Due Diligence?

Written By

Priya Kapasi Shah, Rohit Gandhi

Published on

February 20,
2025

Last updated on

February 21, 2025
12:08

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AI Summary

Investors scrutinise Related Party Transactions (RPTs) during financial due diligence because these transactions can affect financial transparency and business integrity.
RPTs are common in businesses, but a lack of clarity around them is treated as a red flag by investors and auditors.
A key risk is misuse of company funds, where money may be diverted to entities owned by founders or key stakeholders.
RPTs can distort financial statements through inflated revenue or hidden expenses routed via related parties, misrepresenting the company's true financial position.
Failure to disclose related parties or transactions, along with inadequate approval and documentation, signals poor governance and weak transparency.
Such lapses can indicate intentional misrepresentation rather than mere oversight.
RPT disclosure is a mandatory regulatory requirement under the Companies Act 2013, the Income Tax Act, and SEBI regulations.
Non-disclosure of RPTs can result in legal and tax complications for the company.
Businesses should document RPTs properly, ensure they are conducted at arm's length, and disclose them fully in financial statements.

Content Overview

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Investors closely examine Related Party Transactions (RPTs) during due diligence because they can impact financial transparency and business integrity. While RPTs are common, lack of clarity can raise red flags. Here’s why they matter:

Risk of Fund Misuse: Are company funds being diverted to entities owned by founders or key stakeholders?
Distorted Financials: Inflated revenue or hidden expenses through related parties can misrepresent a true financial position.
Lack of Transparency & Poor Governance: Failure to disclose related parties or transactions in the financial statements, along with inadequate approval and documentation, can indicate poor governance, lack of transparency, or even intentional misrepresentation.
Regulatory Compliance: RPT disclosures are a mandatory requirement as per the provisions of Companies Act, Income Tax Act, and SEBI regulations. Any non-disclosure may result in legal and tax complications.

Pro Tip: Always document RPTs properly, ensure they are at arm’s length, and disclose them in financial statements.

How does your company manage related party transactions? Share your experiences or ask your questions in the comments!

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About the Author

Priya Kapasi Shah

Associate Partner | Tax & Regulatory | priya.k@treelife.in

Heads Treelife’s Financial Advisory practice, specializing in investment structuring, cross-border transactions, and tax and regulatory advisory. Also leads on AIF setups and advisory services for GIFT IFSC.

Rohit Gandhi

Senior Associate | Tax & Regulatory | rohit.g@treelife.in

Specializes in financial due diligence, valuations, business structuring, and income tax advisory. Contributes to the Financial Advisory team by helping startups and businesses make informed strategic decisions.