# Why Do Related Party Transactions Matter in Financial Due Diligence?

Published: 20 Feb 2025  |  Last updated: 21 Feb 2025
Author: Treelife
Practice area: Quick Takes
Source: https://treelife.in/quick-takes/why-do-related-party-transactions-matter-in-financial-due-diligence/

## 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.

---

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!

### Related posts:

- [Cracking the Pricing Code: Guidelines for Cross-Border Investments](https://treelife.in/quick-takes/cracking-the-pricing-code-guidelines-for-cross-border-investments/)

- [Key Terms in Share Dematerialization](https://treelife.in/quick-takes/key-terms-in-share-dematerialization/)

- [Understanding Document Authentication: A Guide to Apostillation, Consularisation, and Notarisation](https://treelife.in/quick-takes/understanding-document-authentication-a-guide-to-apostillation-consularisation-and-notarisation/)

---

This is informational content from Treelife. For advice specific to your situation, contact support@treelife.in