Startup Audit: ESOPs, CCPS and Funding Round Checks

A startup audit is different because the equity story is complicated and the revenue story is young. The auditor must test share capital and investor rights, classify convertible instruments correctly, measure the cost of employee stock options, check filings tied to foreign investment, and assess whether the company can keep running on the cash it has.

Last reviewed: 17 October 2026. Facts checked. We ran a web search on employee stock option rules. It returned law-firm, accounting-firm and blog pages. We read the search summaries and did not open the Companies Act, the Share Capital Rules or the Ind AS text. The search indicated that section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 govern employee stock options, including a register in Form SH-6, and that Ind AS 102 applies to certain entities, with other companies following ICAI guidance. Sources disagreed on whether private companies need a special resolution and on how long startup relaxations last, so we do not state those points. One page referred to 2026 amendments that we could not verify. Confirm all points against the current Act and rules. We did not research foreign exchange rules and name them only.

What is distinctive about a startup

• Capital is raised in rounds, each with a term sheet, shareholders agreement and articles that change investor rights.
• Preferred shares, convertible notes and similar instruments carry conversion, liquidation and anti-dilution terms.
• Employee stock options are a major cost and a compliance area.
• Foreign investors bring foreign exchange filings and valuation rules.
• Revenue models are new: subscriptions, marketplaces, usage-based billing. Recognition needs thought.
• Cash burn is high, and the entity may depend on the next round to continue.
• Founder and related-party dealings are common and lightly documented.
• Records are often thin in the early years.

Key risks

1. Share capital errors. Allotments, transfers and authorised capital not matching filings and registers.
2. Instrument classification. Preference shares or notes shown as equity when the terms make them a liability, or the reverse.
3. ESOP. Plan approvals, grant records and the expense not measured or recognised.
4. Valuation. Share price used for issue, grants or transfers without proper support.
5. Foreign investment filings. Reports and pricing conditions missed.
6. Revenue recognition. Gross versus net, discounts and cash burn masking revenue quality.
7. Going concern. Cash runway shorter than twelve months with no committed funding.
8. Related parties. Founder loans, salaries and group dealings not disclosed.

Audit programme in steps

Step 1: Rebuild the capital structure

Obtain the cap table, term sheets, shareholders agreement, articles and every board and shareholder resolution. Reconcile the cap table to the statutory registers, the MCA filings and the bank credits for share application money. Check that every allotment followed the right approvals and was filed on time. Confirm that authorised capital covered each allotment.

Step 2: Classify convertible and preference instruments

Read the terms of each instrument: conversion rights, redemption, dividend, liquidation preference and any obligation to settle in cash. Under Ind AS, these terms decide whether the instrument is equity, a liability or compound. Under other frameworks, the legal form and the terms still matter. Document the reasoning in the working paper. Where terms are unclear, get legal input rather than guessing. Check for derivatives embedded in the instrument, such as conversion at a discount to a future round.

Step 3: Test employee stock options

Obtain the plan, the board and shareholder approvals, the grant letters and the register of options. Follow these steps:

• Confirm the plan was approved as the law requires, and that the eligibility rules were respected.
• Test grants to the register, including grant date, number, price and vesting schedule.
• Check exits and forfeitures for correct treatment.
• Recompute the expense from fair value at grant date, expected vesting and the vesting period, if the entity applies a fair-value method. Check how the fair value was derived and by whom.
• For entities that do not apply the fair-value standard, check which guidance the company follows and apply it consistently.
• Check disclosure of the plan in the financial statements.

Step 4: Test valuations used

List every valuation used in the year: issue price, ESOP exercise price, transfers and buybacks. Obtain the valuer's report, check the valuer's independence and the date, and compare to the price actually used. Differences between valuation and price need explanation, as some may have tax or foreign exchange consequences.

Step 5: Review foreign investment compliance

Where foreign investors hold shares or convertible instruments, check that inflows were received through banking channels, that the required reports were filed within the time the rules require, and that the issue price met the pricing guidelines in force. Confirm the sector and the investor are permitted. Report gaps to management, as late filings can lead to penalties through compounding.

Step 6: Test revenue

For each revenue model, understand the contract and the performance obligation. For subscriptions, check deferral of the unearned part. For marketplaces, decide whether the company acts as principal or agent and tests gross or net presentation. See our Ind AS 115 audit guide. Review discounts, cashbacks and referral payments, which may reduce revenue rather than be marketing cost. Use the order-to-cash checklist.

Step 7: Test cost, burn and capitalisation

Review the largest cost heads: cloud, marketing, salary and contractors. Check capitalised product development against the evidence the standard asks for. See amortisation under Ind AS 38. Test payroll and statutory dues, and the classification of consultants and freelancers using the payroll checklist.

Step 8: Assess going concern

Prepare a cash forecast for at least twelve months after the balance sheet date. Compare burn to cash and committed funding. Read board minutes and term sheets for evidence of the next round and whether it is signed or only discussed. See how auditors evaluate management plans and the going concern indicators post.

Step 9: Test related parties

List founders' loans, salaries, rent and group dealings. Check approvals and disclosure. Use the related-party procedures.

Step 10: Check statutory compliance and recognition

Confirm incorporation, registrations and any recognition under the startup policy the company relies on, and whether tax or other benefits are claimed on the strength of that recognition. Check applicability of CARO and internal financial controls reporting. See the CARO guide.

Common findings

• Cap table that does not match registers or filings.
• Convertible instruments shown as equity without analysis.
• ESOP grants without board approval or a proper register.
• No valuation report behind the issue price.
• Foreign investment reports filed late or not at all.
• Gross revenue booked where the company is only an agent.
• Cash forecast showing runway under twelve months with no funding.
• Founder loans without documents.

Which Indian rules to check

Name only. Verify current text:

• The Companies Act, 2013, especially section 62, and the Share Capital and Debentures Rules, 2014.
• Ind AS 32, Ind AS 109, Ind AS 102 and Ind AS 115 for entities required to follow them, or the applicable AS and ICAI guidance otherwise.
• The Foreign Exchange Management Act and the rules on non-debt instruments and pricing.
• The Income-tax Act provisions on share issue, valuation and perquisite tax on options.
• The startup recognition scheme of the government, if relied on.
• CARO and the rules on auditor reporting on internal financial controls.

FAQs

Is CCPS equity or debt?

It depends on the terms and the accounting framework. Read the terms, and do not assume.

Who values the shares?

A registered valuer or merchant banker where the law requires, otherwise per the rule applicable.

Is going concern a real issue for funded startups?

Yes. Cash runway without committed funding is a common reason for an emphasis paragraph.

Related Articles

• Ind AS 115 revenue recognition audit guide
• Going concern: how auditors evaluate management plans
• Related party procedures under SA 550
• CARO 2020 clause-by-clause guide

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