How To Do Due Diligence

How To Do Due Diligence
Galapagos by Julian Cohen. Why?

Due diligence: the detailed investigation of an investment opportunity enabling you to make a fully informed decision whether to proceed or not

Due diligence is vital for every financial decision you make

That doesn’t just include due diligence on the high earning lending and investment opportunities found on SIPPclub.  You should undertake due diligence on every financial transaction you’re considering.

With the benefit of hindsight, even a modest level of due diligence would have triggered the realisation that borrowing 125% of a property’s value from Northern Rock was bound to end in tears.  Who, in their right mind, would voluntarily put themselves into significant negative equity?

Ask those who collectively lost $20 billion through the Madoff scandal how much due diligence they really undertook.  Its success was based on recommendation.  But just because your friend is receiving a high income doesn’t prove it’s legitimate. Nor does it remove the need for you to carry out your own due diligence.  A little look ‘under the bonnet’ would have revealed the extent of the problem.

What about those who invested in Lehman Brothers, left with nothing when it collapsed?  Just because it’s a bank doesn’t mean you don’t have to check!

Along with thousands of other notable failures, the above were all regulated by the authorities.  It proves that regulation is no guarantee of security or success, or that you don’t have to worry about due diligence.  You must always carry out due diligence on both regulated products and alternative opportunities too.

An overview of due diligence

Detailed due diligence should reveal that the legal structure of the investment is clear and robust.  You should know what physical asset you’re holding, how it’s owned and managed, as well as the circumstances in which it can be sold or transferred. 

Other considerations include what obligations you and the product provider have, the conditions that must be observed and what happens if either of you fails to observe them.  Sometimes this involves legal contracts, particularly in the case of lending opportunities.  And often, it’s wise to seek opinions from your trusted professional and financial advisers.

Due diligence on alternative lending and investment opportunities

It doesn’t matter whether you’re choosing to invest your SIPP money into a packaged investment, or lend it to a business or an individual, the key risks are:

  • Lack of liquidity meaning it might be difficult to recover your money when you need it
  • It’s often hard to value the underlying asset
  • There’s often little governance by the authorities, particularly with overseas investments
  • Complicated contractual terms and conditions
  • Lack of on-going information about the investment

One of the easiest ways of carrying out due diligence to establish whether an opportunity is worth pursuing is to have the product provider or the potential borrower answer a series of relevant questions.  Good quality literature and supporting evidence should give you all the answers you require, and where any of the questions remain unanswered, obtain them before you part with your money.

Valuation Of The Asset

  • How has it been valued?
  • Who valued it?
  • Are they independent of the provider?
  • What does the valuation include?

The Use Of Your Money

  • Where and who does the money go to?
  • What is the money used for?
  • Is it clear how fees, charges, marketing, salaries and costs are paid for?
  • Is there transparency over the costs and do they make sense?

Business Plan

  • How does the provider or borrower plan to extract value from the asset?
  • How feasible is the plan and what assumptions is it based on?
  • Is this tried and tested or something radical and unproven?
  • What research can be provided to support the plan?

Marketing Materials

  • Are the projections realistic?
  • Does the documentation fairly represent the risks?
  • Can the predictions be legitimately justified?

The People Involved

  • Who is the project principal?
  • Who else is involved in the project?
  • What are their motivations for being involved?
  • What are their backgrounds and track records?

Fund Raising Methodology

  • Why is the project going ahead?
  • Why are funds being raised this way and not through banks or other sources?
  • Is there a definite fund raising target or an open-ended requirement?

External Influences

  • What are the variables that can impact the opportunity?
  • How will price changes affect the costs and the returns?
  • Is it susceptible to currency fluctuations, interest rate movements, inflation and other variables?
  • How will changes in legislation, politics or economic downturn affect the outcome?

An angel investor's view of due diligence

A due diligence conclusion

In addition to the usual marketing and contractual paperwork, to complete your due diligence, you should also obtain and verify the following:

  • Incorporation details on all parties
  • Biographies of the directors and management team
  • Business plan and financial projections
  • Flow of funds and audited accounts
  • Independent valuation of the asset
  • Legal opinion on the product’s regulatory status

Due diligence may sound complicated and off-putting, but you avoid it at your cost.  It doesn’t have to be a daunting task.  After all, good quality providers of both lending and investment opportunities should have already answered all of the above questions and produced the relevant documents for inspection.

And if they haven’t, the very best due diligence advice is don’t proceed until they have!

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