Due Diligence Process

The due diligence process may encompass:

• Credit and background checks on all principals and management team.
• Investigating the financial background of all principals (personal and corporate).
• Physical “on-site” inspections.
• Detailed review of the title, property survey and other legal documents related to your property.
• Review of historical operating financial statements.
• Detailed review of your prospective business plan for the property.
  Review of your Professional Feasibility Study.
• Review of all required entitlements, permits, licenses and approvals.
  Insurance reviews.
• Hiring industry consultants to help evaluate the potential risk of the investment.
• Consulting of lawyers for legal matters and preparation of legal contracts.
• Environmental assessment reports.
• Appraisal review.
• Third party structural and engineering reports.

As you can see, there is a lot that goes into a prospective lenders due diligence. Keep in mind; this is just an example of what a prospective lender’s due diligence could involve. Costs may range from $10,000 – $50,000 or more depending on the complexity and the size of your deal and the lender.

Lenders prospective on due diligence fees

Because of the uncertainty in today’s market, the lenders are really doing their homework before they commit funding for your project. The issue that the lender is experiencing is that it takes more time and money to conduct proper due diligence than it has in the past. Unfortunately, sometimes they discover that the borrower has misrepresented the project and their financials. Hence, they have expended a lot of time and money on a project they fully intended on funding and find out it’s not what was represented on the front end. Their solution is to sift out who is real and who is not. The lender will charge the prospective borrower up front for the costs.

What can you do to protect yourself?

Examine the lenders! As an experienced Mortgage Banker that has been involved in funding millions of dollars worth of transactions, here are a few things to ask a prospective lender:

Are you a direct lender or broker? If they state they are a direct lender, ask where their funds come from. The reason this is important is there are many firms representing that they are lenders when in fact they are nothing more than brokers. Their goal is to negotiate a deal with you and then take it to market and try to raise the money on your behalf. If you are paying them a due diligence fee, the most important thing you need to understand is whether they actually have the money to fund your transaction.

Ask them for their due diligence process up front. Make sure they quantify exactly what they are charging you for and what gets reimbursed in the event they do not close. Remember everything is negotiable. If they truly want to fund your project they will be flexible on their fees.

Do they accept third party reports ordered by yourself prior to them conducting due diligence? You may be able to conduct some of the lenders due diligence prior to submitting your project. If you are going to have to pay for this anyway, you might as well control the cost and process. This also allows you to include these items in the submission upfront, as part of the loan package. Hence, you are providing the lender as much up front, allowing them to give you a genuine indication of interest, prior to charging you a due diligence fee.

If a client is not prepared to pay this due diligence fee, then funding sources will not work with them, this is non-negotiable. Funding sources do not give millions of dollars to companies without a due diligence process beforehand. This is not only common sense it is good business sense. Go to a bank, apply for a loan, and see if the bank has you fill out forms, answer many questions about yourself and your company and pay fees related to applying for a loan before you receive any money, then you’ll better understand the due diligence process.

Lenders and investors are interested in making profitable investments therefore funding sources will not use their own funds to investigate a project and operate at a financial loss. Investments are about calculating the amount of perceived risk and managing that risk. The due diligence process is about a potential lender finding out about the company seeking funding, the members of its management team, and gauging if the company is a potentially profitable investment. The Lenders’ due diligence fees are required to be paid before closing and the Applicant is expected to pay these expenses before the funding source begins its due diligence process.