Due Diligence on a Potential Deal or Partner

It is impossible to outline a single set of guidelines for due diligence, but here is a basic checklist, in no particular order, to begin your due diligence with a deal presented by another investor (referred to as offeror here). No money or commitment should change hands until you have satisfied at least this preliminary checklist. After all, you spent a significant period of time making your hard-earned money; don’t throw it away in 30 minutes. Unfortunately, this happens all too often. In many cases with experienced investors who should know better.

1. How well do you know the person offering you the deal? What is their reputation? Get names of other investors the offeror has done business with and talk to those along with other investors you know about their experiences or knowledge of this person. If you don’t know those investors, find out about them as well. Put more stock in the experiences of those investors who have been dealing with the offeror for years rather than a short period of time and have done several completed deals with them. What were their deals? Did they work out as expected? Did they check out what the offeror said? Did they receive the proper paperwork? Don’t rely solely on offeror’s references. A recent study showed that 40% to 60% of resumes have false references. You need to have independent references as well. For example, check with the president of a REIA local to where the offeror lives. Ask others in investment groups or classes where you met the offeror if they know him and his ethics. You can’t get too many references.
2. Ask the offeror about their experience and history. Ask what you will find if you run a credit-check or background check. You ask tenants and borrowers for this information, why wouldn’t you with someone with whom you are thinking about investing. Then run their credit, civil and criminal background checks. I once did due diligence on a fellow where everything checked out until I ran a background check for $40 to find he was in bankruptcy. Check the Secretary of State’s website for any entities the offeror may control or be associated. Then Google search those entities as well. What do you find?
3. Google the offeror. No kidding. Ladies are searching the Internet for background information on blind dates or someone they just met. You should search anyone you think you are considering investing your hard-earned money with as well. You may be surprised by a Better Business Bureau rating or a newspaper article on their business ethics.
4. Ask the hard questions. What is their experience? Review the paperwork for the deal. Who is the owner shown? Does the offeror have a right to sell the property or secure your interest, depending on the deal? Then check county records for who actually owns the property. Assure you will be properly secured when you invest.
5. Does this investment constitute a security? This can be a hard question to answer, but generally, if you are not to be involved in control and decisions of the investment other than putting up the capital upfront, in order words, you are depending on the efforts of the offeror or someone else to generate the profits, it is a security. This covers a lot of investments being offered, so be careful. Hopefully, the offeror is a solid business person, meticulous and honest. But, if their activities comes to the attention of the state’s securities division or the SEC, your investment, including return of capital and profit, could be adversely affected over the couple of years required to work through the issues. I have seen investors lose large amounts of money when the offeror was performing, but ran into a securities problem. Sometimes their records were seized and bank accounts frozen. No matter what their intentions, they could not continue to perform.
6. Will the investment be in YOUR NAME so you can oust the offeror and take over if you decide to do so. It’s your money so you should control the investment. This is a biggie!
7. Confirm the deal is as it is being presented. This is one reason why you should only invest in your own backyard where you know the market. If this investment is in another location, you should go there and confirm what the offeror is saying is indeed correct. Sometimes, you will find the offeror even with the best intentions has made a mistake or is too optimistic in their projections. It is your money, don’t investment in someone else’s dream, just the hard facts of the investment.
8. Ask for last two years of financial statements and tax returns. No kidding. They can always say no. Their reaction to this request can often be very informative. If they do provide these items, great. Then call their accountant to confirm they are real. If they decline to provide, what is their excuse? If you are looking at taking them on as a partner, you really need this information.
9. If you are partnering, does the joint venture agreement describe that venture and responsibilities of partners as you expect or does it need to be revised to be more specific and in line with the discussions you have had with the offeror?
10. Never, never, never write a check directly to the offeror. Should you decide to invest, always send your funds directly to the attorney or title company doing the closing, along with closing instructions. These instructions should be specific as to exactly how the funds are to be applied and the signed and filed documents you expect in return. Always get title insurance and require a Closing Protection Letter from the closing agent who is also issuing title insurance. It costs nothing extra and assures your written closing instructions as to paperwork affecting/securing title is done properly and funds applied according to your direction.

Is there more that you need to do? Heck yeah! Every deal will need the details confirmed as if you are doing the deal on your own. You should never invest in something you do not understand or with someone you have not thoroughly vetted. Be careful of the securities issue as you investment could easily get caught up in any trouble the offeror gets into.

The long and short of it is that you should always control your money or the investment of that money. The best approach is to invest yourself and not take on any partners if possible…