A Due Diligence Framework for Investments

Due diligence works best as a process rather than an instinct. The framework below moves from cheap, fast checks to expensive, slow ones, so that most unsuitable opportunities are eliminated before you have spent much on them.

It applies to real estate, private deals and managed investments alike. The order matters: each stage is designed to be capable of ending the process.

Stage 1: Preliminary screening

The goal here is to spend an hour and be willing to stop.

• Validate credentials. Confirm every licence, certification or registration relevant to the opportunity, and confirm its category. Registers are public and free.
• Confirm the entity. A free ASIC company search establishes that the company exists, when it was registered, and whether it is in administration.
• Search the people. Company extracts give you directors; directors give you other companies; other companies give you a track record. Run a bankruptcy search on each.
• Examine historical performance. Ask for prior projects and verify them independently. A claimed track record you cannot confirm from any source other than the promoter is not a track record.
• Check warning lists. ASIC’s published warnings and Scamwatch alerts take minutes to search.

If something fails at this stage, stop. The remaining stages cost real money.

Stage 2: Strategy and thesis evaluation

• Understand the thesis. What has to be true for this to work? Write it down in one paragraph. If you cannot, you do not yet understand the investment.
• Identify the failure modes. What has to go wrong for you to lose money, and how likely is each? For development, the usual answers are approval delay, cost escalation, funding failure and market movement.
• Assess alignment with your goals. Match the investment against your risk tolerance, your time horizon and your liquidity needs. Private property deals are illiquid for years, and your capital is committed regardless of what changes in your life.
• Establish the downside. Not the projected case. The case where the project takes twice as long and costs more. What do you get back?

Stage 3: In-depth analysis

• Evaluate management. Experience, qualifications, and — more revealing — what happened to their previous ventures. Ask about a project that went badly and listen carefully to the answer.
• Review the market. Current conditions, comparable evidence, absorption rates and the competitive landscape. Verify the promoter’s comparables independently.
• Test the assumptions. Every feasibility contains assumptions about price, cost, timing and finance. Change each one adversely and see what survives.
• Understand the regulatory pathway. For Queensland development, this means the assessment category and what drives approval timing.
• Trace the money. Which account does your money go into, who is a signatory, who can move it, and how would you know if it moved?

Stage 4: Communication and relationship assessment

This stage is softer but genuinely predictive.

• Ask specific questions and note the answers. Specific questions answered with general reassurance is a pattern.
• Test responsiveness under mild pressure. How someone responds to a difficult question before you invest is a reasonable guide to how they will respond after.
• Ask what happens when things go wrong. Who decides, who tells you, and how quickly?
• Put material questions in writing and keep the answers. This costs nothing and is occasionally decisive.

Stage 5: Documentation and structure

The most important stage, and the one most often rushed.

• Read the binding documents. The Information Memorandum describes the deal; the executed agreement creates it. List every representation that matters and find each one in the agreement.
• Establish the fee cap. Not the rate — the total, and what happens if the project runs long. See management fees in property syndicates.
• Establish borrowing restrictions. Can the project take on debt, and whose consent is required?
• Secure information rights. Read access to accounts and accounting systems, written into the agreement, and not revocable without your consent.
• Secure decision rights proportionate to your capital.
• Understand the exit. Deadlock, forced sale, default and wind-up provisions. These become the most important clauses in the document at the worst possible moment.
• Get independent legal advice from a lawyer acting for you alone.

Stage 6: Monitoring

Due diligence does not end at settlement.

• Reconcile reports against primary records where you have access
• Watch for reductions in reporting frequency or specificity
• Re-run company and property searches periodically to catch new charges
• Treat any withdrawal of access as a material event, and act on it immediately
• Keep contemporaneous records throughout

Why the order matters

The framework front-loads the cheap checks because most opportunities that fail, fail early. Spending $60 on searches before spending $6,000 on legal fees is the whole point.

It also front-loads the checks that are hardest to argue with. A register entry is a fact. A feasibility is an opinion. Establish the facts first, and assess the opinions in light of them.