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Introduction

Due diligence is an investigation of potential investments to validate all facts, like reviewing financial records and anything else considered material. Due diligence in general sense refers to the care that must be taken by a person before entering into a contract or any form of financial transaction with another party.

The purpose of this guide is to provide a research-based tool for the organization team, whether specialist or generalist, and a methodology for and orientation to thinking about due diligence. Using The Due Diligence Tool, an investor will be able to ask the most important questions about the organization’s health. He/ She will review the most telling documents, ask the most salient questions, and have an understanding of what to look for and what to make of what is learnt.

The tool is not designed to be used as a report card, resulting in a passing or failing grade. Nor will it guarantee particular outcomes. The objective behind performing due diligence is that the conclusion obtained from this research will give a clear picture and help in the decision making by aggrandizing the quality and quantity of the available information to the investigators and by making sure that this information is used congruously to proof the cost, benefits and risks.. Its use offers an opportunity for honest dialogue between investee and investor about the health and prospects of the organization they both want to succeed. Finally, while this is an initial effort to lay out a general framework for due diligence, the intent is to provide a foundation upon which to build and improve. We hope this will stimulate further conversation about the practices of the sector, and look forward to continued improvements to the product we offer herein.

Due diligence has now become a necessary and sinuous process on which most of the business decisions depend. It relates with the necessary precautions that a company must take by studying the other company and understanding their assets and drawbacks before a contract is made.

Why Due Diligence?

Due diligence has two main definitions. Firstly, it is a process of assessing risks and opportunities of a proposed transaction, although it is not simply an audit in that context. Secondly, it is the standard of care required during a particular transaction, particularly prior to that transaction. In both contexts it involves investigating the accuracy of the information related to prospective investment or business decision and evaluates the future potential of the subject matter of the transaction.

With origins in the private-sector world of business and finance, the term “due diligence” refers to the process through which an investor researches an organization’s financial and organizational health to guide an investment decision. The decision to fund or not to fund is based upon a balance of objective data analysis, insight into the general state of organizational health and stability, and intuition. A sound and thorough due diligence review is the process through which all the factors that make up that equation are uncovered and understood. It is the process in which a program officer seeks the “truth” about an organization. Foundation program officers are faced with multiple challenges in assessing whether to recommend an investment to their board or decision-making committee. First, they must ascertain whether and to what extent the proposed activity coincides with the organization’s guidelines and priorities. Next, they must assess the worth of the proposed activity itself — does it advance the field, provide needed services or generate new learning? If the proposal survives this initial scrutiny, it must then be weighed for its relative merits beside many other worthy proposals. This process requires a great deal of skill and sensitivity. Due diligence protects a foundation’s investments and reputation and advances its mission and overall strategy. While the idea contained in a proposal might be a strong one, there are still many questions to consider. For instance: Does the organization have a successful track record? Does it operate under an appropriate governance structure? Is it financially and operationally sound? An over reliance on the strength of the ideas presented in a proposal, without ferreting out these organizational strength factors, can lead to funding a project that does not succeed in producing expected results, or worse. A program may not fail because an idea is flawed. Indeed, in many cases we never learn whether the idea was sound or not. Rather, the project fails because of organizational weaknesses — internal strife, disorganization, financial or legal problems — that preclude it from having a chance to succeed on its merits. Due diligence is an essential step in the proposal review process, and it deserves more than a perfunctory approach.

Finally, there are currently no accepted standards for due diligence review in the philanthropic sector. Due diligence is, as practiced, more art than science. Thus, practices within an organization can be highly idiosyncratic — developed by investors, one by one, to meet their own understanding of their investments priorities for proposal review. There are no time honored, well-regarded tools on the organization bookshelf.

While due diligence is not intended to provide an insurance policy against failure, it can ensure that a program officer has a thorough understanding of the various strengths and challenges an organization presents — and, thus, an understanding of the level of risk a particular grant may carry. While risk is dealt with differently by each foundation, understanding the risk inherent in a particular investment is essential. It can help an investor, for example, to decide whether or not to invest in the organization. It can also inform the investors the amount to invest and the profit to be derived from the investment. And, it can ensure the investor has a thorough understanding of an organization’s strengths and weaknesses and thus can effectively support organizational efforts toward success.

There are several reasons for conducting due diligence. Some of those include:

Confirm the accuracy of information provided prior to investigation, especially in the context of a transfer of assets or shares
Identification of the current situation of the business
Avoid misunderstandings between investors and the target company
Identify the risks (both firm-level and macro-level), shortcomings, returns and benefits of the business
Avoid unprofitable investments
Reveal hidden facts and potential problem areas such as pending lawsuits and contingent liabilities
Expose risks and liabilities
Verify past records of the target company

Two Approaches to Investment Proposals

There are two general approaches to investment making that may affect the approach to due diligence:

Proposals that arrive unsolicited, in response to published guidelines
Proposals that are invited or requested by an investee — either directly to a specific organization, or through a request for proposal (RFP) — in order to advance a strategy or initiative established by the organization.

Companies that have invited proposals may have a level of familiarity or confidence in an organization or project. It is important to avoid the temptation, however, of taking shortcuts in due diligence if you assume you know an organization well. There have been instances of serious issues inadvertently missed or overlooked because a lack of careful due diligence.

The Process of Due Diligence

When you receive a proposal on your desk, the first step of proposal review is generally consideration of the alignment of the investee organization and proposed project with your company’s guidelines and interests. If this initial review is positive, due diligence typically commences with broad research and information gathering to provide a good understanding of the organization, how it fits into the field and the way in which this project will advance your company’s strategy. You might also contact colleagues for their view of the organization and its work. Then, you move on to get to know the investee on a deeper level, including interviews with some combination of the executive director, board chair, other board members and staff members key to the proposed investment project. Each of these activities is covered in depth in this tool.

The basic steps in a due diligence process are laid out below

Step 1:

Review investment proposal, budget and supplemental documents
Review proposal for fit with company’s mission, guidelines and strategy
Familiarize yourself with the basics of the proposed project and the organization
Review Supplemental materials, such as strategic plans, financial reports, marketing materials, staff bios, etc.
Assess strength of the project focus and design
Consider viability of project budget and overall financial health

Step 2:

Conduct additional preliminary research
Ask your colleagues (investors and other experts in the field) for their input
Review the organization’s Web site
Seek out other available data and information relevant to the project

Step 3:

Conduct interview(s) with organization’s leadership site visit or phone
Get to know the executive director, key program staff and board leadership
Explore the organization’s health and capacity, including track record, governance and executive leadership, vision and strategy, staffing partnerships, communications and finance
Delve more deeply into the proposed project, focusing on planning, outcomes and evaluation

Step 4:

Conduct additional follow-up research as needed
Probe areas of concern through additional research and discussions with colleagues and staff or board leadership

Step 5:

Analyze and apply your due diligence findings
Consider “red flags” and assess the risk they pose to the success of the project
Weigh the factors important to your organization; determine if there are any “deal breakers”
Consider options for structuring the investment
Make decision about investment

Step 6:

Synthesize information and present to others
Write up due diligence findings and decision
Craft funding recommendation for staff and board review

The culture of your organization and its relationship with investees will largely shape the level and timing of direct interaction with applicants. Some organizations prefer not to engage with applicants until they are more certain than not that they have a viable proposal for their portfolio. Other organizations, notably some community organizations or smaller organizations that work closely with their communities, begin the due diligence process with a phone call and then proceed to in-person meetings or site visits if all indicators are promising after an initial level of document review and background research. Finally, there are organizations that make grants based solely upon the written proposal submitted and don’t seek additional contact. Regardless of when in the process you engage with the potential investee (if at all), it is important to acknowledge that once you have had personal interaction, it feels more difficult to say no. Indeed, it is critical to choose your interactions wisely so as not to raise inappropriate expectations. This is discussed further in

“Getting to Know the Investee”.

Due Diligence, Table 1 The main due diligence topics

Due diligence topics	Focus of enquiries	Expected results
Financial	Validation of historical information, review of management and systems	Confirm underlying profits. Provide basis for valuation
Legal	Contractual agreements, problem-spotting	Warranties and indemnities, validation of all existing contracts, sale and purchase agreement
Commercial	Market dynamics, target’s competitive position and target’s commercial prospects	Sustainability of future profits, formulation of strategy for the combined business, input to valuation

Types of Due Diligence

Different due diligence procedures exist. Due diligence subject matters may vary depending on the nature of the business transaction. The most popular kinds of due diligence concentrate on commercial, legal, and financial issues. The major subjects for due diligence, the areas of inquiry, and anticipated outcomes are listed in Table 1. Human resources, culture, insurance, risk, real estate, taxes, the environment, information technology (IT), pensions, and other areas are among the others covered by due diligence.

Financial Due Diligence

Special skills and knowledge are required to conduct financial due diligence. Therefore, a qualified accountant, or Certified Public Accountant (CPA), and an individual who is a financial professional must participate in the process. Financial due diligence is required to confirm the assumed financial situation of the target company. Financial due diligence compels the target company to update its financial statements and casts doubt on the accuracy of the financial statements. A financial statement review consists of an analysis of the balance sheet, income statement, cash flows and related supporting documents. Financial due diligence includes analysis of the target company’s past financial performance, current financial situation, and future financial projections. Financial audits require financial indicator analysis, trend analysis, and review of relevant documents. Financial due diligence allows the acquiring company to uncover hidden facts and discrepancies information provided by the target company (such as contingent liabilities). Research topics include the target company’s capital structure, profitability, costs and expenses, liquidity, trade credit, financial credit, dividend payment policy, working capital requirements, fixed assets, off-balance sheet items, and pricing policy included. Financial due diligence mainly focuses on potential risks that affect the value of the target company. This is a process that helps ensure the accuracy of accounts related to tax liability. In addition, tax due diligence is performed to review tax obligations, identify tax planning options and uncover tax risks that may affect the value of the target company. Successful financial due diligence depends on the accuracy of the information provided by the target company. Transaction quality is especially important in cross-border transactions. Some accounts contain errors and are missing important documentation. Additionally, language barriers in annual financial statements can complicate transactions. Preparing for financial due diligence is a stressful process, especially for target companies. Senior management can put high pressure on technical and administrative staff to produce good looking financial reports in a short period of time. To meet expectations, employees break some rules and falsify financial records. This hampers successful due diligence. In addition, excessive expectations, unrealistic goals, and inadequate research by the acquirer can lead to financial due diligence failures. An imperfect due diligence process is one of the main reasons deals end in financial disaster.

Legal Due Diligence

Legal due diligence consists of examining the legal affairs of the target company to effectively protect investors from risks. However, it does not replace contractual protection. The acquirer will request a review of legal documents to avoid risks relating to the target company’s status, ownership structure, assets, contracts, obligations, intellectual property, etc. This increases the bargaining power of the acquirer and ensures that the acquirer is not exposed to uncovered legal risks. Legal due diligence is usually done by an attorney. The target company will provide the documents and information requested by the acquirer. Attorneys check to see if the target company has serious legal issues. Attorneys can also request material contracts, patent listings, copyright and other intellectual property documents, insurance coverage, employment contracts, and pending litigation against the target company. Legal due diligence is critical in cross-border transactions that require time and special knowledge of foreign regulations and systems. It is important to understand the differences between tax law, labor law, and property law. Therefore, most acquiring companies hire professional advisors to conduct cross-border transactions. Professional consulting firms typically work with local experts to better understand different business environments, laws and regulations. Local partners typically provide support in understanding the political, economic and cultural issues of doing business. After reviewing the documents, the acquirer’s attorneys and advisors prepare a legal due diligence report. The legal due diligence report includes a summary of information checked, a summary of information requested but not provided, and any misrepresentation findings. Lawyers and consultants involved in legal due diligence also participate in the conclusion of contracts. Lawyers write the terms of the contract.

Commercial Due Diligence

This is known as market due diligence. Commercial due diligence allows the acquirer to examine the target company’s market performance. Commercial due diligence results are valuable indicators of demand for a target company’s products and services. Commercial Due Diligence requires a combination of internal data and insights from customers, suppliers and experts. A data room is set up for internal analysis. Internal marketing analysis covers topics such as marketing plans and strategies, sales budgets, sales forecasts, regional sales distribution, pricing policies, product policies, distribution channels, advertising strategies, and participation in trade fairs and exhibitions. External market analysis analyzes the target company’s market position, analyzes the most important customers, geographical customer distribution, competitors’ positions, suppliers and market opportunities. Site visits, interviews with key customers and suppliers may be required in this connection. The main interest in commercial due diligence is the future growth of the target company. This can be achieved by focusing on projected sales and future profits. Information provided by commercial due diligence reflects the value of the target company. Commercial due diligence findings help price negotiations.

Understanding the Context of Your Work

One key to success is your knowledge of the ﬁeld and region with which you are concerned. The deeper your knowledge and the broader your view, the more keen your questioning and your subsequent assessment of what you ﬁnd. Using your network of colleagues is an important part of this strategy, as is keeping abreast of the current research and best practices in the ﬁeld.

It is also important to understand your organization’s strategy — what are you responsible for accomplishing? It is equally important that you understand the foundation’s general philosophy and what it wants to get out of due diligence, because it is not a one-size-ﬁts-all eﬀort. That is, the process will not be applied the same way to every proposal and applicant organization. Thus, it is important to ground yourself in your organization’s values related to a variety of issues covered in the “Assessment Questions” section of the tool. Finally, you need to know the “deal-breakers,” if any, for your organization.

The Components of a Healthy, Profitable Organization

This is a succinct summary of the essential components that are linked to successful businesses. While a whole book could be written on the aspects contributing to a healthy, well-functioning profit-making enterprise, many have already been written*. The people, ideas, and resources that make up nonprofits are a complicated, diverse mix. Nevertheless, for them to be successful in furthering their goals, the following prerequisites must be met:

A Function of Good Governance

The organization’s board of directors establishes the mission in collaboration with the executive director before creating strategies and directives to further it. Additionally, it offers a connection to the community it serves and an impartial check on management’s decisions.

A Competent Executive Director

A profit-making firm needs a staff leader who is a master of all trades. She must collaborate with the board and employees, serve as a link to the community, funders, and clients, map out the organization’s future, generate money, and serve as an ethical role model. The executive director establishes the tone for teamwork among employees and internal communications.

A Reliable Financial Management System

Profitable businesses require a system that restricts spending and provides management with accurate, timely reports on income and expenses. For accountability and decision-making, management also need data, including an annual budget. Regular external audits should be conducted by the finance committee and, on occasion, by independent auditors.

Workable, ethical, and legal practices in human resources

Profit-making firms often spend more than 80% of their income on staff members’ salaries, benefits, and supervision and training. They must effectively manage this function while abiding by intricate legal requirements, paying employees fairly given the resources available, and inspiring them to provide their best effort. Internal communications must be organized to give staff members appropriate input into decision-making and up-to-date awareness of other organizational units’ operations.

A Successful Fund Development Strategy

A nonprofit must acquire cash in one way or another, whether it is from grants, contracts, fees, or individual donations. It’s life or death, and a nonprofit that is struggling to raise money is really in peril. The board and executive director must cooperate to raise the required cash whether or not there is a development director.

A Consistent, Clear Message

A nonprofit must explain its mission to anybody who could support it or benefit from it. Beyond a newsletter, its marketing and communications initiatives should utilize all forms of media and seize opportunities to convey its narrative.

A strong program that advances the organization’s mission is its core competency.

Getting to Know the Investee

The challenge of getting to know the investee rests on a variety of levels. Successful due diligence relies heavily upon your ability to listen beyond the investee’s written or spoken words. The process is an opportunity to seek the “truth” about an organization, that is, to go behind that which is presented on paper.

Establishing a Relationship through Due Diligence

The tone of the future relationship is established during the contact between the investor and possible investee during the due diligence phase. It’s possible that this is the organization’s first interaction with your foundation, so take advantage of the chance to establish a cordial relationship that will help your future collaboration. If this isn’t your first encounter and the connection hasn’t been as fulfilling as you’d want, now is the moment to start putting things back on the correct track.

A due diligence procedure that educates and benefits both parties is efficient and rewarding. By offering a description of the process and its goals, inquiring intelligently, treating the applicant with respect, and maintaining an open mind, the investor can assist in making the process beneficial and meaningful for the applicant. Examining an organization’s organizational health can help you better understand an organization and its proposed project. This is especially true if the program officer adds value to the process by providing insightful comments and recommendations.

Building Trust and Setting Expectations

It cannot be stated too frequently that trust is essential to a successful due diligence process.

How can one establish trust? Being truthful in your discussions with investors is a first crucial rule. To put it another way, follow through on your commitments and avoid making promises you know you won’t be able to keep.

Additionally, it’s crucial to be consistent in your actions and to be upfront and honest about the investing process, including what you look for and what the investees can anticipate. Like Investors, Investees converse with one another and compare notes. Be mindful that a network of neighbors who you have an interest in getting along with may be watching what you do. The foundation of the partnership is honesty and reliability.

Clarifying roles, responsibilities, and expectations at the beginning of the proposal review process is another technique to establish a trustworthy rapport. The reasons we are interested in your idea are as follows, along with what we need from you.

Continue to be clear about what is expected of the candidate moving forward. Let them know exactly what you anticipate from them, what you will be asking of them, and why. It is advantageous for an applicant to have a similar understanding of the procedure to you. Don’t assume that something makes sense. It is simple to become so ingrained in our jobs and procedures that we lose sight of what it could be like for someone on the “outside” to experience what we take for granted.

Finally, show respect to every investee. Even the most experienced nonprofit directors might get confused and frustrated by the investment proposal process. In their efforts to win your organization’s support, investees can run afoul of your needs or expectations. Always try to show and encourage respect, especially under difficult conditions.

Even if you ultimately decide to decline an investment request, by adhering to these trust-building principles, you will build a foundation of trust and goodwill with the investee that will benefit you both in the long run.

Site Visits

Site Visits are frequently a crucial component of due diligence. Site visits may be conducted by some organizations prior to an investment being made or after it has been made as part of continuous relationship building and project monitoring. Still other organizations hardly ever visit the sites, and only when making significant investments.

Site visits should never be taken lightly, regardless of when or why they are carried out. Site visits are a crucial component of your research and help the business set higher standards for itself. Therefore, it’s crucial that you express the “meaning” of this additional time commitment to both parties clearly when you decide to do a site visit.

Scope of the Due Diligence Tool

This tool’s technique involves just the bare minimum of due diligence; in other words, it’s a strategy that enables you to make wise investments. It is not a means of ensuring extremely deliberate generosity. It is not a tool that promises results either. The tool will ultimately be successful if it aids in your ability to fully comprehend the organization, including its advantages, disadvantages, and difficulties.

As you perform your due diligence, it’s crucial to keep in mind that profit-making organizations’ governance structures and management systems range in sophistication. A proposal should not be rejected because of a proposal’s lack of complexity in and of itself. The Investor team top priorities when using the tool are the following three questions:

How likely is it that this planned initiative will be successful? Is the application (investment) a good plan, in other words? Will the leadership of the application (investee) be able to carry out its stated intentions?
Does the applicant have a sufficient understanding of the tasks at hand and the resources at its disposal to successfully handle this project?
What further actions may the investors do to support this organization’s success beyond providing the requested funds?

Components of The Due Diligence Tool

Speciﬁcally, the components of the tool are as follows:

Proposal and Document Review

This section includes guidelines for performing an initial review of the written proposal and budget (as well as supplemental documents).

Conversation with the Applicant

This section provides assessment questions to be used in an in-person or phone meeting with the applicant, covering “big-picture” organizational issues (e.g., governance and executive leadership, vision and strategy development, and ﬁnancial health), as well as issues that are speciﬁc to the project being proposed for funding (e.g., planning, staﬀing outcomes and evaluation).

We have included the questions to ask, what to look for, and how to understand what you are seeing and hearing. We have also listed issues, called “red flags,” that are critical enough to warrant further attention and review, or that can suggest that making a grant may not be a wise decision.

Implementing Your Due Diligence Discoveries

On the basis of the knowledge you gained from the proposal review and applicant talks, this section gives variables to take into account and possibilities for making judgments. The tool might encourage you to ask questions that don’t necessarily have clear answers. Or that a particular response can have a different meaning in various organizational situations. The tool’s goal is to elicit thought, not to produce a precise numerical result or a set answer. As a result, it contains a range of strategies you might take into account when formulating your final funding proposal.

Review of Proposal and Documents

Reading the proposal, budget, and other supplemental materials supplied by the investee visiting their website, and speaking with the company’s colleagues or other experts are the first steps in the due diligence process to learn more about the organization, its programs, and its place in the industry. Guidelines for this first stage of the procedure are provided in this area of the tool.

Project Goals and Planning

The core of pre-grant due diligence is the evaluation of the programmatic focus and project design.

To asses whether the organization’s justification is reasonable and whether the suggested technique is likely to have the desired effect, this includes a review of the project plan and planned outcomes.

The rigor with which you evaluate the project design and outcomes expressed by the potential grantee will rely on the foundation’s culture and values. Some funders require each grant recipient to submit a thorough logic model or theory of change. (A logic model is a design and evaluation framework for programs.)

Others merely look for a concise description of the expected outcomes, together with well-developed activities that are likely to produce the results the grantee is hoping for.

You should be aware of the overall backdrop of the proposed project and how well it aligns with the strategy of your foundation before diving into the intricacies of the project design.

As noted above, part of the ongoing work of a program oﬃcer is to remain current with the ﬁeld in which you make grants, paying attention to trends, including research and keeping abreast of the organizations that are well respected, innovative and successful — whether or not they are your grantees.

The initial questions in your proposal review should include:

Does the project ﬁt within the ﬁeld? How will the project beneﬁt the ﬁeld or the community? Is there a need for the services and outcomes?
Is the approach solid? Are there better approaches for achieving the outcomes?
Does the project ﬁt with your organization’s theory of change? Does it build on other investments?

The second level of consideration revolves around the ﬁt between the proposed project and the organization in which the project is housed. You are seeking a solid and clear alignment between the organization and its work, and its ability to meet its goals.

Questions to ask your- self include:

Does the project ﬁt with the organization’s mission and theory of change? Does it shift the organization away from its mission?
Does the project design make sense? Do the proposed activities ﬁt with the overall project goals?
Do the costs make sense?
Is the program likely to succeed in achieving its desired results? What are the major challenges to success? How will these challenges be addressed?
Is this the right organization to do the job? Are there others doing anything like this; and if so, might they do it better?
Does the organization have a successful history of running a similar project? If the pro- posed scope of work is new for the organization, does it have the capacity to meet the goals?

The answers to these questions may not be found within the proposal, however, so additional document review or research may be necessary. You can gain signiﬁcant insight into an organization by reviewing its strategic plan, staﬀ bios or ﬁnancial statements, for example. A visit to the organization’s Web site can also be valuable.

You will also want to consider the applicant’s reputation among your foundation colleagues and experts in the ﬁeld:

How are the organization and its key staﬀ leadership perceived in their peer group and by other funders?
Does the organization have a positive history of working and networking with others in the community?

Project Budget and Overall Financial Health

Even though it is only one criterion for organizational health, financial health is a crucial one. The existence and expansion of an organization depend heavily on its capacity to handle its finances. A company needs to make sure that it plans for future expenses and that it earns at least as much money as it spends.

Examining the project budget is the first step in identifying financial problems. You ought to:

Acquaint yourself with the project’s budget.
Examine the staffing breakdown for the project: Does the suggested staffing structure seem adequate?
Take into account whether or not the project supports the organization’s work: Do the two go together?

After becoming familiar with the project, its costs, and revenues, you should focus on evaluating the organization’s overall financial situation. The balance sheet, which will provide you with a picture of its financial situation at a particular period, is an excellent place to start. Generally speaking, a company’s total current assets (such as cash, receivables, and securities) should exceed its total current obligations (such as payables, deferred revenue, and current-year loan and note payments) in order to avoid short-term solvency issues. On the other side, a company may not be using its funds wisely if its cash and equivalents vastly outweigh its current liabilities, or if its current ratio is 3:1 or higher.

Examine the applicant’s revenue statement and balance sheet for the following signs of financial stability:

The company has enough working capital to cover its present liabilities plus three months’ worth of operational expenses.
The organization’s net assets are positive (also known as its “fund balance”).
There is no operating deficit for the company this year (revenue exceeds expenses).

Additionally, it is a good idea to confirm that the organization has submitted a form 990 to the IRS and that the data from its audit supports that on the 990. The most recent 990 can also be used to check whether the highest-paid employees’ pay seems suitable and reasonable. It should be emphasized that not all program officers have a strong aptitude for or love for financial management. You are not alone if this field of research intimidates you in some way. There are classes on how to understand nonprofit financial accounts as well as books, manuals, and other resources.

Conversation with the Investee

You can proceed to learning more about the application and its planned project through an in-person meeting or phone chat if, after reviewing the proposal and supporting papers, there is a good fit with your foundation’s policies and values and the project is of interest.

Consider this meeting, whether it is over the phone or in person, as the start of a relationship. The main goal of this meeting is to motivate the applicant to continue the conversation. You will have the chance to ask questions during this conversation in order to gauge the many facets of the organization’s health.

Each component of organizational evaluation is intricate and essentially its own field of study. Nonetheless, you should build your basic understanding of the key areas of nonproﬁt management and be prepared and comfortable discussing them within the context of the tool.

Basic Tips for Effective Interviews

It is helpful to use the proposal documents you have reviewed as a starting point for your discussion. They contain information the applicant is familiar with, and that establishes a comfort level that can help you start a productive conversation.

Always ask open-ended questions. That is, avoid questions to which the only answers are “yes” or “no.” You will not learn much nor will you generate worthwhile conversation! Open-ended questions typically start with:

Tell me about… How do you… What are…?

The tool itself provides many examples of questions that will elicit information that is useful without leading the interviewee to the “right” answer.

Keep questions simple. Don’t combine multiple areas of inquiry to form a long, complex, difficult-to-track question. One question at a time focused on one issue of interest is the best method to guide a conversation.

Avoid questions that communicate judgment. For example, “You didn’t think about the implications of…, did you?” This is a sure conversation stopper, and will it inhibit your ability to foster an open and honest relationship.

Always conclude your conversation with one of the following questions:

Is there anything I didn’t ask about that you wish I had asked? Is there anything we have left out and not talked about?

The Assessment Questions

The assessment questions are divided into seven topic areas, although all are interrelated. These areas are:

Organizational History and Track Record
Governance and Executive Leadership
Organizational Vision and Strategy
Proposed Project: Planning, Outcomes and Evaluation
Human Resources
External Relationships and Communications
Financial Health

Within each area of assessment, the tool includes the following information:

Overview of assessment area: a brief explanation of why that area is crucial to due diligence and a healthy profit-making firm.
Who to interview: A list of the best candidates for each evaluation area, organized by role.
What to look for and the questions to ask:

For each of the assessment topics, there are suggested questions to think about and a corresponding set of effectiveness indicators to watch out for. You may find potential “red flags” that have been included. Red flags are indications that the nonprofit may not be able to utilize the company’s funding because it is lacking in a critical area of organizational capacity.

Organizational History and Track Record

It’s crucial for you to comprehend the backdrop of an organization by understanding its history and track record. It will describe the organization’s overall accomplishments, the key difficulties it has encountered, and how it fits into its local community and industry.

This area of due diligence heavily relies on discussions with other funders and field groups that may be knowledgeable about the potential grantee, as well as on a review of the information that the organization has provided to you regarding its history, work, and accomplishments.

In addition to your study, you can learn crucial details by asking the candidate the questions we’ve suggested below directly.

Category of Issues	Questions to Consider	Indicators of Effectiveness	Red Flags
History	Tell me about the history of your organization. What have been the key milestones in its development? What have been the most signiﬁcant accomplishments of the past three to ﬁve years?	The organization has a proven ability to succeed. The organization has a track record of results that demonstrates an impact on its constituency or target population.	The organization’s leadership cannot (or will not) openly articulate both successes and challenges.
	What have been the most signiﬁcant challenges?
Recent Accomplishments	What have been the most important accomplishments this past year?	The organization has a recent record of an active and vital program.	The organization cannot demonstrate recent program accomplishments.

Executive Leadership and Governance

An effective, profitable business needs both strong governance and staff leadership to remain healthy and stable. As a result, the board of directors and executive director of an organization, as well as their interaction, are frequently two of the most crucial factors in determining the strength and capability of an organization.

Any profit-making organization’s governing body that provides governance and strategic direction is the board. You can gain insight into the stability and health of an organization by being aware of how the board operates. You must have faith in the executive director’s capacity to lead the organization and carry out the activities outlined in the plan because he is the senior staff leader.

It is also vital to evaluate how successfully the board and executive director are likely to collaborate, utilizing one another’s strengths and strengthening one another’s weaknesses. The ability and willingness of the board and chief executive to collaborate, to seek assistance when necessary, and to make adjustments are crucial success factors for any profit-making organization, particularly during any period of crisis or vulnerability. Few weaknesses within a profit-making company are fatal in and of themselves.

Category of Issues		Questions to Consider		Indicators of Effectiveness		Red Flags
Role of the Board		Describe your board and the role it plays in the organization. How do the board and E.D. work together? How are decisions made? What is the board’s role in strategic planning? In fundraising? In ﬁnancial oversight?		An active board, engaged in ﬁscal oversight, structured in a way that makes sense for the governance needs of the organization. A board and E.D. that understand, and agree upon, their respective roles. Board members who are willing to contribute money, with a goal of 100% board giving (amount given is less important).		The board is not active or is disengaged, especially with regard to ﬁscal oversight. An E.D. who doesn’t value a strong board of directors, or who has a very negative perception of or relation to the board. A mismatch between E.D. and board perceptions of their respective roles.
Structure of the Board		How does the board make decisions? Do appropriate committees exist? How often does the board meet? If applicable, what is the role of any advisory board(s)? Who serves on it?		An E.D. who understands the importance of developing an eﬀective board, and looks to the board to ﬁll in skill gaps. Enough board members to get the work done. Adherence to board member term limits.		The organization cannot demonstrate recent program accomplishments.
	Composition of the Board		Who is on your board? What do they bring to the organization? How do you recruit and select your board members? Who is involved in this process? Describe your commitment to diversity of staﬀ and board members.		A board that is representative of the community or stakeholders it serves. A diversity of membership on the board, with skills and knowledge important to the organization, especially ﬁnancial management and organizational knowledge. A strategic, ongoing board nominations process.		Staﬀ members (other than the E.D.), staﬀ spouses or relatives on the board.
	Relationship Between E.D. and Chair		Describe the partnership between the E.D. and the board chair. How do you/they work together?		A working relationship that shows positive, mutual regard and respect.		Obvious conﬂict between the E.D. and the board chair. A clear diﬀerence in their respective views of their roles and how they work with each other.
	Executive Leadership		For E.D.: What are your background and qualiﬁcations? How long have you been with the organization? How do you work with staﬀ? How do you work with the board of directors? For board members: Describe the leadership your E.D. brings to the organization.		An E.D. who is a passionate leader, knowledgeable about managing the organization if she doesn’t have all the skills, she is aware of what is needed and has resources to get the needed skills. An E.D. with the qualiﬁcations to run the organization, and a good reputation in the community and the ﬁeld of which the organization is a part.		An E.D. who fails to inspire your (or her board’s) conﬁdence. The E.D. does not have the necessary experience or training to run the organization. Or the opposite exists: the E.D. is well trained and experienced, but does everything herself, and the whole organization would collapse in her absence.

Organizational Goals and Plans

The board’s responsibility for establishing the organization’s vision and general direction is crucial. The board must participate in creating the organization’s strategy and plans in collaboration with the executive director and other staff leadership. Having a thorough awareness of the environment in which the organization operates is necessary for this. Due diligence should be given extra attention to visioning and strategy formulation since they demand a crucial combination of governance and leadership that is essential to a successful business.

Category of Issues	Questions to Consider	Indicators of Effectiveness	Red Flags
Vision	What is your organization’s mission? What is your vision for the organization?	Agreement between E.D. and board as to the mission and long-term vision for the organization.	Leadership is unable to articulate mission and/or vision.
Strategy Formation	How do you set overall direction for the organization? Do you have a current strategic plan? If not, how do you develop strategy? Who is involved in strategic planning and thinking?	A current strategy for achieving the organization’s mission with realistic goals. Involvement of the board in strategy development.	Leadership cannot describe any internal process by which opportunities are evaluated and/or goals are set.
	How do you incorporate current strategies into your work?
External Environment	How does the organization keep abreast of the latest thinking in your ﬁeld? What are the top three challenges facing the organization over the next ﬁve years?	Leadership can describe programmatic trends or movements in the ﬁeld and how they will aﬀect the organization’s work.	Inability to articulate major challenges beyond needing funds.

Proposed Project: Planning, Results, and Evaluation

Your initial reading of the proposal ought to have given you a solid understanding of the applicant’s intended endeavor. But the written word has its limitations. To gain a deeper knowledge of what the leaders want to achieve, it is essential to speak with the applicant.

Ask the applicant about the project’s strategy and plan, as well as the resources required to carry it out, throughout your conversation. Ensure that the programmatic objectives and results the nonprofit has established are clearly defined, significant, and measurable.

Evaluation serves a number of purposes. Through ongoing evaluation, organizations can learn how they are doing in terms of achieving their goals and receive direction on what is working and what needs to be altered and improved. Additionally, evaluation provides information that is useful to funders and other professionals in the field. Last but not least, good evaluation procedures support accountability.

Although the degree and focus can vary greatly, most investors expect some sort of program review from at least some of their (bigger) investees. Effective organizations should be able to explain anticipated objectives and describe a plan for tracking and measuring the progress of their activity. They ought to have ways to assess their results and apply what they discover to their programmatic approaches.

The inability of an investee to track and evaluate its performance is a “deal breaker” for investors. For others, there is a commitment of resources to engage with grantees to grow it since that ability is really vital. Investors who want independent review typically supply the funding to support the job because evaluation is expensive. Other investors merely want the most fundamental monitoring and evaluation, which the profit-making firm can provide internally. Therefore, the main concern is if you are receiving the evaluation data required to satisfy the norms and values of your specific organization.

Interviewees: Executive director, key program staﬀ, board member that is a project “champion” or supporter

Category of

Issues

Questions to Consider

Indicators of Effectiveness

Red Flags

Project Planning

Describe the basis for your approach to this project. What research do you rely upon for your proposed approach?

Describe the resources needed to accomplish your goals, and how you plan to obtain them.

If relevant, discuss the following:

• Scalability of model

• Replicability of model

• Potential for broad impact

• An innovative approach

The methodology makes sense, given what is considered accepted or best practice in the ﬁeld.

The project design supports the applicant’s theory of change (whether consciously articulated or implicit).

The project plan allocates appropriate resources (staﬀ, expertise, money, an appropriate time frame) to

accomplish what is anticipated.

The logic model6 or rationale for the program does not make sense.

The approach is outmoded, showing a lack of awareness of developments in the ﬁeld in recent years.

Category of Issues

Questions to Consider

Indicators of Effectiveness

Red Flags

Project Outcomes

What are the goals and outcomes identiﬁed for this project?

What was the process for developing the outcomes? How do you use lessons learned from previous projects?

Describe your organization’s greatest strengths in terms of your capacity to achieve your intended outcomes.

What signiﬁcant challenges inhibit your ability to achieve your intended outcomes?

Desired outcomes are plausible and aligned with the nonproﬁt’s mission and strategy.

Goals are realistic and achievable within the grant period.

The resources available are appropriate, and the cost of the program will result in a reasonable impact.

Outcomes are SMART: speciﬁc, measurable, achievable, realistic and time sensitive.

Project plans are overreaching — goals are too ambitious or resources available are clearly insuﬃcient to reach the goals.

The outcomes are not in alignment with the theory of change for the project.

The cost-beneﬁt analysis is unacceptable (i.e., it is not worth the expense for the anticipated impact).

Evaluation

How do you evaluate your programs? What tools do you have in place?

How do you incorporate what you learn into your ongoing and future work?

What is the plan for evaluation for this project? What resources are allocated for evaluation in the project budget?

Organization knows what it accomplishes and can articulate how it will apply what it learns.

If outcomes are not achieved, leaders can explain why and have strategies to improve ability to meet outcomes.

Organization has no understanding of the value of tracking its outcomes.

Human Resources

Most profit-making organization spend the majority of their budgets on staﬀ, including salaries, beneﬁts and taxes, so human resources management is worthy of strategic thought and planning. This includes developing sound practices in hiring and management, building an organizational structure that meets the needs of programs, and providing staﬀ with opportunities for ongoing learning and professional development.

There are two primary human resources management functions: the technical side (maintaining employee ﬁles, collecting salary and beneﬁts information, and conducting periodic reviews); and the strategic side (recruiting, developing and retaining a motivated, excellent staﬀ). Organizational leaders must manage these human resources functions wisely, complying with complex government laws and regulations, compensating people adequately within limited resources and motivating them to perform their best. In reality, however, few nonproﬁts have well-developed human resources management, so this area can be challenging to assess. It is important to keep in mind the reality of resource constraints of any company you are assessing, balanced with the need to eﬀectively meet the organization’s human resources responsibilities.

As you assess the human resources of an organization, ask about the number of people on staﬀ, their qualiﬁcations and experience, the professional development opportunities oﬀered on a regular basis, and the organization’s ability to eﬃciently and eﬀectively grow or reduce its staﬀ as needed. You will want more detailed information on the key staﬀ who will work on the project you are being asked to fund in order to assess their capacity and skills for delivering the services proposed.

Interviewees: Executive director, key program staﬀ

Category of Issues	Questions to Consider	Indicators of Effectiveness	Red Flags
General Staff and HR Concerns	Describe your organizational structure and staﬀ roles/reporting relationships. How are staﬀ recruited and hired? How are staﬀ oriented and trained for their jobs? How do you handle staﬀ performance reviews?	Organizational structure is clear and there are logical lines of reporting for staﬀ. Organization values and invests in staﬀ training and development. Contractors and/or consultants are used and managed appropriately.	Staﬀ turnover seems unusually high. There is no evidence of a human resources function within the organization — no job descriptions, no organizational chart, etc.
	How do you invest in professional development for staﬀ?
Project Staff	Who are the staﬀ members responsible for the proposed project? What are their backgrounds and qualiﬁcations?	There is suﬃcient staﬀ with the skills and experience to do what the organization says it will do.	The key project staﬀ do not have the necessary experience and/or training to do the job.

External Communications and Relationships

Understanding how an organization interacts with and positions itself in the external environment is an important part of due diligence. An organization’s capacity to communicate who it is and what it does, and its ability to develop and skillfully manage external relationships, can impact the organization’s overall eﬀectiveness. You should spend time exploring the work of the applicant in both of these areas.

The way an organization communicates with its external audiences can greatly aﬀect its potential to remain viable. When an organization knows how to communicate eﬀectively, its relationship with its stakeholders is strengthened. Through marketing and communications activities, an organization makes its stakeholders aware of what it does and the value of its work. When an organization’s constituents are fully aware of its achievements and value, they are more likely to support it ﬁnancially, politically and programmatically.

Look for organizations that can communicate their message clearly and eﬀectively and can communicate and form relationships with important stakeholders. A proﬁtable enterprise that has a communications or marketing plan — and is working to implement it — is likely to be more eﬀective in cultivating and maintaining a loyal constituent base and to have better relation- ships with funders and donors.

Further, the willingness and ability of a company to collaborate or partner with other organizations is a vital capacity in today’s profit-making sector. It is important that an organization’s leaders understand their position in the ﬁeld, who they are competing with for resources, and where there are opportunities for strategic collaboration. Partnerships ranging from one-oﬀ situations to long-term relationships are often an indicator that an organization is looking for ways to increase its eﬀectiveness and eﬃciency.

Interviewees: Executive director, board chair or other board member(s)

Category of Issues	Questions to Consider	Indicators of Effectiveness	Red Flags
	Who do you consider your key audience(s)? How do you communicate with those audiences?	The organization has a clear message to communicate about its work and role in the community.	Lack of awareness of the need to communicate.
Communications	How do you disseminate information about your work or share what you learn with others in the ﬁeld?	The organization has a communications plan that describes audiences and outlines strategies and tactics to reach them.
		There is an awareness of the importance of sharing knowledge.
External Relationships	What partnerships or collaborations are you involved in? What role do you play? How do you approach and develop partnerships or collaborative relationships with others? Who is your “competition”? How do you work with them?	The organization has a strong awareness of others in its ﬁeld both competitors and partners. The organization looks for ways to collaborate, and engages in creative partnerships. E.D. and staﬀ participate in network or coalition activities, such as collaborative trainings or roundtable policy discussions.	The organization tells you it has no competition because there is no other organization that provides the same service. Lack of involvement in or awareness of key networks or coalitions. Lack of awareness of key competitors, believing it has no competitors.

Applying Your Due Diligence Findings

In the introduction to this tool, it was stated that due diligence is both art and science. Once you have immersed yourself in the process of rigorously examining an organization and its leadership through the course of due diligence, you will have a clearer understanding of the truth of this statement.

It would be terriﬁc if your investigations led to a consistent set of ﬁndings either all great or all bad. However, this is generally not going to be the case. In reviewing your due diligence ﬁndings, you may uncover some issues that lead you to a favorable impression of the organization and others that cause you concern. You may also have identiﬁed red ﬂags.

The analysis of due diligence ﬁndings is generally a weighing of a variety of factors in order to determine whether you should feel caution about making the grant recommendation.

During the course of due diligence, you will develop an understanding of the organization’s ﬁnancial health, its capacity to deliver on the proposed project, its reputation in the community and its approach to working with others. You will also develop a perspective on the leadership of the organization — both paid and volunteer. Now is the moment to consider all the factors that have come into play and to explore how to balance what you have learned in order to reach a decision about whether the organization warrants an investment from your organization.

What Are Your Organization’s Values? How Do They Relate to Investment Decisions?

Every organization has values that are reflected in decisions about investments.

These will shape your due diligence process and the way you evaluate what you learn. It is your responsibility to understand what matters to your foundation and how you weigh those issues in your process. Examples of specific values might include:

Board and staff diversity: Does it matter to your organization that the staff and board are representative of the constituencies the company serves? How strongly will you take a position?

Social enterprise issues: If you are investing in social enterprises that must demonstrate financial sustainability by the end of your commitment to the organization, you may have this bottom line as a clear value that guides your assessment.

Financial capacity and practices: Some organizations place a particular value upon understanding and promoting financial competency. Extra attention may be paid to this area, and effort invested in assisting grantees in building their capacity in financial management.

Key Issues

In some cases, financial due diligence can be perceived as audit. This kind of definition only limits the scope of due diligence. While audit covers the past and the present financial status of the target company, the financial due diligence provides financial historical review and it also considers the future prospects of the target company. The financial due diligence benefits from audit reports, however, it is an in-depth report on the financial health of the target company and it also considers post-integration period.

In order to understand whether or not the deal makes sense financially and socially, due diligence is essential. The companies should reflect their CSR policy in their operations to minimize the risks and maximize the sustainability of their products and services. The efforts in this field are based on the commitments to respect to society.

Future Directions

Due diligence is not simply a checklist of the required information. It provides useful insight information about the target company and it reveals the hidden facts and critical issues. The scope of due diligence should be broad and deep. The parties involved in due diligence should not focus on the cost of the process. Rather, they should pay attention to quality of the information and risks associated with the deal.

In order to reduce risks, it is important to allocate ample time for due diligence. However, in today’s fast-paced environment, the duration of due diligence processes is short. This leads to poor and incomplete due diligence that results in merger and acquisition failures which may have negative impacts on economy, employment, and society. It would be interesting to investigate the duration of due diligence process depending on size of the deal, type of the industry, and type of the deal (being cross-border or local). Yet, there has been no study investigating the impact of the duration of due diligence process on the success of the deals.

Red Flag Identification and Understanding the Risk

In your analysis of the data collected through document review and interviews, you may have identiﬁed red ﬂags in one or more of the assessment areas. Red ﬂags are ﬁndings that indicate the company is not be fully capable of implementing the investment.

It is important to note: Not all assessment areas will reveal red ﬂags, and not all red ﬂags mean that you shouldn’t award an investment.

Further, you may have issues that matter to your particular foundation and would be a deal breaker so, your organization may have additional red ﬂags beyond those that has been included.

If you have identiﬁed any red ﬂags, they can be recorded on Worksheet #2: Assessment Questions. You then need to assess the risk that the red ﬂags, taken as a whole, represent to the organization’s objectives. This involves looking at the big picture formed by the due diligence process:

What do the red ﬂags tell you?

Overall, what is the level and nature of the risk in making this investment? Does the potential beneﬁt outweigh the risk?

Are there actions that might eﬀectively manage or ameliorate the risk?

This evaluation must take into account the fact that the red ﬂags can’t be weighted equally. Some issues are relatively simple to address through the use of an outside consultant with speciﬁc expertise (e.g., setting up an adequate ﬁnancial management system). In other cases, it may take more time to aﬀect real change (e.g., an organizational culture that does not promote appropriate involvement of the board of directors). In some cases, it may be highly unlikely that the organization will ever meet the funder’s minimum standard in an important area.

It will be your challenge to determine how to move forward with funding decisions in light of any identiﬁed red ﬂags. Your assessment and understanding of the red ﬂags can be guided by the following set of questions:

How extensive are challenges or organizational deﬁciencies? Are there many red ﬂags across diﬀerent areas, or are they clustered?

Taken as a whole, are the challenges signiﬁcant (critical) enough to aﬀect the organization’s ability to carry out your grant? Why?

Could the issues be addressed? How?

Is the organization willing to take the necessary steps to remedy the weakness or deﬁciency? Are you willing to provide resources to support it?

Providing organizational support such as additional equity capital or consulting assistance to an organization that could beneﬁt from it is an option if your organization generally supports such activities for investees. What this red ﬂag analysis can provide is a better understanding of what an organization might need in order to advance its mission and succeed in implementing your investment plan.

Factors to Balance

In determining how to address problems surfaced by the due diligence process, here are some key factors to consider:

Size of investment: Is it large for your organization? If so, you will want to be sure about your decision to fund. A diﬀerent level of analysis is needed for diﬀerent sizes of grants. You know what is “large” for your organization, and when you are considering a high level of investment, or a long-term investment, your due diligence process will likely be more exacting and
Size of investment relative to the applicant’s budget: Will this make a large impact on the company’s annual operating budget? If so, it will be critical to pay attention to the health of the organization and its capacity to manage a large infusion of
Recent leadership changes at the applicant organization: If there has been a re- cent leadership change, you may choose to spend additional time exploring the reasons for the change and trying to understand how the organization is managing the transition. Times of leadership change can be challenging, and may warrant additional support or a decision to postpone new

Communicating Your Due Diligence Findings to the Applicant

Once you have completed due diligence and analyzed what you have learned, what do you communicate to the applicant? In order for due diligence to be a useful process for both the investor and investee, thought should be given to what and how you communicate back to the applicant. Whether your ultimate funding decision is yes or no, you have learned things about the organization that may be helpful to it.

This communication takes time. However, it is this extra step and investment in the relationship that makes due diligence a valuable process for both parties. Whatever the mode of communication — in writing, by phone or in person — think carefully about what you will say and how you will say it.

Be honest, but not critical or judgmental. Make observations about the organization’s health and challenges, but don’t criticize.

Be clear about the reason(s) you are choosing not to invest. It is difficult to turn down a grant applicant and even more difficult to communicate that information directly. It is helpful to the applicant, however, if it understands the reasons for your decision. If you are denying funding, be clear on your reservations about the organization’s health and stability.

Be specific. Discuss issues in the proposal or supporting documents, or things that you learned in the course of your interviews, that raised red flags.

Acknowledge strengths and challenges. Don’t just communicate your concerns about challenges. Take time to point out the strengths of the organization that you have observed.

It is not your role to play judge and jury. However, if you have invested time in due diligence, you have learned things about the organization — strengths and challenges — that the leadership might appreciate hearing about.

Offer your perspective, communicate with positive regard, and you can ensure that due diligence has benefited both the investor and the investee.

Appendices

Worksheets

Three worksheets are provided for The Due Diligence Tool:

Materials for Review

This is a list of documents to request in an assessment of a prospective grantee. These documents are supplemental to the programmatic information you receive with a proposal.

Initial Proposal and Document Review Questions

This includes questions for you to consider as you go through the steps involved in the initial review of the applicant’s proposal, budget and supplemental materials (particularly ﬁnancial documents).

Assessment Questions

This worksheet contains a chart of the questions for organizational leaders with space to track brief comments and to mark red ﬂags that arise.

Due Diligence Tool Worksheet #1

Materials for Review

Proposed Project

Narrative proposal
Investment proposals to other organizations (for reference purposes)
Current strategic plan or business plan (showing how resources will be used toward achieving organizational and program goals)
Evaluation plan(s) or tools to track progress, if available

Financial Health

Proposal-speciﬁc documents

Proposal budget
A list of all anticipated project funding (committed, secured, pending)
Audited financial statements (cash flow, balance sheet, income statement, footnotes) for the last three years, including an auditor’s report and quarterly and annual statements.
Auditor’s correspondence for the past five years. These are letters sent to management that outline areas to improve profits and efficiency.
Unaudited financial statements for comparison.
Company credit report.
A schedule of accounts receivable
A schedule of accounts payable. Check these for any overdue or unpaid accounts that might impact profit.
An aging schedule of accounts payable and accounts receivable.
A list of outstanding debt.
- Search for any clauses that increase debt if a company is sold.
- Scan for any related parties that have loaned money to the company. This includes manager, investors, and shareholders.
A list of unrecorded liabilities, which you usually find when interviewing the seller or employees.
A list of collateral for debt.
A schedule of depreciation and amortization methods over the past five years.
Analysis of gross margins.
Analysis of fixed and variable expenses.
A list of the company’s internal control procedures.
A list of assets and liabilities.
A schedule of inventory.
Projections, capital budgets, and strategic plans.
- Projections should include revenue by product type, customer, and channel.
- Projections should also include all financial statements such as a balance sheet, cash flow statement, and cash-on-hand.
- A list of growth drivers and possible clients and customers.
- Industry and company pricing plans.
- Analysis of projected expenditures and depreciation.
- Any perceived risk in foreign markets such as inflation, political strife, and exchange rates.
The general ledger.
Analyst reports.
Breakdown of sales and gross profits by geography, channel, and product type
Planned projection vs. actual sales chart.
Capital structure.
- Current shares outstanding.
- A list of all stockholders with options, warrants, and notes.
A list of non-operational expenses. Many companies put operating expenses in this category to pad their earnings.

Organization documents

Organization-wide budget
Interim ﬁnancial reports to senior management and to the board of directors
Annual ﬁnancial statements from the end of the most recent ﬁscal year (audited, if available)
Auditor’s letters to management
Interim balance sheet and income statement
Budget for current ﬁscal year (with year-to-date numbers, if available)
Most current FIRS Form if available
An Organizational chart

Organizational History and Track Record

General organizational documentation, including annual reports, investment reports, newspaper clippings,
Organization’s URL address

Governance and Executive Leadership

Board member list, with name, position on board, location, community/professional aﬃliation,
Executive director’s resume
List of other management staﬀ with brief biographical information

Employees and Benefits

Copies of stock purchase and stock option benefits for employees.
Worker’s compensation claims history.
Unemployment claims history.
List of employees and their positions, current salaries, years of service, and total compensation over the past three years.
An explanation of the company’s salary philosophy.
Pay history and pay freeze information, which helps you decide if current employees will expect a raise soon.
All nondisclosure, non-compete, and non-solicitation agreements between employees and company.
Resumes, history, and experience of key employees such as senior level management.
A list of union affiliations and contracts.
List and description of all employee health and welfare insurance policies.
Descriptions of any labor disputes, arbitration, or grievances settled or outstanding over the past three years.
Copies of collective bargaining
A list of any officers in criminal or civil litigation.
Actuarial reports for the past three years.
Layoff and severancepackage information.
A list of harassment, wrongful termination, and discrimination disputes within the past three years.
A copy of the employee handbookincluding policies on vacation, sick days, benefits, holidays, and paid leave. This allows you to compare your current situation with others in the industry.
Turnover data for the past two years.
Documents on pension plan fundingand distributions.
The results of formal and informal employee surveys.

Due Diligence Tool Worksheet #1

Materials for Review (cont.)

Vision and Strategy

Most current strategic plan or business plan
Other materials related to strategy or strategy development eﬀorts

Human Resources

Organizational chart
Job descriptions for each staﬀ position
Resumes of key staﬀ on proposed project

External Communications and Relationships

Marketing/PR packet, including materials such as brochures, newsletters,
Communications plan, if available

Due Diligence Tool Worksheet #2

Initial Proposal and Document Review Questions

Steps in Process

Questions to Consider

First-Level Proposal Review

• Does the project ﬁt within the ﬁeld? How will the project beneﬁt the ﬁeld and/or the community? Is there a need for the services/outcomes?

• Is the approach solid? Are there better approaches for achieving the outcomes?

• Does the project ﬁt with your organization’s theory of change? Does it build on other grants?

Second-Level Proposal Review

• Does the project ﬁt with the organization’s mission and theory of change? Does it shift the organization away from its mission?

• Does the project design make sense? Do the proposed activities ﬁt with the overall project goals?

• Do the costs make sense?

• Is the program likely to succeed in achieving its desired results? What are the major challenges to success? How will these challenges be addressed?

• Is this the right organization to do the job? Are there others doing anything like this; and if so, might they do it better?

• Does the organization have a successful history of running a similar project? If the proposed scope of work is new for the organization, does it have the capacity to meet the goals?

Discussion with Colleagues

• How are the organization and its key staﬀ leadership perceived in their peer group and by other funders?

• Does the organization have a positive history of working and networking with others in community?

First Level of Financial

Consideration

• Become familiar with the project budget.

• Review the description of the project’s staﬃng: Does the proposed project staﬀ design seem adequate?

• Consider how the project supports or doesn’t support the work of the organization: Do the two ﬁt to- gether?

Financial Document Review

• Does the organization have working capital that is equal to the current liabilities plus three months of operating budget?17

• Does the organization have positive net assets (also called a “fund balance”)?18

• Does the organization have an operating deﬁcit (expenses exceeds revenues)?

• Has the organization ﬁled a Form 990 to the IRS,19 and does the information in its audit corroborate the info on the 990?

Due Diligence Tool Worksheet #3

Assessment Questions

Area of Review	Question	Notes
Organizational History and Track Record
History	Tell me about the history of your organization. What have been the key milestones in its development?	Red Flags? (List below) q Yes q No
	What have been the most signiﬁcant accomplishments of the past three to ﬁve years?
	What have been the most signiﬁcant challenges?
Recent Accomplishments	What have been the most important accomplishments this past year?	Red Flags? (List below) q Yes q No
Governance and Executive Leadership
Role of the Board	Describe your board and the role it plays in the organization.	Red Flags? (List below) q Yes q No
	How do the board and E.D. work together? How are decisions made?
	What is the board’s role in strategic planning? In fundraising? In ﬁnancial oversight?
Structure of the Board	How does the board make decisions? Do appropriate committees exist? How often does the board meet?	Red Flags? (List below) q Yes q No
	If applicable, what is the role of any advisory board(s)? Who serves on it?

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Governance and Executive Leadership (cont.)
Composition of the Board	Who is on your board? What do they bring to the organization?	Red Flags? (List below) q Yes q No
	How do you recruit and select your board members? Who is involved in this process?
	Describe your commitment to diversity of staﬀ and board members.
Relationship Between E.D. and Chair	Describe the partnership between the E.D. and the board chair.	Red Flags? (List below) q Yes q No
	How do you/they work together?
Executive Leadership	For E.D.: What are your background and qualiﬁcations? How long have you been with the organization?	Red Flags? (List below) q Yes q No
	For E.D.: How do you work with staﬀ? How do you work with the board of directors?
	For board members: Describe the leadership your E.D. brings to the organization.

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Area of Review	Question	Notes
Organizational Vision and Strategy
Vision	What is your organization’s mission?	Red Flags? (List below) q Yes q No
	What is your vision for the organization?
Strategy Formation	How do you set overall direction for the organization?	Red Flags? (List below) q Yes q No
	Do you have a current strategic plan? If not, how do you develop strategy?
	Who is involved in the strategic planning and thinking?
	How do you incorporate current strategies into your work?
External Environment	How does the organization keep abreast of the latest thinking in your ﬁeld?	Red Flags? (List below) q Yes q No
	What are the top three challenges facing the organization over the next ﬁve years?

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Area of Review	Question	Notes
Proposed Project: Planning, Outcomes and Evaluation
Project Planning	Describe the basis for your approach to this project. What research do you rely upon for your proposed approach?	Red Flags? (List below) q Yes q No
	Describe the resources needed to accomplish your goals, and how you plan to obtain them.
	If relevant, discuss the following: • Scalability of model • Replicability of model • Potential for broad impact • An innovative approach
Outcomes	What are the goals and outcomes identiﬁed for the project?	Red Flags? (List below) q Yes q No
	What was the process for developing the outcomes? How do you use lessons learned from previous years/projects?
	Describe your organization’s greatest strengths in terms of your capacity to achieve its intended outcomes.
	What signiﬁcant challenges exist in your capacity to achieve your intended outcomes?
Evaluation	How do you evaluate your programs? What tools do you have in place?	Red Flags? (List below) q Yes q No
	How do you incorporate what you learn into your ongoing and future work?
	What is the plan for evaluation for this project? What resources are allocated for evaluation in the project budget?

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Area of Review	Question	Notes
Human Resources
General Staff and HR Concerns	Describe your organizational structure and staﬀ roles/reporting relationships.	Red Flags? (List below) q Yes q No
	How are staﬀ recruited and hired by the organization?
	How are staﬀ oriented and trained for their jobs?
	How does the organization handle staﬀ performance reviews?
	How does the organization invest in professional development for staﬀ?
Project Staff	Who are the staﬀ members responsible for the proposed project? What are their backgrounds and qualiﬁcations?	Red Flags? (List below) q Yes q No

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Area of Review	Question	Notes
External Communica	tions and Relationships
Communications	Who do you consider your key audience(s)? How do you communicate with those audiences?	Red Flags? (List below) q Yes q No
Communications	How do you disseminate information about your work and/or share what you learn with others in the ﬁeld?	Red Flags? (List below) q Yes q No
External Relationships	What partnerships or collaborations are you involved in? What role do you play?	Red Flags? (List below) q Yes q No
	How do you approach and develop partnerships or collaborative relationships with others?
	Who is your “competition”? How do you work with them?

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Area of Review	Question	Notes
Financial Health
Organizational Budget	How do you develop your organizational budget? What is the role of the board in the process?	Red Flags? (List below) q Yes q No
	Has your organizational budget increased or decreased from last year? Please explain why.
	What is your anticipated organizational income breakdown in the committed, identiﬁed and unknown categories?
Project Budget	Describe the project budget and how it supports the plan outlined in the proposal narrative.	Red Flags? (List below) q Yes q No
	How much of the project funding is committed? What will happen if you don’t receive the anticipated funding from other sources (known and unknown)?
	How did you arrive at your budget estimates? (Ask them to further explain any line items that are questionable or unclear)
Financial Position and Trends	Describe your organization’s current ﬁnancial state.	Red Flags? (List below) q Yes q No
	Has the organization borrowed money? If so, what are the terms of the loan? Was borrowing for capital expenditures such as a building or to cover an operating loss?
	(If debts exceed available cash) what is your plan for debt reduction?
	(If there was an operating loss) what are you going to do to avoid another loss this year?
	What is your vision for (continued) ﬁnancial health? Where do you see the organization, ﬁnancially, in ﬁve years?

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Financial Health (cont.)
Financial Systems and Reporting	What ﬁnancial statements do you generate? How frequently? Who prepares them? Who reviews them?	Red Flags? (List below) q Yes q No
	Describe the ﬁnancial expertise on your board. What role does the board play in ﬁnancial oversight?
	What is the process for providing the board with regular ﬁnancial information?
Fund Development Planning and Oversight	Describe your fund development plan (i.e., fundraising goals and plan for reaching them).	Red Flags? (List below) q Yes q No
	How is the board involved in fundraising?
	What role do board members play in developing strategies to maintain or grow the organization’s contributed income?
	How do you monitor progress against your fundraising goals? What role does the board play in this process?
Funding Mix	How would you describe the health and balance of your funding mix — i.e., is it diversiﬁed enough? What areas, if any, do you seek to change or improve? How?	Red Flags? (List below) q Yes q No
	What are your concerns, if any, about your funding picture?

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Market Research and Due Diligence

The Due Diligence Tool

Introduction

Why Due Diligence?

Two Approaches to Investment Proposals

The Process of Due Diligence

The basic steps in a due diligence process are laid out below

Types of Due Diligence

Financial Due Diligence

Legal Due Diligence

Commercial Due Diligence

Understanding the Context of Your Work

The Components of a Healthy, Profitable Organization

Getting to Know the Investee

Components of The Due Diligence Tool

Executive Leadership and Governance

Organizational Goals and Plans

Proposed Project: Planning, Results, and Evaluation

Human Resources

External Communications and Relationships

Key Issues

Future Directions

Red Flag Identification and Understanding the Risk

Factors to Balance

Communicating Your Due Diligence Findings to the Applicant

Appendices

Worksheets

Due Diligence Tool Worksheet #1

Materials for Review

Proposed Project

Financial Health

Organizational History and Track Record

Governance and Executive Leadership

Materials for Review (cont.)

Vision and Strategy

External Communications and Relationships

Due Diligence Tool Worksheet #2

Initial Proposal and Document Review Questions

Due Diligence Tool Worksheet #3

Assessment Questions

Assessment Questions (cont.)

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Assessment Questions (cont.)

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

Assessment Questions (cont.)

Due Diligence Tool Worksheet #3

Assessment Questions (cont.)

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