Whether buying a business or providing senior debt, the deal comes down to trust.  How well do you know the borrower and how much do you trust he or she will not default?

Assessing the integrity and ability of a borrower is challenging – even when the assets backing the loan appear rock-solid.  What you see is not always what you get.  Unfortunately, there is no stereotypical “fraudster” – the scam artist can neither be profiled nor categorized.  A polished CEO with an impressive background can look the same as every other swindler.  Lenders need to be particularly mindful of who the borrower is and this means conducting proper due diligence.

Investigative due diligence is designed to determine a prospective borrower’s character; but it must go way beyond the basic check-the-box background check.  A criminal record or mediocre credit score is certainly helpful to know, but a clear criminal record or good credit does not necessarily mean the lender is qualified to pay the loan back.  You need to dig deeper.

First, you need to confirm the borrower is honest in how they present themselves: confirm degrees, professional licenses and other credentials.  Then, you need to see what businesses the person has been involved with over the years.  And this is not just confirming what’s on a resume.  Are there other companies the executive has formed over the years that you don’t know about? The most common factor in a successful Ponzi scheme is the shady LLC that is used to embezzle the money.  (Just ask Bernie Madoff, Robert Allen Stanford, Andrew Caspersen and every other convicted Ponzi schemer.)

In addition to checking criminal history or DUIs, lawsuits, bankruptcies, judgments and liens must be reviewed.  Was the lender sued by other financial institutions in the past (as in: are you next in line?)?  If the executive has had personal financial problems, it is likely your line of credit that will pay off his own indebtedness.  And, even though a case might be closed or dismissed, that does not mean the merits of the case are irrelevant.  When you look at the complaints filed in closed cases, you can learn a lot about allegations made against a person or company (fraud, discrimination) and also understand how the case was resolved (e.g. is there a looming judgment against the company which would deter its ability to succeed). This type of information is not as concrete as having bad credit but is of equal importance when assessing the quality of the lender.  This type of analysis is imperative.

Lastly, you want to see if the borrower has been involved in anything controversial over the years.  This includes reviewing traditional media sources (more than Google!) to identify any connections to bad people or incidents.  And of course, the most recent spot for outrageous behavior is social media.  Lies on LinkedIn, threatening political rants on Facebook and salacious pictures on Instagram are all more common than you might think.  These “posts” can clue you in on how the borrower behaves outside the office, and sometimes this behavior is unethical or symptomatic of future bad behavior that could affect reputational risk and asset quality.

Background investigations can have differing scopes and the level of the research should depend on your exposure and familiarity with the borrower.  Also, contacting other lenders or people who have worked with the borrower is crucial: you need to understand what their reputation is “on the ground” and be alert to other red flags because it is all about reducing non-performing loans.