Why does due diligence? 

Recent losses on private loans have demonstrated that the lack of diligence on the borrower and collateral verification are responsible for many defaults. A study by PKF O'Connor Davies points out that weakness in debtor analysis and the absence of independent asset verification are driving losses in direct lending. To mitigate these risks, they recommend applying layered protections, including due diligence of the debtor, collateral verification, enforceable contractual clauses, compliance covenants , as well as continuous monitoring. 

Best practices for credit analysis 

• Information gathering and verification: The basis of a solid analysis is to collect financial, asset, and behavioral data and corroborate it with independent sources to avoid fraud and discrepancies.
• Legal compliance and risk assessment: Due diligence must comply with data protection laws and document consents. At the same time, debt ratios, cash flows, and stress tests are used to anticipate possible future defaults.
• Use of technology and qualitative analysis: Digital platforms help automate validation, consolidate information, and detect patterns, while professional judgment assesses the quality of the management team and the particularities of the sector. A tool that is frequently used in the market as an independent validator is Sheriff. 

Today, several platforms are used, which function as tools that provide the information needed to make better decisions when structuring a loan. 

Critical Elements in Private Debt 

Due due diligence goes beyond financial analysis: it involves knowing the debtor, understanding the business, its scope, and the governance of the company under analysis, verifying ultimate beneficiaries, reputation, internal controls, market context, and current regulations; validating and protecting collateralthrough public records, inspections, and appropriate contractual clauses; and maintaining continuous monitoring of the collateral. Real-time information is key, because changes in the company or the market can deteriorate the value of the guarantees and thus increase the VaR (Value at Risk) of the financing. 

Phases of due diligence and key controls 

A well-executed due diligence is structured in stages, each with specific objectives ranging from initial contact with the borrower to post-disbursement monitoring. The main phases and associated controls are summarized below: 

1. Pre-selection and KYC: validate the identity of the borrower and final beneficiaries, reviewing sanctions lists, legal and financial backgrounds, as well as reputation to avoid risky counterparties.
2. Financial and operational analysis: evaluate financial statements, cash flows, and coverage ratios, and review contracts and licenses to detect litigation or contingencies. This is complemented by an assessment of the debtor's business and industry.
3. Collateral and documentation review: confirming the existence and registration of assets, assessing their recoverability, negotiating guarantees and covenants that protect the lender.
4. Post-monitoring: maintain continuous monitoring of the financing and the debtor company, the latter's solvency, and the value of the collateral through periodic reports and early warnings. 

Evolution of Private Debt 

Over the past decade, private debt has experienced sustained growth and significant structural transformation, consolidating its position as a core asset class within alternative markets. What was previously characterized as a space for flexible solutions, less supervision, and bilateral relationships now operates under much more demanding standards in terms of information, governance, and regulatory control.  

This change has been driven by the strengthening of regulatory frameworks, the growing participation of institutional investors, and the need to mitigate risks evidenced in recent financial stress cycles. The result is an ecosystem where informality has been replaced by robust documentation, external audits, formal valuation policies, and reporting periodic and structured reporting to investors. The convergence towards standards increasingly similar to those of banks is now a reality, reflecting the maturity and professionalization of the industry. 

Recommended resources and readings 

For further insight, review: PKF O'Connor Davies (layered protections and examples of faults), Debexpert (checklists and validation methods), Preqin Global Report (market information), and the SBS and Basel III regulations regulations on risk management, compliance, and new requirements. 

Raimundo Fuenzalida 
Portfolio Manager, Private Debt, Fynsa AGF