Trust, but Verify: 4 Common Myths That Increase Risk in Private Credit
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March 30, 2026
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During transactions, and specifically with private credit deals, standard due diligence confirms the story that a debtor tells a creditor but is not intended to identify financials that are fundamentally incomplete or intentionally inaccurate.
Similar to the recent private credit deals gone awry that have been plastered across the news, the most significant risks rarely appear in plain view on the balance sheet. These risks exist in operational blind spots, inconsistent reporting, and assumptions that go unchallenged. More troubling, intentionally inaccurate information is inherently difficult to detect in private companies.
Enhanced due diligence (“EDD”) can close that gap. A growing number of creditors and investors are realizing that conducting EDD is more than just a defensive layer; it may be a core underwriting capability. It enables them to identify risks earlier, price transactions accurately, and deploy capital with conviction.
Current market volatility and rising investor scrutiny are raising the bar for transparency and risk identification. Despite the perceived heightened need for vigilance, many market participants hesitate to conduct EDD. Naysayers believe that a few unforeseen risks are preferable to the increased likelihood of losing the deal entirely.
With stakes this high, understanding the limits of standard due diligence is essential. These gaps can spell the difference between a successful deal and a disastrous one.
How Does Enhanced Diligence Uncover Risks That Standard Diligence Might Miss?
Standard due diligence, such as a Quality of Earnings analysis, verifies the financial story that the debtor is telling. It confirms that revenue exists, that cash flows support debt service, and that legal structures are sound. Standard due diligence attempts to answer the question: Is the deal viable based on the information provided?
EDD tests whether there may be more to the debtor’s financial story that is not disclosed directly. This approach assumes that the information provided may be incomplete, biased, or even deliberately misleading. Where standard due diligence validates, EDD detects. EDD identifies risks beyond reported information to help evaluate their potential impact on the deal. These concerns and risks may include fraud, conflicts of interest, multiple collateral pledging, off-balance sheet transactions, or anomalies in financial operations.
Think of it like buying a car: a test drive shows if it runs and looks okay, but only a full inspection reveals hidden issues—engine wear, faulty wiring, or poor service history.
When Is There a Need for Enhanced Due Diligence?
In the same way that every corporate misstep does not warrant a full forensic investigation, every transaction does not require the same level of EDD. A right-sized, phased approach based on increasing or changing risk factors unique to each transaction is critical. As concerns about the business or the quality of information received from management increases, the procedures required to address these concerns should also increase.
What Does Enhanced Diligence Really Identify?
EDD goes beyond the usual red flags in financial statements; it aims to uncover behavior or operational issues that standard due diligence cannot detect. More importantly, EDD can quickly surface red flags that may indicate a more systemic problem.
For creditors, owners, and investors, EDD can provide additional confidence in the investment. By deploying the right team that includes industry-specific expertise and rigorous oversight, creditors can identify many unforeseen risks based on what the borrower provides and what the borrower can prove. This can feel like an insurance policy, enabling the lender to move forward with the deal with confidence.
Four Myths That Cause Creditors To Avoid EDD
There are many reasons creditors choose not to perform enhanced due diligence, but many of these reasons are unfounded.
| Myth | Reality |
|---|---|
| EDD is not on creditors’ radar | For creditors who regularly conduct transactions, they can often go into auto-pilot and have a traditional due diligence playbook they execute. Increasing industry and investor protection risks require considering methodologies outside of traditional due diligence. |
| EDD slows deals down | When scoped appropriately, EDD should run in parallel with standard due diligence and does not need to impact deal timelines. |
| EDD significantly increases due diligence costs | Targeted due diligence is both modular and scalable. By employing a surgical, risk-based approach, costs are kept in check. Limited increases in EDD scope can also be viewed as a “cheap” insurance policy and investor protection tool for creditors. |
| EDD can damage relationships | If done correctly, debtors do not know that EDD is ongoing in parallel with traditional due diligence. Additionally, debtors increasingly expect deeper diligence as a component of the lending process. |
With the myths addressed, the next step is translating enhanced due diligence from theory into practice. This helps ensure strong underwriting without disrupting deal flow.
How Can Firms Avoid Delays in the Diligence Process?
Planning is key.
- Creditors should apply risk-based scoping. Not every deal calls for the same level of analysis or scrutiny. By gaining a clearer understanding of the debtor’s business through standard due diligence, the creditor can more accurately determine where additional research is necessary. Additionally, developing and utilizing firmwide frameworks to determine the level of risk going into a deal can ensure accurate scoping. For example, firms can utilize a three-tiered, firmwide EDD model such as basic, enhanced, or advanced diligence, based on identified risk level.
- When possible, integrate EDD into existing workflows. EDD is often a time-constrained exercise, with many disparate workstreams. While each team works independently, there ultimately needs to be a unified view that enables the diligence process to move quickly, without sacrificing rigor.
- Use specialized teams rather than generalist approaches.Specialized teams will more quickly identify gaps between what the debtor reports and what due diligence can validate. Once these gaps are understood, specialized teams can better assess how the deal may be affected. These teams can also leverage pattern recognition from prior engagements, enabling faster identification of red flags and proper risk weighting. Lastly, some areas of diligence require deep technical expertise. While a generalist can notice that something seems wrong, a specialist can connect abstract risk to financial consequences.
How To Navigate Complex Borrowers With Confidence
Enhanced due diligence is often no longer optional but rather a strategic advantage. By uncovering operational gaps, behavioral red flags, and undisclosed transactions, EDD strengthens underwriting, accelerates informed decision-making, and protects investor capital. Firms that embrace EDD, even in a limited capacity, gain both transparency and confidence, positioning themselves ahead of the competition.
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March 30, 2026
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