Research by iCapital has found that about 40% of advisors assist their clients with private direct investments, in things such as commercial real estate, small or early-stage companies and even middle-market firms. Direct investments are found through a variety of sources, including angel investor networks and syndicates, but the most common way of finding them (as indicated by almost 80% of our survey respondents) is through friends and family. Clients frequently bring these opportunities to their financial advisors for assistance with due diligence and an assessment of how well the asset fits in with the clients’ stated investment objectives.

It’s important to keep in mind, though, that even if direct investments can deliver portfolio benefits for experienced investors, they can also introduce significant risk. If a client learns about an investment through a friend, family member or work colleague, it does not lessen or in any way negate that client’s need for rigorous due diligence before he or she proceeds. Every deal will have its own nuances that require investigation, but we offer below a non-inclusive set of fundamental elements that should always be evaluated if you’re presented with an opportunity a client has found.

It is worth noting that when professional private fund managers pursue an investment opportunity, they often spend six to 12 months conducting diligence and evaluating it.

Diligence on the management team. An obvious first step with any direct deal is becoming familiar with the team that will be operating the asset. This means getting references—calling investors in past transactions and third-party advisors who know the space and its reputable players. The capability and credibility of the team (as well as whoever else would be taking your money, say if there is an intermediary or finder) should be established up front. This can save significant time and expense, because if doubts arise about the team there is little point in conducting further due diligence.

What is the team’s track record? How can you verify that? And how many years of experience do they have in the relevant industry or asset class? How long have they been working together, and what are their respective areas of responsibility? There are always key individuals, as there are in funds, who will be critical to success; these often include the operational lead and the business development or sales head. In addition to understanding who the key players are that are responsible for past success, one must ensure those people are still incentivized to work the same way on this deal and devote the same time and attention, and that they are properly locked in. It is inadvisable to put money into any deal that does not feature a meaningful investment by the management team.

Operational and market diligence. Investors must also develop an informed view on the underlying business itself, including factors such as the market opportunity and the company’s growth profile, the competitive landscape and the defensibility of company margins, as well as any secular trends that could impact the business. Understanding the primary operating metrics and revenue drivers is important; it’s also essential for you to examine the business’s historical data going back several years, even if it’s not a predictor of future performance.

And it’s key to find research about the metrics for the business’s market size, its supply/demand dynamics, the barriers to entry for new players and the business’s cyclicality. Porter’s “Five Forces” analysis on industry competition can be a useful framework for looking at corporate assets. Even if a team has delivered home runs in their industry in the past, it’s important to understand how exactly that value was created, as the market may have changed.

In addition to educating themselves about the asset classes generally, investors must develop conviction about a company’s business plan. What exactly does the management team plan to do, over what time frame, to grow the business? This work is vital to contextualize financial projections and make an informed assessment of whether the base case is indeed realistic or in fact skewed to seem more attractive.

Financial diligence. Investors should ensure they are not overpaying or stepping into a financially precarious company, which means they must thoroughly investigate the financial profile of the business and its implied valuation (an earnings or EBITDA multiple for a corporate asset and a cap rate for a real estate deal), which can then be compared with similar assets. A comprehensive review of the income statement, balance sheet and cash-flow statements is essential.

Do the financial projections make sense? If it looks too good to be true, it probably is. The proverbial “hockey stick” forecast, which shows flat results followed by a sudden uptick, should itself be a major warning flag. Is the company coming off an unusually strong year at a frothy point in the cycle that will be hard to repeat? Was there a onetime event that caused earnings to jump? Is the company carrying debt? How is it servicing that debt, and when does the debt come due? Does the company have audited financials? If not, who prepared the financial statements? In the case of real estate, research must include evaluating metrics such as occupancy levels as well as rent and price per square foot relative to comparable properties.

Legal diligence. Never assume that a commercial enterprise actually exists or that a given entity in fact has title to specific real estate. Real estate title and corporate filing searches represent a relatively minor diligence expense that can save you major heartache down the road. If your lien is 10th in line, it is likely worthless, and there is no excuse for not determining this in the beginning.

All documentation received from the finder or management team should be independently confirmed to the extent possible, which means you should conduct site visits for real estate and confirm the commercial activity that has been represented for a business, as well as understand the sources of any data.

Deal terms. It is vital to fully understand the financial structure of what you are investing in, including whether you are taking common stock, preferred stock or some other security, and all the rights associated with that security (as well as the rights others have that you don’t). How are your investment and shareholder rights protected if things go wrong? It is also important to identify the other investors in a deal; less-experienced investors should be particularly concerned about deals not backed by a legitimate entity with a successful investment track record or dedicated deal team, warning signs that ought to prompt more extensive due diligence. If possible, the investors should consider structuring the investments as small tranches linked to verifiable milestones.

Key risk analysis. Before making any investment, it is crucial for you to take a step back and check the key risks that are being taken. For corporate assets, this list will emerge from the analyses we have mentioned; while it is difficult to generalize, common issues for companies include their operational risk, the risk they will face margin compression or the risk their business will become obsolete. In the case of real estate, interest rate risks and location risks always exist to some degree. Be sure to take a hard look at the downside case and understand how competitors and comparable properties have performed in past downturns.

All deals necessarily feature risks, and it is key to have a handle on these at first look if you are to objectively evaluate whether the investment presents an attractive risk-adjusted return.

It is difficult to overstate the risk involved in having individual investors make private direct investments. Putting aside deals actually designed to fleece investors, for every home run there are countless strikeouts, and even experienced investors who conduct intensive, professional due diligence can lose capital.

Qualified clients seeking private market exposure should consider diversifying these investments by using a fund, which offers the benefit of institutional diligence and active oversight. If a deal is rushed and information is scarce, proceeding with an investment is more like a roll of the dice, and if you do not have the ability to underwrite for the stated return targets yourself, a direct investment is probably not suitable.

Even if all institutional diligence boxes have been checked, it remains advisable to stick to industries in which you have experience—or to real estate assets in locations you are familiar with and have some prior knowledge about.

Do not be afraid to ask lots of questions and demand the information described here. Fundamentally, investors should never put more than 2% to 3% of their overall net wealth into a single deal, no matter what it is. Comprehensive due diligence on each opportunity is essential, but the bottom line is, do not invest more than you can afford to lose.