Due Diligence: Red and Yellow Flags

Prospective grantees use grant proposals to inform and inspire grantmakers about exciting new possibilities. They almost never highlight significant risks or potential organizational weaknesses that could threaten their success. Thus, the due diligence burden falls to the funder. Funders need to assess both the capacity of the proposing organization and the likely success of the project being proposed. The due diligence is most important for large grants or very public projects, where the risks of failure are the greatest.

Unfortunately, I have learned from personal experience that the enthusiasm generated by a proposal can blind a funder to hard questions. As a result, funders sometimes conduct limited due diligence that is subject to confirmation bias, the tendency to interpret information received so as to confirm what the funder already believes.

Complete due diligence, which is necessary for the largest grants, would answer the following questions:

At the level of the organization:

• Are the grant-seeking organization’s goals aligned with yours?
• Do their values align with yours?
• Does the organization have a clear strategy for its work that leads to effective tactics and demonstrated impact?
• How much does the organization's leadership monitor and evaluate their work?
• How well do they know their field?
• Have they fully and on a timely basis complied with legal requirements (e.g. filing federal and state forms)?
• Do they have conflict-of-interest and financial control policies?
• Do they have adequate staff capacity, and what is the reputation of their staff?
• Is the Board diverse and playing an active oversight and fundraising role? It is often wise to meet the board chair in the due diligence process.
• Do two years of the organization’s audited financial statements show a financially stable future?

At the project level:

• How much market research did they do?
• What evidence is there that the project has a good chance of success?
• Do you know enough about the possible impediments to success to ascertain whether the activities to be undertaken can overcome them? If you don’t know, who can help you inform you?
• What assumptions is the organization making that would have to be true for the project to succeed?
• What financial and reputational risks would you be taking by funding the project? Is there a risk that the project could actually do harm?
• Is the budget appropriate for the work needed? A budget that is too little to get the job done is no better than an oversized budget.
• How likely is it that the organization will be able to continue the work when your funding ends? Wishful thinking based on no track record doesn’t count.
• If it is not likely that the project will outlive your funding, does it make sense to require matching funds from the onset so that other funders are invested from the beginning?

Answers to these questions could come from information provided by the prospective grantee, peer funders, prior independent evaluations or independent research.

Not every concern uncovered through due diligence should be treated the same. Some issues are cautionary and manageable. Others should prompt serious hesitation or a decision not to proceed.

Yellow flags are warning signs that merit further inquiry, mitigation, or close monitoring. On their own, they may not be disqualifying, especially if the organization is self-aware and taking steps to address them. Examples of yellow flags include gaps in evaluation capacity, an overly optimistic sustainability plan, limited experience with a new line of work, or a budget that appears tight but plausible.

Red flags point to deeper problems that are unlikely to be resolved through additional funding or oversight. These include misalignment of values or goals, weak or inattentive governance, lack of basic financial controls, failure to comply with legal requirements, repeated leadership turnover, or a project built on assumptions that are demonstrably false. Red flags raise the risk that a grant could fail or cause reputational harm, regardless of intent or effort.

Context matters. A single yellow flag may be acceptable if counterbalanced by strong leadership, transparency, or a compelling track record. Multiple yellow flags, however, can aggregate into a red flag. Ultimately, due diligence is not about eliminating risk entirely, but about understanding which risks you are willing to take and which you are not.

If you would like to discuss specific situations or learn best practices in due diligence, please email JFN Consulting at yossi@jfunders.org.