Chapter 6

Hundreds of books and thousands of speeches and millions of forums exist to teach you “how to make an investment." This will not be one of those.

Instead, we’re going to look at a humble question: “how does an investment get approved?” Readers of this may or may not be in a position to move millions of dollars into an investment, but odds are that you’re able to help influence how investment research gets delivered. To do that effectively, you need to know how the approval process works.

It’s pronounced eye-see, not ‘ick’

Virtually every institutional investor uses some form of an investment committee (IC) to guide their investment approval process. At the private equity (PE) firm where I worked before starting Cadence, the IC convened once or twice a month, and it was terrifying.

The junior analysts spend countless hours building financial models and writing memos. VPs and MDs navigate internal politics in order to make way for approval, all while keeping the CEOs and CFOs at the target company comforted that, yes, the money is on its way.

When the meeting itself begins, questions can come from any direction, and an inability to deliver a crisp answer shows either lack of conviction in the idea or lack of preparation. Either one can be bad for one’s career.

But first, what, technically, is an IC?

Stewards of capital

An investment committee can be a single-person with sole approval authority. Or it can be a group of people who represent the LPs and GPs of a fund.

The bylaws of a fund’s formation documents will explicitly state the rules governing investment decisions. Maybe it says unanimous consent is needed, or maybe just a majority. Maybe certain members of the IC hold veto power so long as certain conditions are met. Maybe every capital outflow requires IC approval, or maybe there’s a material threshold below which the owner of the deal can make a unilateral decision.

The point is that the ICs are consistent in their function and purpose, but very inconsistent in their composition.

Sponsors, leads, and monkeys

A universal term worth knowing is deal sponsor. This is the person at the fund who has the authority to bring deals to the IC. They may not have been the person who runs the deal (that would be the deal lead). In some funds, the deal sponsor and the deal lead are the same person.

Supporting the whole process at the fund are the analysts on the deals. There isn’t a formal word for such team members, but sometimes they’ll be called monkeys (see Antonio García Martínez’s book Chaos Monkeys to get a better idea of what I'm talking about).

A typical timetable

If you are supporting a due diligence project, knowing where it is in the timetable for investment approval is crucial.

Here’s how it typically works:

• Monday mornings are for partner meetings. This is when updates are shared about investment ideas that are in process. When a deal is sufficiently baked (and yes, you can expect to hear that term), it will get added to the next IC meeting.

• A 1-3 hour IC meeting will happen only when an investment idea is ready for execution. A meeting can cover multiple ideas. These meetings are a huge drain of energy and resources, so they tend to happen once a quarter or a bit more often. If the IC has members who don’t work at the fund (e.g., a LP representative or two), these will most likely be senior personnel whose schedule books up weeks in advance.

When a deal is confirmed to be on the agenda for an IC meeting:

• The deal team works incredibly hard to prepare a memo. The deal lead will send interim drafts to the deal sponsor in the days and weeks leading up to IC.

• No more than 24 hours before an IC meeting, the deal sponsor will circulate the investment memo.

• The management team members at the target company may be asked to participate in part of the meeting. This generally only happens at PE funds. It doesn’t happen at earlier stage venture capital (VC) deals since the IC has likely already met the management team during preliminary due diligence. And it doesn’t happen at hedge funds buying public shares since company management generally only meets with such funds after they’ve made the investment.

During the IC meeting itself:

• The deal sponsor opens the discussion with an overview of the deal and its merits and risks. This may only last a few minutes.

• The deal lead, who may have dozens of pages in a memo, will go through a longer presentation (15 minutes to an hour) presenting more details. Sometimes there’s a hard rule that questions can come at the end. Most of the time, questions get fired hard and fast to the deal lead throughout the whole presentation.

• When time is up, the secretary of the IC calls for a motion to approve, and the IC members vote.

• At some funds, IC meetings are open such that deal teams can watch other deal teams during the IC. At other funds, each deal team is invited in for their portion and then dismissed afterwards.

Here’s my Venmo handle

The final thing to point out is that investments are only funded after legal documents are signed. This process, formally known as closing, generally happens after an IC meeting.

So it is possible that the IC will approve an investment, but the funds never get transferred because of a legal complication. If, alternatively, a due diligence fact emerges post-IC, pre-closing that changes the investment thesis, then an emergency session of the IC may be held to decide whether to withdraw or proceed with the investment.

Finally, once the money is actually received by the investment target, then it is generally accepted for that company to announce the funding round.

Congratulations, you've finished our guide on the investment due diligence process! Hopefully you feel better equipped to help your client extract the insight they need during your next assignment.

Interested in learning more about the investment world? Visit the Cadence blog for more resources to help you level up your knowledge!