The Long Arithmetic: Issue 10

By the time a private deal reaches you, it has been dressed for inspection. There is a data room. There is a track record with the good years in bold. There are references, and every one of them says yes.

So you do the thing you were told to do. You read the memorandum, you scan the projections, you check that the boxes have contents. You nod. And somewhere in the nodding, the weight of the paper starts to feel like the safety of the decision. It is not the same thing, though it reads like it on a Sunday afternoon with a thick PDF open.

I have read hundreds of these documents, and for a few of years I reviewed them from the sponsor's side. The documents that raise money fastest are often the ones that answer every question a careful person would think to ask, cleanly, before the person finishes asking it. Strength of the underlying deal is a separate matter. A clean answer is a product. It can be manufactured.

This is what I see: the questions that decide how a private deal ends are usually the ones the sponsor is quietly hoping you will not ask. And the tell is whether the answer is allowed to be uncertain.

Reading the documents matters. I have made that case before, and I am not walking it back. A memorandum tells you the structure, the fees, the terms, the things you are entitled to know and should. Skipping that is laziness with a confident face.

But notice what the standard checklist is made of. What is the projected return. What is the fee. Who is the sponsor and what have they done. Every one of those has a clean answer, and a deck exists to supply it. The projected return is a number in a large font. The track record is the deals that worked, arranged to be seen. The questions are built for answers, and the answers were ready before you arrived.

That is the quiet problem with running due diligence as a checklist. A checklist rewards completion. You get to the bottom, every line has a response, and completion feels like safety. But the deal was designed by someone who knew the checklist too and had months to prepare for it. You are grading an exam the other person wrote.

The useful questions have a shape in common. None of them has a clean answer, which is exactly why they are uncomfortable to ask and easy to leave out.

The terms themselves are answerable, and they sit in the document. I have written about finding them: the fees, the waterfall, what a capital call obligates, whether a sponsor can be removed. This is the other set, the questions no document answers, which is why they are the ones that get left out.

The first is about alignment. Everyone answers "are our interests aligned" with a yes, and the fee schedule that would complicate the yes is already in the document. What is not in the document is the moment your interests and the sponsor's come apart. So the question is: when the plan stops working, whose outcome does the structure protect, yours or theirs? A sponsor who has sat with that will tell you plainly. One who waves it off has told you something too.

The second is the bad case, in the sponsor's own words rather than the deck's. Ask what a genuinely bad stretch looks like here, who decides what happens when it arrives, and what they did the last time one came. The document can tell you who holds control on paper. It cannot tell you how this person uses it under pressure, and that is the part that decides how the deal ends for you.

The third is about the assumptions, and here I will borrow a phrase I have used before. "Conservative underwriting" usually means the sponsor chose the assumptions that make the deal look good and called them conservative. Ask which specific assumptions the return depends on: the revenue that keeps climbing, the price the asset sells for years from now, the interest rate that stays where it is. Then ask what happens to your return if one of them is wrong by a little. The point is how much has to go right for the number to hold.

None of these produces a yes or a no. That is the point. They trade the feeling of a completed checklist for an honest picture of what you are actually holding.

Here is the part that took me too long to learn. When you ask a question with no clean answer, the answer matters less than what the person does with the uncertainty.

A sponsor who meets every hard question with total confidence has told you something, and it is not what they think it is. Either they have not sat with the ways this can go wrong, or they have, and they would rather you did not. Both are the same warning wearing different clothes. The investors I learned from treat risk as the range of things that can happen rather than the one thing projected to happen, and the people worth trusting talk that way on their own, before you press them.

The one you want does something quieter. They tell you the assumption that would hurt you most. They name the deal in their history that lost money and what happened to the investors in it. They are comfortable saying "I don't control that" about the things they do not control. That comfort is hard to fake, because it costs them the easy sale, and a person willing to cost themselves the easy sale in front of you is showing you how they will behave after the money is wired and you are no longer in the room.

I think of one sponsor I invested with who told me, before I asked, about a deal of theirs that had gone wrong. It paid one distribution and then nothing came after. They put their own money in to carry it through the worst of it, and it took almost two years to come back. They sold it in the end and made the investors whole, and it was plain that making them whole mattered to them. Nobody required them to tell me any of that. That is the sponsor I trust, because someone who volunteers the hard version of their own history is telling you how they will treat you when the deal in front of you is the one that goes sideways.

So the checklist still earns its place. It is aimed at the deal, though the thing you are really underwriting is the person who will make every decision you do not get to see.

Most bad private investments did not fail for lack of research. The binder was full. The boxes were ticked. What was missing was the one question the investor sensed and skipped, because asking it felt rude, or naive, or like it might talk them out of something they had already decided to do.

So before the next deck arrives, the question to ask is a private one. Which question have you been leaving out, and whose comfort were you protecting by leaving it out, yours or the sponsor's?

Reply and tell me the question you tend to avoid asking, and what you think is behind the avoiding. I read every one.

Disclaimer: This is not financial advice. Consult your CPA or licensed advisor before acting on anything specific to your situation.

Until Monday.

Alina