Reviewing policies to ensure cash as needed.

• Author: Egan, III, John J.
• Position: CASH MANAGEMENT

Cash-management and investment policies have come under the microscope. The recent volatility in the United States credit markets has caused many companies--as well as investors--to turn their attention to the preparation and adoption of their policies.

Although, on occasion, relegated to an afterthought by busy financial executives and their boards of directors, the advisability of prudent investment policies has become increasingly clear in recent months.

Today, the creditworthiness of even the largest financial institutions has come into question as a result of their investments in subprime mortgages, leveraged loans and various derivatives. Likewise, many cash-management investments offering enhanced yields have been exposed as illiquid and risky investments. To wit: investments in illiquid auction-rate securities have recently made it harder for many companies to access their cash for short-term needs without suffering substantial losses.

These issues are of particular concern to startup and development-stage companies, which typically need to raise and maintain significant pools of capital to fund current expenditures, usually in anticipation of commercial operations.

The matter is also relevant to the venture capital, private equity and other institutions that invest in these companies. These institutions understandably will demand that their growth capital is appropriately preserved and invested.

With these issues in mind, it's a good time to reconsider best practices with regard to the establishment and maintenance of cash management and investment policies.

Make sure the company has an investment policy that is periodically reviewed and approved by its board of directors.

Companies that have not yet adopted a formal investment policy should do so immediately. Companies that have previously adopted and investment policy should carefully review it, ideally in consultation with the company's outside financial advisers, to ensure that it appropriately addresses the current financial objectives of the company.

Specifically, investment policies should be carefully tailored to appropriately balance the trade-off between the preservation of capital and return, and this trade-off will likely be informed by the financial health of the company and its business as well as the relative volatility of the credit markets. For most emerging companies, safety of principal and liquidity (i.e., the ability to turn short-term investments into cash) will trump yield as paramount factors.

Investment policies should be periodically reviewed by management, then discussed with and approved by the board of directors, or a committee thereof. Also, financial officers should be mindful of the parameters of the policy, and ensure that any modifications to it are appropriately communicated and approved by the board prior to implementation.

The investment policy should also be communicated with the company's outside financial advisers, to better ensure that investment decisions are made in accordance with the policy.

In addition, careful consideration and adoption of an investment policy can be an important factor in avoiding inadvertently falling within the definition of an "investment company" and becoming subject to the regulatory regime of the Investment Company Act of 1940.

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