Everything to Know About Portfolio Management in VC

The process of gathering, measuring, monitoring, and tracking crucial performance measures across the portfolio companies and active funds is known as portfolio management in the context of Venture Capital firms. Such precautions also guarantee that the capital is not exposed to undue market risk. The basis of the entire process is the ability to make well-informed decisions. According to a study, 70% to 80% of venture capital funds in the US market provide entrepreneurs with inappropriate advice, and that number may likely rise to 95%. Proper implementation of portfolio management resolves this. Many venture capital funds base their operations primarily on portfolio management. This article illustrates a generic framework of VC portfolio management and its components. 

VC portfolio management 

Portfolio management refers to the procedure used by investors to evaluate data, make choices, and allocate resources to increase or safeguard the value of their investments. A more intense focus on VC portfolio management includes expanding market channels, product development, hiring support, and much more, that extend far beyond the capital spent. To establish a portfolio, venture capital firms typically hold a certain number of start-up companies. At the same time, they also offer funding and value-added services to several start-up companies. In light of limited resources, venture capitalists should think about how to choose the ideal portfolio size for start-up businesses when providing venture capital financing.

What is VC portfolio management? 

A VC fund’s internal portfolio management process includes market analysis, supervision, risk profiling, and the creation of multiple potential exit options. A VC will require updated information from its portfolio businesses frequently to move through these processes. The main objective of portfolio management in venture capital is to safeguard and boost the value of investments.

How does VC portfolio management work?

Risk can be decreased through portfolio investment without reducing rewards. An investor with expertise in portfolio analysis could be able to consistently make money trading. Every investment has a reward and a risk component. Investors have an intuitive understanding of risk. It can be assessed by the standard deviation/variance of the rate of return and generally refers to the chance that the rate of return from a security or a portfolio of securities will deviate from the corresponding expected/average rate. The VC investment process includes the following steps:

• Deal initiation
• Screening 
• Due Diligence
• Deal structuring
• Post investment activity
• Exit plan

The creation of an optimal portfolio fit for every individual investor involves the following three key steps:

• Choice of securities. 
• Building each feasible portfolio with the assistance of the chosen securities.
• Choosing the weights/proportions of the various constituent securities in the portfolio to make it the investor’s ideal portfolio.

The working concept of VC Portfolio management is the technological integration of these two steps.

What is VC portfolio management based on?

VC firms can assist businesses in gaining momentum by utilizing their networks, which often include hundreds of industry specialists who can assist companies in entering new markets, finding cost-effective vendors, and closing high-impact agreements. Recognizing the necessity to concentrate on your strategic, tactical, and operational levels is the first and basic aspect of portfolio management.

Risk Profiling

To choose the right investments and asset allocation for a portfolio, a risk profile is crucial. Each individual has a unique risk profile because risk-taking is influenced by psychological characteristics, loss-taking ability, investor age, income, and expenses, among many other things. The most typical risk profiles for investors are as follows:

• Conservative means seeking financial security, low risk, and limited or negative returns. Possible Allocation is  Debt and other: 90–100%; Equity: 0–10%
• Moderately conservative is willing to accept a little amount of risk in exchange for potential long-term rewards. Possible Allocation will be 10-30% equity; 70-90% debt and others.
• Moderate, that is, seeking low risks and substantially better returns over the medium to long term. Possible Allocation is 10–30% for equity; 70–90% for debt and other assets.
• Moderately aggressive means taking up substantial risk to maximize rewards over the medium to long term. Possible allocations are as follows equity: 70–90%; debt and other 10–30%
• Aggressive denotes willing to take large risks to maximize long-term rewards. Possible Allocation is Debt and other: 0–10%; Equity: 90–100%

Market Research and Oversight

In the venture capital sector, competent research abilities and ongoing supervision are crucial for sorting through potential investments, firms, people, and markets that are connected to a potential investment that is ideal for a contemporary venture capitalist. VC firms frequently focus on a single investment type and occasionally they are industry-specific. A VC may therefore manage a diverse range of industries in their portfolio. Investors should strive to comprehend the most recent study on the expansion and transformation of each market and business. This assists investors in making informed initial investment decisions, subsequent funding decisions, and timely exit strategy recommendations.

Exit Strategies

Venture capitalists typically implement exit strategies when they decide to close an investment due to underperformance or if the business is continuously losing money. Executing an exit strategy is also necessary due to legal issues, shifting market conditions, and liability litigation. Mergers and acquisitions, management buyouts, and initial public offerings are some of the exit options used by venture capitalists. A portfolio management strategy should include a description of a suitable exit strategy. This aids investors in minimizing risk and comprehending the value of a portfolio’s probable outcomes.

Components of VC portfolio management

The ability of a venture capital firm to help and support the businesses in its portfolio sets it apart from other players in the sector. There are four fundamental steps in this aid process. They are company analysis, portfolio monitoring, portfolio company assistance, and venture capital decision-making. When an initial investment closes, these businesses get going and continue until the exit transaction is finished.

Portfolio monitoring

Portfolio monitoring, in the context of private equity and venture capital firms, refers to the methods used to gather, monitor, and measure key performance indicators across the portfolio companies and the active funds. The procedure is essentially the same regardless of the Portfolio Company or fund. Data and other pertinent information are acquired from the portfolio and utilized to produce quarterly reporting. This reporting is used by all stakeholders including the Board, investors, and internal teams to evaluate the effectiveness of the value creation plan and the overall portfolio health.

Company analysis

Company analysis is a method used in portfolio management where investors examine assets by gathering data on the company’s profile, goods and services offered, and profitability. It is also known as fundamental analysis. This procedure entails a detailed examination of the company portfolio, industry features, customer demand, vendor supply, price, and financial ratios. An effective method for assessing a company’s success is through a company analysis. To complete the process of company analysis, investors occasionally turn to SWOT analysis and PEST analysis (which evaluates the strengths, weaknesses, opportunities, and threats in an industry) as well as factors affecting the political, economic, social, and technological aspects of a sector.

Venture capital decision making

According to the National Venture Capital Association, venture capital investments totaled $48.3 billion in 2014, of which app start-ups accounted for more than 40%. VC funds take massive financial risks by investing in businesses in the hopes of striking them rich and reaping enormous returns. Securing funding, especially venture money, is incredibly challenging. Less than 1% of all ventures receive funding from venture capital. Because of the intricacies of financial statement analysis, VC decision-making is challenging. As a result, to decide how to understand and react to various events, VCs rely on a combination of prior knowledge and template recognition. They employ these two strategies to identify when a trend signals an issue requiring action.

Portfolio company assistance

The investment lifecycle involves several significant milestones for portfolio businesses. A few of the notable transitions include executive changes, facility closures, M&A deals, employee cutbacks, rebranding initiatives, spin-outs, and reorganizations. The following support will typically be given to portfolio companies by all VC firms

• Exit or Financing Transactions
• Strategic Counsel
• Upskilling techniques
• Utilizing Contacts
• Catastrophe Control

This support is technically referred to as Portfolio company assistance.

VC portfolio management metrics

A few key performance measures are routinely used to compare and evaluate venture capital funds. Typically, the gross multiple is utilized to comprehend the success of the underlying investments.Net multiple, which includes the management firm fees paid by limited partners, aids in understanding the success of the fund. Multiple on invested capital (MOIC), which gauges the value of investment concerning the capital invested. The term “Distributions to Paid-in Capital” or “DPI” refers to the value of realized distributions from the fund, divided by the amount of paid-in capital at that particular time. The ratio of residual value to paid-in capital, or RPI, measures the portfolio’s unrealized value at a given moment divided by paid-in capital. Additionally, rate of return or time-based performance indicators such as Gross IRR and Net IRR is employed as VC Portfolio management metrics.

True North KPIs

Providing enterprise-wide direction and guidance for improvement can be done using the True North Metrics form. These indicators reflect organizational objectives rather than the objectives of specific activities. The following questions are addressed by the True North Metrics form.

• What is the overall strategy of the whole company?
• What are the most important metrics for the business’s administration, manufacturing, shipping, and customer service departments?

True North KPI aids in the process of directing the portfolio companies on the right path by adopting the following measures

• Improve business Performance to increase Sales and Customer Loyalty.
• Comparing portfolio performance to benchmark KPIs (key performance indicators).
• Develop and Implement Strategy based on data-driven insights.
• Drill down to team and individual coaching reports with a single click.
• Establishing standards and ranking behaviors according to special roles with automated activity capture and long-term trends.

Financials and cash position

A measure of a company’s liquidity is denoted by its cash position. It reveals how much cash is available with it at any particular time. To determine the maximum net capital invested, this metric compares the actual cash contribution to the overall capital commitment. The purpose of this is to assist a portfolio manager:

• in understanding the capital commitments, 
• to take into account the reality that capital calls occur over time, and 
• to consider the possibility that a fund will receive revenues and distributions before the whole amount of capital calls are made.

Investors often assess their cash position by determining the proportion of cash and cash equivalents in their portfolio. Cash position is also a helpful measure for stock market analysts and potential investors, as it can be calculated using the company’s quarterly cash flow statements. When a company’s cash and liquid assets are insufficient to satisfy its liabilities, red flags go up. The liquidity ratio is calculated by dividing an organization’s current assets by its liabilities. The objective of an entity is to have a ratio that is greater than one because that indicates that they have the resources necessary to continue operating.

Ownership and Cap Table Data

A capitalization table, commonly referred to as a cap table, is a spreadsheet or table that details all of your company’s securities, such as stocks, options, equity, warrants, etc., and who owns them. They are used by all organizations, to display their equity capitalization or total ownership capitalization. A company’s equity ownership capital, such as common equity shares, preferred equity shares, warrants, and convertible equity, are listed on a cap table. They are frequently used by private corporations to offer details about their owners, investors, and market valuation. The history of a company’s issuance of new securities, ownership dilution, and employee stock options can be reviewed by founders and entrepreneurs, venture capitalists, angel investors, investment analysts, and portfolio managers from the cap table.

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