Venture capital is often referred to as an apprenticeship business because so much important learning comes from day-to-day experiences. Yet, as an article published by the Business Development Bank of Canada (BDC) explains, you can shortcut the learning process by learning from experts: “Your learning curve can be shorter—and your results better—if you learn from pros who’ve already mastered key parts of the business.” This is especially true in the case of portfolio management.
Here’s a breakdown of five expert tips for venture capital portfolio management, inspired by a BDC article, and including some of our own favorite insights from expert venture capitals.
View your portfolio construction strategy as a launchpad, not an endpoint
As a venture capitalist, you know that tomorrow’s potential investors will scrutinize your results today. They’ll assess whether you achieved what you set out to and how well you actually did relative to those goals. Although you shouldn’t shy away from changing your investment strategies when warranted, it’s important that you are ready to explain any changes. Remember, your LPs will value consistency in your strategy.
Hadley Harris, founder and general partner of ENIAC Ventures, wrote an insightful piece on Portfolio Construction for Dummies that explains how to choose your initial portfolio construction strategy. The key, according to Hadley, is that your initial strategy is just a starting point, and it must be measured and adjusted over the life of the fund.
In thinking of your strategy as a launchpad—not an endpoint—you should embrace strategic deviations. A change in direction often results in a shorter runway to produce expected returns from the portfolio. But, if you don’t communicate this change in direction and document it, others’ will evaluate your plan less favorably.
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Maintain decision clarity
Portfolio investing is as much about the deals you choose not to participate in as it is about the deals you choose to be involved in. You need to ask the right questions and make sure that it’s clear who gets to vote on investments. You should also ensure that the rules of engagement are established up-front so that you have decision clarity—questions around whether one person is allowed to vote, and whether another person can kill a deal, should be crystal clear.
Bo Ilsoe, a longtime investor, reminds us that the life of an average VC fund is 14 years. With an average 14-year lifespan, you are likely to invest or hold portfolio companies through at least one major global crisis. Having clear guidelines in place so that you can make critical, difficult decisions swiftly is key, especially in times of turmoil.
Assign one partner to oversee the whole portfolio
First coined by Aristotle, the adage “the whole is greater than the sum of the parts” is very applicable to venture capital. You should view your portfolio, not as a collection of companies, but, instead, as a capital pool required to produce aggregate returns over a 5-to-10-year period. This is why some experts recommend having one partner who is responsible for thinking about the portfolio as a whole.
Gabriel Matuschka, Partner at Fly Ventures, and Mattias Ljungamn, Founder & Managing Partner of Moonfire, both passionately describe the importance of venture capitalists gaining new decision-making skills—such as being “data futurists” and adopting “end-to-end data-driven approaches”. Although these skills will be critical to success, you shouldn’t lose sight of the benefits of having one person at the helm whose role is simply to optimize Aristotle’s foresight.
Ljungman and Matuschka’s idea of a data-driven approach to investment is also already here. Affinity Analytics gives firms the ability to dive into their extensive networks and discover new insights that shape their business decisions.
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Keep capital reserves top-of-mind for follow-ons
The ability to make a subsequent investment in a company is key to optimizing results. There is nothing worse than losing out on the benefits of a deal simply because you don’t have available funds for follow-up capital. Beyond sourcing and closing new portcos, you and your team should:
- Articulate a clear reserve policy
- Establish reserve funds and implement a protocol for partners to review regularly
- Be ready to shift reserves accordingly when the situation demands it
On this topic, Eliot Durbin from Boldstart Ventures has shared three valuable nuggets of advice. First, “expect 20% of your portfolio to drive 80% of returns”. Second, “pay attention to founders that get those 1x – 3x returns on their first rodeo because the next will be better”. And third, “plan your percentage reserves for follow-on investments because ownership in your winners matters most.”
Don’t spread yourself too thin. Striking the right balance between quality and quantity is a challenge when each investment carries some degree of risk, but by maintaining a reserve strategy you can capitalize when one of your investments pays off.
Collect the right data
Collecting valuable relationship data makes reporting on your portfolio easier, but it also helps you to effectively manage it. With tools available for automating contact data entry, data analytics, and business intelligence, maximizing the value of your data is now a must for a successful firm.
On the topic of data and modeling, Hadley Harris says the key is to build out two models.
- The first is a fund model with a number of companies and projections about how broad or deep you follow.
- The second is a liquidity model to project when money will come back for recycling and the triggers for investing past initial investable capital. The process of recycling capital allows the fund to gain leverage without exposing limited partners to additional risk beyond their capital commitment.
Portfolio management is an area of venture capitalism that is challenging at the best of times and is very difficult to understand until an entire fund cycle has occurred. By following the best practices from experts outlined here, you’ll avoid some of the common pitfalls associated with portfolio management.
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