Your portfolio could be history in the making

Asset allocation and diversification are fundamental pillars of private equity and venture capital portfolio management. How capital is allocated across company types and stages, industries, regions and vehicles is central to fund strategy. How assets are allocated is influenced by fund objectives and plays a big part in risk exposure. Diversification, in particular, helps ensure a fund isn’t overly exposed to a single risk factor. As well as being a core part of venture capital and private equity portfolio monitoring, allocation and diversification are also the backbone of a fund's Private Placement Memorandum (PPM), which is presented to prospective investors during the capital raise process.

The returns generated by a fund ultimately rest on the performance of its investments. That’s why performance measurement and reporting are a critical part of portfolio management. Private equity and venture capital firms both use many of the same core markers for performance, including Internal Rate of Return (IRR) and the multiple of invested capital (MOIC). As part of these performance assessments, it’s common for firms to benchmark portfolio companies against one another and competitors in the wider market. IRR measures the annualized effective compounded return rate of investment. This core metric reveals in plain terms a fund’s returns relative to the amount invested. MOIC adds further insight into fund performance by representing performance relative to an investment’s initial cost. On top of this, VC firms will often rely on additional metrics, given the high-risk, high-return nature of venture funding. For example, venture capital firms often use metrics like “kill rate” (the percentage of failed investments) and “hit rate” (the percentage of investments that deliver a substantial return). The high-risk “barbell” nature of venture capital funding is that only a small percentage of investments, typically less than 20%, will cover the losses of failed investments and deliver positive returns.

Due diligence is the cornerstone of private equity and venture portfolio management. While due diligence happens prior to an investment decision being made, it is still a core part of portfolio management. In simple terms, due diligence involves seeking data, information and insights about an investment that’s being considered before making a final decision on whether to invest. These decision-influencing inputs are varied, making due diligence a multi-pronged approach. Due diligence can be broken into multiple categories, including: Financial due diligence - the assessment of company financials, profits and losses, revenue, assets, debt and more. Market due diligence - assessment of a company’s market position, competition, growth potential, and overall market landscape. Legal due diligence - the evaluation of any legal liabilities, for instance pending liens, torts or claims against a company. Technical due diligence - a review of a company’s operational health, including productivity, staffing and IT. The findings of each of the different forms of due diligence will be combined and assessed to make a decision on whether to invest, playing a fundamental role in portfolio management.

Taking the time to benchmark portfolio companies as part of comparative analysis is a valuable act of portfolio management. In doing so, not only do investors get an understanding of the best performers in a fund, they can also use this information to inform future investment decisions and strategies. For instance, if a certain investment is over indexing when it comes to returns, this may become a preferred investment strategy for future funds. When investors benchmark venture capital portfolio or a PE portfolio, this allows them to run side-by-side comparisons of company valuations, calculating the IRR for each company and and for the fund as a whole.

Once an investment has been made, maintaining oversight is a core function of PE and VC portfolio management. It’s the process of ensuring the capital allocated is used optimally and that the company invested in is operating in a way that produces the highest level of returns for the PE or VC firm that has funded it. Regular reporting and performance tracking make up a big part of this monitoring process. This includes regular updates on things like ownership and cap table data financials and cash position. More broadly, oversight of a portfolio as a whole enables investors to constantly assess how their portfolio aligns with their overarching investment focus. These days, oversight is very much the domain of PE and the VC portfolio management tools available. This type of purpose-built technology enables investors to gain real-time visibility into portfolio performance.

A major part -- and competitive advantage -- of PE and venture capital portfolio management is the value creation they can bring to their portfolio companies. Put simply, value creation is the actions firms can make, and the support they can provide, to portfolio companies to increase their performance, and thus the investment returns they deliver. Private equity firms often take an active role in managing their portfolio companies. To improve a company’s operations and financial performance, a PE firm will take actions like bringing in new senior executives, strategic advising and cost-cutting. In the event of a leveraged buyout, a PE firm may install an entirely new board and management team with the goal of dramatic value creation. While driven by the same underlying principles, VC firms take a slightly different approach to value creation. Especially when it comes to early-stage investing. The companies that venture capital firms invest in are often at an early or growth stage, meaning they lack the level of management experience and infrastructure that established companies have. In this scenario, VC firms will often propel value creation by playing a hands-on role in company strategy, business development and recruitment. Whatever the actions firms take, value creation is a pivotal part of private equity and venture capital portfolio management that can have an outsized impact on investment returns.

Risk is an inherent part of investing -- and a central component of private equity and venture portfolio management. As touched on early, the different investment approaches of private equity and venture capital come with a different set of risks that require unique risk management techniques. For private equity, risk comes in many forms: interest rates, exchange rates, management issues, production issues, operational inefficiencies and more. And that’s only within the company itself. PE investments also have an increased exposure to systemic risks caused by changes in market and regional situations. Venture capital is more homogeneous in that investors solely focus on investing in companies, rather than the diverse investment vehicles of private equity investing. However, given venture capital firms invest in private companies at all stages, this brings heightened risk because the chances of failure are higher. In both VC and private equity portfolio monitoring, identifying risk, quantifying it, and assessing its potential impact is a vital part of the process. It influences fund structure and strategy. Firms will create mitigation strategies to prevent exposure to risk, including diversification, hedging, maintaining capital reserves and active involvement in company operation.

Until an exit is achieved for a company, investment returns remain unrealized. On paper, a company may have grown significantly, but an exit must be achieved before a firm and its investors gain the benefit of these “paper gains”. This is where exit planning and strategies come in as a part of PE and vc portfolio management. Naturally, both private equity and venture capital firms aim for profitable exits for all their investments. But how they typically achieve them varies. For venture capital firms, exits usually come via initial public offerings (IPOs) or through an acquisition by a larger company. Both these exit routes are also on the table for PR firms, but they also take a different approach as part of exit planning, by also including how they will improve operations and company profits as part of their involvement in their investments. While both types of firms aim for profitable exits, VC firms often target exits via IPO or acquisition by a larger company in the industry. On the other hand, PE firms, especially those focused on buyouts, often seek to improve the operations of an established company and might exit via a sale to another PE firm or a strategic buyer, or via IPO. When it comes to private equity and venture portfolio management, exit planning and strategies will be considered at the point of initial investment and throughout the lifecycle of the investment, to ensure the optimal exit approach is taken to achieve maximum ROI.