By Christian Claussen, General Partner at Ventech
The construction of a venture capital portfolio requires a combination of strategic planning, due diligence, financial acumen, industry-technological knowledge, and relationship-building skills. Once the portfolio is established, VCs are required to manage portfolio companies which involves a balance between risk-taking and risk management, strategic decision-making, and adaptability in a rapidly evolving startup ecosystem.
In this article, I will highlight a couple of specific key elements for VCs running a venture portfolio while reaching out beyond standard tasks like deal flow generation, market and customer validation, or financial, legal, and technical due diligence.
Part 1: Portfolio Construction
1.1 Adaptability:
Stay Agile: The startup landscape is extremely dynamic. Stay agile and be willing to adapt to changes in technology trends, market conditions, and regulatory environments! Flexibility is key to success in venture capital since disruptive change is the very nature of innovation. Moreover, VCs must carefully adapt to the economic cycle they are operating in.
The particular selection of the type and related risk-level of bets a VC is willing to take largely depends on the specific phase of the economic cycle during the initial investment and the assumed phase when exiting a particular portfolio company. With standard holding times of several years, VCs are hence forced to make long-term projections about the economic cycle lying ahead.
1.2 Continuous Learning:
Stay Informed: Stay abreast of industry trends, emerging technologies, and best practices in venture capital. Continuous learning helps in making informed decisions and staying competitive in the market. It is a fundamental misconception for VCs to be ahead of the trend. The classical panel question at VC conferences about ‘what’s hot / what’s next’ results in the notorious enumeration of today’s trends which are mostly already obsolete when it comes to early-stage investing.
VCs support innovators. Innovation is in fact brought to us VCs by innovative entrepreneurs and not the other way around. VCs are bound to wait for the next innovation like a surfer in the water who opportunistically jumps on his surfboard once the earliest signs of a coming wave are barely sensible. And to stay in the picture, in most of the cases there is no significant wave building up and the surfer either falls into the water (= investment lost) or struggles to stay afloat until reaching the beach (= investment results in a small multiple). Only in rare cases will timing and position allow to catch a monster wave which for the lucky VC results in a so-called ‘fund-maker’, i.e. a return on investment beyond the 20x mark.
1.3 Diversification:
Sector and Stage Diversification: despite an often-seen demand by LPs (Limited Partners) and corresponding claims made by VCs, it is not necessarily a great idea to construct venture portfolios around one or two distinct themes or industry trends. Diversifying the portfolio across different industries, business models, and technologies can help reduce the impact of poor performance in any single investment.
Spreading investments across different stages of development also helps to mitigate cluster risks associated with a particular sector or stage. As a VC who’s lived through multiple economy cycles, at Ventech, we find it easier to defend against risks by investing across different themes, business models, underlying technologies, and trends than diversifying our portfolio largely across multiple maturity stages. This has to do with fund size and our core competency to effectively evaluate a large variety of high-growth projects long before financial KPIs can be demonstrated reliably.
Part 2: Portfolio Management
In this part, we discuss the post-investment activities and strategies vis-à-vis the portfolio companies and how to support them in the best ways and maximize value creation.
2.1 Active Portfolio Management:
Proactive Involvement: Work closely with portfolio companies to provide strategic guidance, mentorship, and access to networks. An actively involved investor can contribute to the success of the companies in which a VC has invested.
For example, we draw at Ventech a clear line between operational support in day-by-day management tasks and the strategic contribution that only an experienced sparring partner can provide. The latter having a much higher economic value whenever fundamental decisions must be taken collectively to navigate through major inflection points and thus helping startups to overcome challenges, make strategic decisions, and increase their chances of success.
Why exactly? More explanations can be found in my blog “I’m calling bullsh*t on these VC ’value-add’ platforms”.
2.2 Risk Management:
Risk Assessment and Adaptation: Continuously assess and monitor risks associated with each investment. Work with portfolio companies to develop contingency plans for different scenarios. This includes anticipating potential challenges and having strategies in place to mitigate risks. On that basis, be prepared to adapt plans drastically based on changes in market conditions, regulatory environments, and technology landscapes. All VCs have experienced the seductive force of hanging in and praying for miracles. Changing too little too late is a common phenomenon in venture-backed boards and in hindsight, most of us can cite cases where much earlier and vigorous course corrections would have resulted in a better outcome.
2.3 Portfolio Rebalancing:
Regular Portfolio Reviews: Periodically review the portfolio to assess the performance of each investment. Consider divesting from underperforming companies and reinvesting in new opportunities that align with the fund’s objectives. Early-stage company building is a Darwinian art and unfortunately oftentimes yield unsatisfactory results.
Experienced VCs are fully aware of that risk and make sure to avoid ‘train wrecks’ where heavily overfunded start-ups hit the wall while impacting the portfolio NAV disproportionally. Cutting losses early enough requires a well-functioning partnership that strives for open communication, sober assessment, and mutual fault tolerance within the front-office team.
2.4 Follow-on Investment Policy:
Supporting Winners: Identify and support portfolio companies that demonstrate strong growth potential. Consider follow-on investments to maintain ownership stakes and provide additional capital for scaling. Besides savvy money allocation, VCs must also manage their bandwidth and make sure to concentrate their precious airtime on the winners. There is obviously a fine line here where the reputation of a VC is at risk when low-performing portfolio companies get ignored. However, spending too much time to save momentum-lacking companies oftentimes results in a lack of strategic support for the winners where the impact of VC-support is much greater.
2.5 Exit Strategies:
Plan for Exits: we all know the old VC saying goes ‘Companies will be bought and not sold’. However, developing clear exit strategies for each investment, whether through IPOs, mergers and acquisitions, or other means can help to set expectations right, and align the interests of founders and investors while ensuring that management keeps an eye on the task of eventually creating liquidation opportunities. Timely exits are crucial for realizing returns and recycling capital into new opportunities.
And I’m not done here.
In the following part, I’ll explain how to successfully manage an active portfolio. Stay tuned for the next episode!
