Jul 7, 2022
Venture Capital

5 Top Strategies Portfolio Managers Can Use to Obtain Optimal Returns

Bram Berkowitz

anaging a portfolio of startups is no easy task. You will likely have more failures than successes, as the majority of startups fail and VCs are often lurking in the background behind those startups, which means they will see their fair share of failure as well. 

The other difficult part of being a portfolio manager is watching companies you passed on succeed, leading you to question your judgment. But portfolio managers are always making difficult decisions whether it’s deciding to fund a startup or to cut one loose. 

If you work hard and follow the right practices, there is plenty of room for success in the industry. Here are five strategies portfolio managers can use to obtain optimal returns.

1. Swing for the Fences

A baseball coach might tell their players not to swing for the fence. Hitting singles and playing small ball is just as effective a way to win games. While that certainly makes sense in baseball, it’s definitely not the case in VC. 

Portfolio managers need to hit home runs to survive because they are dealing with lots of failures. If you invest in ten companies, only two or three may exit. And that’s if you’re lucky. This means those returns must make up for the losses on the seven or eight other companies and then some because VCs have investors they need to pay back as well.

According to data from Toptal, 65% of venture deals return less capital than what was invested in them. For top-performing funds, roughly 90% of returns are derived from less than 20% of their investments. 

Case and point - go big or go home. 

2. Leave Money For Follow-On Investing 

When you are running a VC fund you are not only deciding on what startups you should invest in, you are managing capital and trying to generate the highest returns possible for your LPs. 

And you might be tempted to invest all of your capital in as many seed rounds as possible, you also need to keep funds in reserve for follow-on rounds of your successful portfolio companies. 

It’s hard to find good startups, so when you find a promising one the urge to go in as much as possible is strong. But if you don’t leave capital for follow-on investment, you may get diluted as other investors come aboard. 

According to the intelligence platform Affinity, it’s a good idea for VC funds to create a reserve policy, set aside capital for reserves, and be ready to move quickly if there is a good follow-on opportunity. 

3. Have A Clear Investment Strategy

In a way, VC funds are basically startups themselves. They need to raise capital and don’t always have the easiest path to success. It might be tempting to just go out there with no clear strategy and throw a bunch of darts, but the top portfolio managers are often executing on a very specific investment thesis. 

They’ve hone in on a sector or specific funding round that they think presents an opportunity or is untapped right now. Maybe the partners at the fund have specialized knowledge and experience in a certain sector that enables them to see the future better than anyone else. 

Regardless, it’s a good idea for funds to have a strategy that they can show their investors, which will make raising funds two, three, and four much easier.

4. Create A Solid Organizational Structure

Remember, at its core, a VC fund entails managing tens or hundreds of millions of dollars of other people’s money. While a fund may look like a bunch of founders and companies from different backgrounds, they all need to generate a return to the fund so that it can generate returns, be successful, and maybe raise a second fund.

Most top VC executives recommend that one person – probably the CFO – oversee the entire portfolio in order to ensure that the fund can make its desired returns and pay its limited partners accordingly. Keeping this person away from the human aspect of VC is probably for the best because they really need to make the best decision for the entire team, and one that is not driven by emotion.

Think of them like a General Manager. They are the people that will make the hard decision and cut the affable but struggling player in the locker room. This also leaves room for other managers at the fund to focus on individual companies and really do everything they can to support and help them succeed.

5. Be Able To Provide Value

While VCs provide critical capital that enables startups to grow, many of the best portfolio managers also play a role in helping the company develop. In many cases, the startups are still very early in their journeys and can benefit immensely from advice or mentorship on their business model and growth strategies, among many other aspects of the business. 

Good VC portfolio managers can also provide contacts or help with hiring, which can be one of the most difficult parts of running a business. 

A good VC portfolio manager also knows when not to provide advice. Perhaps it’s a decision the company really needs to make for itself or you simply don’t have knowledge in this area. Be cognizant of that. If your portfolio companies succeed then the fund succeeds, so you should be doing everything in your power to make that happen.

Portfolio management is challenging at the best of times and can be super difficult to understand until an entire fund cycle has occurred. By following the best practices outlined here, you’ll avoid some of the common pitfalls associated with portfolio management.

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