Portfolio Management

To understand the point of view of a venture capitalist, one should understand the environment in which a manager of a venture pool operates; he is investing not in one but in a number of opportunities. One of the foundations of modern portfolio theory is the concept that the return on an asset cannot be viewed by itself; rather it must be judged by its contribution to the portfolio as a whole. Thus, when deciding to invest in a company, the venture capitalist must consider how the expected return on the new investment is correlated with the others he holds. A cardinal ranking of sorts is always involved because the portfolio manager does not enjoy an infinite array of opportunities.

Venture capitalists usually diversify their holdings by categories of risk, investing across varying risk levels: a bunch of start-ups carrying, an average forecasted 40-percent compounded rate of return coupled with later-round financings which promise lower returns as a trade-off for better downside protection and the ability to cash out in the near term. A venture manager cannot decide to put 1 percent of the capital pool in a venture that actually needs 6 percent of the pool in order to reach the next development milestone, not unless someone else can be counted on to put up the next installment.

What's more, professional venture managers understand that, because of the uncertainties involved, elaborate valuation techniques are not ends in themselves in venture investing; rather, these techniques are tools which contribute to (but do not determine) a decision that is based, in the final analysis, on judgment and experience. For example, the investor must consider the outlook for the industry as a whole, the likely competitive position of the issuer, trends in customer tastes, dependence of the business on a few major customers or suppliers, possible product obsolescence, likely capital needs, the ability to leverage, potential impact of changes in the regulatory climate and so forth. Much attention will focus on likely market share.

By VC Experts, Inc.


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