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.
