View this post in an interactive model here.

One of the most important things a General Partner (GP) needs to consider early on when starting a venture fund is their portfolio construction strategy. Nearly every potential institutional Limited Partner (LP) will ask a GP about this strategy. Portfolio construction will impact nearly every aspect of running a fund, including return performance. This Tactyc explores venture portfolio construction and the various trade off implications a GP must consider and enables you to construct your own portfolio to understand how various assumptions impact returns to LPs and GPs.

In this blog post, we use Tactyc to explore venture portfolio construction and the various trade off implications a GP must consider and enables you to construct your own portfolio to understand how various assumptions impact returns to LPs and GPs. Tactyc is a MaC Venture Capital portfolio company and is a no-code platform to build interactive web apps (such as this one) from spreadsheets – making scenario analysis easy and intuitive for anyone.

Getting the Puzzle Pieces Right

Portfolio construction is the careful calculus of a number of different decisions related to how a fund is run and the impact that each of those inputs have on each other. The major contributing factors to portfolio construction are below.

• Fund Size: Simply, the amount of capital committed to fund.
• Management Fee and Carry Percentages: Typically funds have a 2% yearly management fee over the 10-year life of the fund (for a total of 20% of fund size) to cover all overhead expenses and a 20% carry (% of profits the GP receives after investors are paid back in full).
• Fund Level Expenses: In addition to the management fees that are paid to the management company for running the fund, there are other expenses that are deducted directly from the fund assets. These fees include legal set-up costs, fundraising expenses and other administrative, legal and infrastructure costs. These costs can range from $250K on the low end into the millions on the high end.
• Number of Total Company Investments: Some funds run a concentrated strategy and aim to invest in a total of 12-15 companies over the life of the fund, others take a more diversified approach and aim to invest in 30-40 companies, and others aim to invest in 50 or more companies.
• Average Initial Check Size: The average amount that will be invested in the first round of fundraising (assuming that more will be invested in the top-performing companies if there is allocation to follow-on investments).
• Target Ownership From Initial Investment: The percentage of the company the firm will look to get with their average initial check size.
• Follow-On Reserves: The percentage of the fund that will be reserved to make follow-on investments into the fund’s best-performing companies. Some funds have a two-for-one follow on ratio meaning that for every dollar they first invest into a company, two more dollars are reserved for follow-on, while other funds aim to take a larger ownership percentage up front and reserve between 20% and 40% for follow-on.
• Fee and Expense Recycling: Fee recycling is reinvesting the fund expenses and management fees (usually as follow-on investments) as distributions occur. For a $100M fund with a 2% yearly management fee, there will be $20M in total management fees taken over the life of the fund. Many funds look to reinvest the full fund into companies and will invest up to the $20M as companies exit and money is returned to the fund.
• Targeted Net Return: The targeted amount of capital the fund looks to return to its LPs. For a $100M fund, a 3x net return means that the fund targets to return to its investors a total of $300M.
• Required Return Fund Capital to Targeted Net Return: Going off the example above, if a fund is targeting a 3x net return, meaning they wish to pay to their investors $3 for every $1 invested, the required fund return to hit 3x is actually higher than $300M given fees and carry. It is important to understand the total required return needed to hit the targeted net return.
• Graduation Rate Assumptions: Individual company dilution needs to be factored into fund performance. One way to do this is to make some assumptions around the percentage of total companies raising subsequent financing rounds, as well as assumptions on the size and pre-money valuations of those rounds. Some funds may assume that of all the seed investments they make, 50% will successfully raise series A rounds, and of those, 50% will go on to raise series B rounds, and 50% of those C rounds and so on.

Construct your own portfolio

See the interactive model here that enables you to setup your own fund scenario by flexing the following levers to see impact on capital allocation and implied number of investments

Portfolio Construction Trade-offs