Increase Portfolio Value

What is Portfolio Value?

Portfolio value is a fundamental metric used in venture building to assess the overall worth of the assets managed within the portfolio. It serves two primary functions: measuring the progress of each startup and effectively communicating the portfolio's performance to investors. This metric creates a shared understanding between investors and entrepreneurs.

Managing a venture builder requires balancing commitments to both the entrepreneurs, who drive innovation, and the investors, who provide the necessary capital to scale companies. Therefore, portfolio value is a key performance indicator (KPI) that reflects the venture builder's success in creating value for both parties.

Definition of 'Portfolio value'

The total market value of all assets held within a portfolio at a specific point in time. It represents the cumulative worth of the investments managed by the venture builder, based on current market prices or fair value assessments. The portfolio value is essentially a snapshot of the assets under management, and it fluctuates as the values of the underlying assets change due to market conditions, performance, or other factors.

Measuring the Value of the Portfolio

Assessing the portfolio's value involves tracking three core indicators. These indicators provide insight into the current status of the portfolio and its potential for growth. The main indicators used to measure portfolio value are:

1. Builder's Ownership: The equity stake that the venture builder holds in each startup.
2. Invested Capital: The amount of financial capital the builder has invested in each startup.
3. Startup Valuation: The current market valuation of each startup within the portfolio.

The following example illustrates how these three indicators are used to measure portfolio value. Consider a venture builder managing a portfolio consisting of two companies, each with different valuations and levels of ownership:

Using these indicators, we can calculate the total portfolio valuation as follows:

$$V_{p} = \sum_{\text{startup}} (O \times V_{s})$$

Where:

• $V_p$: Valuation of the portfolio
• $V_s$: Valuation of each startup
• $O$: Ownership percentage that the builder holds in each startup

Example Calculation

Using the values from the table above, the total valuation of the portfolio is:

$$V_{p} = (0.7 \times 1,750,000) + (0.54 \times 5,750,000) = 1,225,000 + 3,105,000 = 4,330,000$$

This calculation shows that the total portfolio value is $4,330,000$, based on the builder's equity stakes in both startups. By monitoring this value over time, the venture builder can track the performance of its portfolio and demonstrate value creation to investors.

Other Metrics Related to Valuation

Number of Startups

From the control panel, we can immediately analyze the number of startups that the builder has in its portfolio. The number of startups is a seemingly very simple indicator, which generally constitutes one of the builder's main success indicators.

Typically, a builder commits to its investors to create a certain number of startups each year. Although this indicator is extremely relevant, let us remember that the amount matters only to the extent that it increases the valuation of the portfolio.

If management focuses on creating a large number of startups, putting the valuation of the portfolio in second place, it runs the risk of falling into the dynamic of creating startups whose success forecasts are questionable, to the detriment of continuing to mature existing startups. However, when management focuses on the valuation of the portfolio, it will be predisposed to make decisions that benefit the whole, in the longer term.

In relation to this indicator, it is worth mentioning that it is not always so simple to calculate the value of a startup. Furthermore, it is difficult to determine exactly the moment from which a startup can be counted as such. Some builders consider that the startup can only be counted after its legal establishment or incorporation, while others consider that the existence of a minimum viable product or a entrepreneurial team are sufficient milestones to issue a valuation.

Investment multiplier

The investment multiplier is a key metric used by investors to assess the overall return on capital invested in a portfolio. It reflects how many times the initial investment has multiplied, making it especially relevant for evaluating the performance of a venture builder in generating returns.

The investment multiplier is calculated as:

$$M = \frac{V_p}{I}$$

Where:

• $M$: Investment multiplier
• $V_p$: Current valuation of the portfolio
• $I$: Initial capital invested

For example, if the portfolio is currently valued at $4,330,000$ and the initial investment was $90,000$, the investment multiplier would be:

$$M = \frac{4,330,000}{90,000} = 48.11$$

This indicates that the investment has grown by approximately 48 times its original value, a critical metric for understanding the effectiveness of the builder in growing the portfolio’s value.

Operations performance

The operations performance is an indicator updated annually, used to evaluate how efficiently the management team utilises available resources to grow the portfolio. It serves as a measure of management's ability to generate value in relation to the expenses incurred.

The formula for calculating operations performance is:

$$R = \frac{V_p - \sum I_{\text{startup}}}{AX}$$

Where:

• $R$: Operations performance (or return of operations)
• $V_p$: Current valuation of the portfolio
• $\sum I_{\text{startup}}$: Total capital invested across all startups in the portfolio
• $AX$: Annual expenses (operating costs)

For instance, if the current portfolio valuation is $4,330,000$, the total capital invested is $90,000$, and the annual expenses amount to $120,000$, the operations performance is calculated as:

$$R = \frac{4,330,000 - 90,000}{120,000} = 35.33$$

This value of 35.33 indicates that for every unit of expense, the portfolio generates 35.33 units of value. A higher operations performance value signifies more efficient use of resources in generating portfolio returns.

Absolute return

The absolute return measures the net profit or loss of an investment without considering the holding period or the time value of money, making it different from more time-sensitive metrics like IRR (Internal Rate of Return) or ROI (Return on Investment).

The absolute return is calculated as:

$$\text{Absolute return} = V_p - I$$

Where:

• $V_p$: Current valuation of the portfolio
• $I$: Initial capital invested

For example, if the current portfolio valuation is $4,330,000$ and the initial investment was $90,000$, the absolute return would be:

$$4,330,000 - 90,000 = 4,240,000$$

However, the absolute return does not account for how long the investment has been held. Therefore, it is considered a less sophisticated metric compared to measures like IRR, which factor in the time value of money, providing a more nuanced view of investment performance.

Return on Investment (ROI)

Return on Investment (ROI) provides a percentage measure of the profit or loss relative to the original investment. This metric helps assess how efficiently the capital was used to generate returns. ROI is calculated as:

$$\text{ROI} = \frac{V_p - I}{I} \times 100$$

Where:

• $V_p$: Current valuation of the portfolio
• $I$: Initial capital invested

For example, if an investor originally invested $90,000$ and the current valuation is $4,330,000$, the ROI is:

$$\text{ROI} = \frac{4,330,000 - 90,000}{90,000} \times 100 = 4,611.11\%$$

This means that the portfolio has grown by approximately 4,611% relative to the original investment. ROI does not consider the time component, which can be critical if the holding period varies across investments.

Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) measures the annualised rate of return at which the net present value (NPV) of all future cash flows from an investment equals zero. In other words, IRR is the discount rate that balances the present value of future cash inflows and outflows with the initial investment.

The IRR is determined by solving the following equation:

$$0 = \sum_{t=0}^{n} \frac{CF_t}{(1 + IRR)^t}$$

Where:

• $CF_t$: Cash flow at time $t$ (which can be either inflows or outflows)
• $IRR$: Internal rate of return
• $n$: The number of periods (usually years) in which the cash flows occur

For example, assume the following cash flows for an investment:

• Initial investment: -$100,000$ (negative because it's an outflow)
• Year 1 cash flow: $20,000$
• Year 2 cash flow: $30,000$
• Year 3 cash flow: $40,000$
• Year 4 cash flow: $50,000$

To find the IRR, you would solve for the discount rate that makes the sum of the discounted cash flows equal to zero.

Example Calculation

For the cash flows above, the equation to solve for IRR would be:

$$0 = \frac{-100,000}{(1 + IRR)^0} + \frac{20,000}{(1 + IRR)^1} + \frac{30,000}{(1 + IRR)^2} + \frac{40,000}{(1 + IRR)^3} + \frac{50,000}{(1 + IRR)^4}$$

The IRR for this investment can then be compared to the required rate of return or the cost of capital to assess whether the investment is attractive. A higher IRR indicates a more profitable investment, all else being equal.