In July 2022, Harvard Business School published a case study on Yinglan Tan and Insignia Ventures Partners, set in the context of early 2022, with the following problem (see screenshot of the abstract below):
Explaining the context behind this problem, the case begins with the broader story of the development of Southeast Asia’s venture capital industry. The case also covers Yinglan’s journey from the National Research Foundation to Sequoia Capital then finally building the foundations of Insignia Ventures and leading the deployment of its first two funds into companies across the region.
While the case is not yet available for public purchase, and because this context has already been covered on Insignia Business Review through many articles, podcasts, and even a book, for this article we go straight into taking a stab at this problem. To do this we make use of excerpts and insights from Backing the Bold, the exclusive and official accompanying book to Insignia Ventures Academy’s 12-week experiential venture capital accelerator program.
With the announcement of Insignia Ventures’ Fund III, Insignia has largely addressed the first part of the problem in the case study, which is dry powder needed in order to “climb the ladder” and follow portfolio companies into growth.
But follow-on financing is just a part of what it will take to scale a venture capital firm and the companies it backs in Southeast Asia, as implied by “Insignia’s model would need to evolve, and in important ways come under stress.” And the downturn hinted in the case abstract has indeed manifested over the past year, with no signs of abating significantly in the other direction any time soon.
The other side of the coin, so to speak, is portfolio management. While portfolio management is a broad topic and occupies six out of the thirteen chapters in Backing the Bold, we share three foundational principles on portfolio management from the book. This should help us flesh out how a venture capital firm can scale its portfolio management capabilities, even amidst the market challenges today.
Higlights on Scaling Portfolio Management for a VC Firm:
- Scaling team across sectors with operators or industry experts who can not only find founders and companies in their respective sectors but also be of value beyond the check.
- Scaling “toolkit for founders” through crowdsourced data and owned networks, essentially becoming a platform for talent, capital, and ideas to connect with their portfolio companies.
- Focusing on “finding fishermen, instead of fishing” for the founders, in order to scale their capabilities. Simply, that means introducing founders to experts or even management hires better suited to address urgent needs and changes that demand deeper involvement.
- Leveraging network effects across its portfolio, for example, setting up conversations or meetings for early-stage founders to meet with growth-stage founders.
- Building out its portfolio services team further (ala a16z) to offset some of the work from the investment team at critical junctures, and also as a function of much-needed expertise.
- In a time of remote work, physical presence can be immensely valuable, both from a brand-building and practical perspective in helping portfolio companies. This can range from community events to having on-the-ground teams in specific areas that are more accessible than HQ.
- Building its capabilities not just across sectors, but throughout the life of a company, enabling flexibility in the level of service it can provide.
VCs may have control tower vantage, but they aren’t the ones flying the plane
“The first rule of portfolio management is that it is not the job of the investor to run the company. Seems intuitive, but ex-operator investors, especially those in board director positions, are likely to make that mistake. Portfolio management is all about equipping founders with more holistic perspectives, wider networks, and more than enough capital that would have otherwise taken longer to obtain or more time from the founders that could be instead used towards building a billion-dollar company.” (page 220)
Of course, it’s not as simple as just dishing out advice, making WhatsApp connections, and committing follow-on financing. The best help is purposeful and respectful.
It is built on a deep understanding of the business that not just comes from research or industry expertise but also regular communication in terms of updates and regular due diligence. VCs have the advantage of seeing things from a bird’s eye view (i.e., talking to multiple founders, industry players, and their own research), and the best ones are able to pattern match and translate it into targeted insight for their founders — how can they use this information at this particular stage in their growth with the resources they have?
“Portfolio management being part of relationship building also means that the effectiveness of a VC in delivering value also depends on how much they know about the company.” (page 224)
VC help also always comes with the caveat of uncertainty. Ultimately, VCs and founders, in the face of the future of technology and market uncertainties, are like the blind men in the fable where they feel different parts of the elephant but can’t really know that it is an elephant.
There is also a level of imperfection with respect to the portfolio company as the VC may never 100% know what is happening on the ground, whether by circumstance or intention.
Regardless of what the future holds, the final call is made by the founders and company management. The investor’s job is to put their founders in the right position to make these decisions effectively, whether by offering strategic direction or connecting them to leaders and capital to execute these strategies.
One can imagine early-stage VCs as those in flight control directing pilots on taking off and landing. They are nowhere near the plane and they see all the other planes flying around, know the kind of weather at the point of landing and takeoff, and have multiple vantage points on what the overall environment is like. But sitting in the cockpit are the founders, and there are times when founders may decide to make a different call than what is advised.
As Yinglan shares in a call with Fazz Financial Group CEO, Hendra Kwik: “Because it’s my job as a board director [not] to run the company for you. And I think a lot of ex-operators make that mistake because they try to operate from the board which is usually a recipe for disaster. I think the right role for us is, “Hey, we can’t expect to know what’s happening in a few hundred people organization like Payfazz. But I think we have a broader vantage point.”
So, we are able to sort of surface things that are happening macro-wise, worthy of consideration to the CEO. Our job is to make you the Superman, and empower you with some extra superpowers by leveraging our experiences from other domains and other geographies.
Ultimately the decision is still made by you. But I think the beauty is that we may have seen other mistakes or pitfalls in previous companies that may be useful for you to consider. And we try to ask questions that you know best [what] the right answer is.
Hopefully, that helps you make a better decision or avoid a pitfall or pothole. I think that hopefully, we’ve done our job. The other thing that we try to do is that we are essentially a glorified recruiter. I think as you mentioned correctly, you know one of the great things about being a CEO is to surround yourself with good people or great people.
Recruiting takes out a bit of time. We try to share the load by referring you to good candidates or sometimes we help with recruitment. Sometimes we help with the selling of the candidate. So I think that that is one of the things I spent quite a bit of time on. The third one is of course capital strategy.
If you do your job right, there are only three things you need to do right, one, you need to set a strategy for the company. Two, you attract great people to do all these jobs. And third is to ensure that the company never runs out of money. So our job is to help you shine in these three areas.
…We try to give you some data points on what we are seeing in the industry. So I think that that’s our role. And there’s no way we can understand what’s going on in the company. What we can do is to sort of pick up things we see, and give you some data points so that you can come to the right conclusion yourself. So that’s pretty much it.”
What does this mean in terms of scaling a venture capital firm?
- A VC firm can scale its team across sectors with operators or industry experts who can not only find founders and companies in their respective sectors, but also be of value beyond the check.
- A VC firm can also scale its “toolkit for founders” through crowdsourced data and owned networks, essentially becoming a platform for talent, capital, and ideas to connect with their portfolio companies.
What does this mean for founders? It’s important to listen to investors but not follow them blindly. The best founder-investor relationships enable psychological safety and intellectual honesty.
VCs manage portfolios, not individual companies
The underlying implication of a venture capitalist’s ability to provide big picture thinking and pattern matched insights to founders is the reality that investors are not just paying attention to one company.
“This ability of being able to aid founders in these areas stems from the fact that venture capitalists are not just focused on one company, but an entire portfolio. This brings us to the second rule of portfolio management: venture capitalists approach portfolio management from a portfolio perspective. One can think of this as looking at it from the bigger picture and how to create a winning portfolio (scale) as opposed to just focusing on every single company…
…Combined with the reality that not many startups succeed, and investors only have so many hours in a week to spend between sourcing, due diligence, closing investment rounds, and then portfolio management, investors have to be strategic with how they spend their time with each company.” (page 221-222)
Sounds intuitive and obvious, but this has deep implications for how venture capitalists think about scaling, especially over the life of the fund. Ownership, performance, and urgency are then key considerations in strategizing portfolio management.
For example, over the initial impact of the pandemic, and likely even the first half of 2022, VCs had to strategize how they would spend their time working with their portfolio navigating the sudden changes in the tech markets and fundraising environment.
As Yinglan shares in a call back in early 2020: “What we’ve done is we’ve spent the past two weeks doing a stress test on our portfolio. At a high level, you know, I think 75% of our companies have a pretty healthy balance sheet of 12 to 18 months runway…I think another 10 to 15% have six to 12 months and another like 10% have less than that six months.
Those companies we really went down and planned out scenario planning right so assume you know revenue doesn’t drop which is unlikely because there’s a big demand shock. Assume revenue drops 80% then the worst case assumes revenue drops to zero or 90%. And then come up with what you should do in these kinds of situations. We came up with a lot of defensive measures for people you know, like cutting OPEX or shifting CAPEX payments or stop some of the expenditure and stop the bleeding. Cash is king right now.
And then for the offensive majors, are there new channels that are online? If you have a restaurant for example, can you solve your food delivery online? If you have a cosmetic company, they don’t have any offline shops, and you do more of the sales online. And so on and so forth.”
What does this mean in terms of scaling a venture capital firm?
- VCs may instead focus on “finding fishermen, instead of fishing” for the founders, in order to scale their capabilities. Simply, that means introducing founders to experts or even management hires better suited to address urgent needs and changes that demand deeper involvement.
- A VC firm may want to leverage network effects across its portfolio, for example, setting up conversations or meetings for early-stage founders to meet with growth-stage founders.
- A VC firm can build out its portfolio services team further (ala a16z) to offset some of the work from the investment team at critical junctures, and also as a function of much-needed expertise.
What does this mean for founders?
- It’s important to be clear on what to expect from specific investors in terms of what they can and are willing to bring to the table, even before they invest.
- It’s also important to know what to expect (or what can be gained) from being part of a certain portfolio of companies.
- It can be useful to know how far along in a fund, or in its funds, the firm is with respect to the investment they are going to make.
VCs balance relationships building with casting a big net on investments
The previous two items illustrate the “distance” venture capitalists have from their investments (i.e., they are not the ones running the company, and they are looking at multiple companies), and it is precisely because of this “distance” that this third principle comes into play — the importance of portfolio management in building relationships and strengthening trust of founders. This trust serves as a lubricant for better alignment and communication between investor and founder on the company’s growth trajectory, leading to a win-win scenario for both.
This is also hinged on venture capital being a service industry. And the best customer service requires trust building over time (not just at the point of investment) and through the ups and downs of company building. This becomes harder to do if the VC firm is unable to keep up with the size (how much), range (how diverse), and volume (how many) of its investments.
“This relationship building does not just mean spending time, but what we’ll call “get real” time…it is important to call a spade a spade, especially when things are not going well. This candor with founders also entails sticking it through with them in the rough times as well as the good.
The demands of relationship building seem to go at odds with approaching portfolio management with a portfolio perspective and doing things at scale. But the reality is that there should be a balance between the two. Every company is unique but the VC business model also means that VCs can’t afford to spread their eggs too thin across all the baskets they invest in.
In order to strike this balance between managing a portfolio of companies and building one-on-one relationships with founders, venture capitalists work as a team, delegating specific value-adds to specialists hired by the firm for this very purpose…For angel investors, the lack of a team to work with means they rely more on a network to really maximize their value-add. Or they can join a syndicate with other angels, though the syndicate requires less commitment in driving value-add for their portfolio than a more institutional VC firm would.” (page 223-225)
What does this mean in terms of scaling a venture capital firm?
- In a time of remote work, physical presence can be immensely valuable, both from a brand building and practical perspective in helping portfolio companies. This can range from community events to having on the ground teams in specific areas who are more accessible than HQ.
- A VC firm may look at building its capabilities not just across sectors, but throughout the life of a company, enabling flexibility in the level of service they can provide.
What does this mean for founders? It’s important to know what kinds of investors one needs at each stage of growth, and what value-add would ideally be present with these investors.
Boils down to people
At the end of the day, venture capital is a people industry. While technology can be powerful in helping venture capital firms scale as much as their portfolio companies, it is less about replacing human interactions as it is optimizing decision-making of people and catalyzing connections between people.
Especially in a tough fundraising market where the pressure is on for VCs to not just find the outlier opportunities that will emerge in this period earlier than the rest of the market, but also to be able to follow-on on those companies who are likely to come out of this challenging period stronger than ever, it becomes more important to keep up with portfolio companies and have the right people doing that.
To reference this insight from Fazz Financial’s Hendra Kwik on our podcast: “In the early days, when I raised Payfazz’s first ticket from Insignia and the first ticket from YC, I thought that after I have money, problems will be solved, but actually, you will have another problem. Right after Series A, you have another problem. After Series B you think your problems are solved, but actually, you will have another set of struggles and you will realize that actually, it’s normal, that you will always find these hardships.
And it will be impossible for you to solve it alone. So that’s why I keep mentioning people. You need to leverage people around you. You need to bring a good set of investors who can support you from the investment side, and also be a good board of directors. They can be good people to support you in your decision-making. A good C-level and good team members can be the people to help you execute [on your decisions]. Don’t try to do everything alone because that’s going to drive you crazy. And maybe a lot of founders try to do everything themselves and that will make them feel really stressed and depressed.
So that’s what I want to share with founders: focus on people. In this case, I’m not only talking about the people that you recruit, but also the people on your board and the people that are brought by your investors, because they can influence a lot in your company.”
Of course, this is just one way and one dimension to think about scaling for a venture capital firm. If you have other ideas and would like to execute on those at Insignia Ventures, check out our open roles here and on LinkedIn.