Portfolio monitoring

Venture capital and private equity firms frequently have many different private companies in their portfolios, and they typically hold these investments for many years. As firms manage their investments, it’s critical to have accurate and timely information about how various companies are performing. 

Monitoring the performance of a portfolio allows fund managers to track the progress of their portfolio companies, locate potential problems, and strategize for a future exit or other financial milestones.  

What is portfolio monitoring?

Portfolio monitoring is the process of collecting and analyzing information related to the performance of a private investment fund. This typically includes financial data related to a portfolio company’s performance, such as valuation, revenue, and customer growth, as well as more objective matters, such as compliance with laws, regulations, and the fund manager’s mandate. 

Portfolio monitoring is a fundamental aspect of operations for venture capital firms, private equity firms, and other fund managers. Accurate monitoring allows investors to make more informed strategic decisions about their portfolios and to keep limited partners (LPs) and other stakeholders informed about the performance and value of their fund investments.  

Key components of portfolio monitoring

Fund managers typically monitor the performance of their portfolios across a wide range of criteria. Some of these are fund-level metrics that track the performance of the portfolio as a whole, while others are company-level metrics focused on the portfolio’s component parts.

Fund performance tracking

There is no single all-in-one metric that can completely describe the performance of a private investment fund, particularly a fund that is still actively managing its investments. To get the fullest picture possible, fund managers typically assess performance in a few different ways. 

• Internal rate of return (IRR) is a measure of the annual growth rate that an investment is expected to generate, accounting for all future cash flows. It is expressed as a percentage, with higher IRRs correlating to higher expected returns. 

• Multiple on invested capital (MOIC) is a measure of the return multiple that a fund has generated. To calculate a fund’s MOIC, simply divide the fund’s gross distributions by the amount of capital that was initially invested in the vehicle. 

• Total value to paid-in capital (TVPI) is another multiple that measures fund performance. It includes both the realized and unrealized value of a fund’s investments, unlike MOIC, which only includes realized distributions. Because of this difference, TVPI is often more useful for tracking the performance of active funds that still have unrealized investments. 

• Distributions to paid-in capital (DPI) is similar to MOIC, in that it is a multiple that tracks the value of a fund’s realized distributions relative to the size of the fund. While MOIC relies on gross distributions, however, DPI typically tracks distributions net of any fees or expenses. 

• Residual value to paid-in capital (RVPI) is a return multiple that measures the theoretical value of any unrealized investments in a fund portfolio in relation to the size of the fund. Mathematically speaking, the TVPI for any fund should be equal to the sum of the RVPI added to the DPI (e.g., if a fund has RVPI of 0.5x and  DPI of 0.5x, its TVPI is 1x). 

• Metrics like IRR, TVPI, and DPI are reliant on fund managers having an estimate for the value of their unrealized investments. In some cases, managers use a fund’s  fair market value (FMV) as a proxy for their current worth. The FMV is an assessment of what a company’s shares would sell for in a hypothetical transaction in the current market under typical market conditions. Private companies typically receive an appraisal of their FMV at least once a year, in the form of a 409A valuation. Other fund managers may use their own internal methods to assess the value of unrealized investments.  

Portfolio company metrics

Just as they do at the fund level, investors also typically look at portfolio performance at the company level from several different angles. These different metrics can reveal different insights about the various strengths and weaknesses of the companies that make up a fund portfolio. 

• Revenue is a basic measurement of how much money a company is bringing in. Fund managers frequently look to annual recurring revenue (ARR) as a way to track the revenue growth that a company is displaying from one year to the next. 

• EBITDA is an acronym that stands for earnings before interest, taxes, depreciation and amortization. At a basic level, the metric is designed to measure a company’s ability to generate cash. By setting aside taxes, depreciation, and amortization, it aims to discount factors that are less within a company’s control and give a more accurate picture of direct financial performance. 

• Burn rate is a measurement of the degree to which a company’s expenses are outstripping its revenue. In other words, it’s a measure of how much cash a company is spending over time. Startups often calculate their burn rate on a monthly basis. Burn rate typically only applies to unprofitable companies, because a company that is profitable is earning cash, not spending it.  

• A company’s cash runway is the amount of time it can remain in operations before running out of money. The length of a company’s runway is closely informed by its burn rate. If a company has a higher burn rate, that means it is spending its available capital more quickly, which results in a shorter runway. 

• Market share is a description of how successful a company has been in capturing available revenue within a specific audience. If total sales in Segment X comprise $10 million, and Company A is responsible for $5 million of those sales, then Company A has 50% market share within Segment X.  Investors might also use other metrics besides revenue to examine market share in different ways. 

• Retention rate and churn rate are two sides of the same coin. Retention rate measures the percentage of existing customers that a company retains over a specific period of time, while churn rate measures the percentage of customers a company does not retain. Since retaining existing customers is typically seen as far easier and less expensive for a company than winning new customers, a high retention rate is typically seen as a sign of financial strength. 

• Customer acquisition cost is the typical amount of capital that a company spends to gain a new customer. This includes spending across all avenues, including marketing, sales, and employee salaries. Companies with low customer acquisition costs are typically able to grow more efficiently. 

• Customer lifetime value is a measurement of the expected financial value that a new customer will bring to a company over the full timeline of the customer relationship. This value is typically expressed in terms of net profit, but it can also rely on revenue. 

• Customer acquisition cost and customer lifetime value can be combined to create the CAC-LTV ratio, which is a multiple that expresses how much value a new customer is expected to bring relative to the cost of acquiring that customer. For instance, if a company has an average customer acquisition cost of $10,000 and an average customer lifetime value of $30,000, it would have a CAC-LTV ratio of 3x.

• Fund managers must also keep a close eye on the debt and capital structures of their portfolio companies and how these structures may either influence or be influenced by other performance  metrics. If a portfolio company carries debt, for instance, its loans might have covenants that are tied to things like the debt-to-EBITDA ratio. Or, if a venture-backed company raises new funding, that additional capital will likely impact its runway.

→ Learn more about startup metrics and KPIs.

Benchmarks

Many of these different metrics for portfolio monitoring would be meaningless in a vacuum. Private investors typically use various industry benchmarks as a way to compare the performance of their own funds and portfolio companies to the typical performance across the rest of the market. 

Industry-specific metrics

Depending on the industry within which a company operates, the typical metrics for success might look quite different. The expected churn rate in the SaaS industry, for instance, is lower than it is for a company selling consumer goods. When assessing performance, investors typically compare a portfolio company’s key metrics against the metrics of other companies in the same sector. 

Peer-group performance comparisons

In addition to sharing an industry, companies can be similar in many other ways, too, such as their size, their business model, their geographic location, or their level of funding. Comparing a company’s metrics to specific peer groups—for instance, other Series A fintech companies based in New York—can provide additional context and granularity to funds monitoring their portfolio performance. 

Exit valuation benchmarking

For most private investors, the ultimate purpose of investing in a private company is to achieve an exit and generate a positive financial return. As such, a fund manager typically keeps a close eye on other exit outcomes in the market and uses those outcomes as key points of comparison to help assess  whether potential exit prices for their own portfolio companies are in line with recent norms.

Fund-level benchmarking

Just as they compare the performance metrics from their portfolio companies against the metrics of other businesses, private investors also compare the performance of their funds against the metrics of other vehicles. 

As is the case at the company level, these fund-level benchmarks can be based on a number of variables, including the size of a fund, the types of investments the fund pursues, the industries in which the fund invests, and the fund vintage. Benchmarking figures can vary significantly across these different categories. For example, the performance benchmarks for a $10 million venture capital fund devoted to fintech deals that was raised in 2020 may look very different from the benchmarks for a $4 billion fund devoted to commercial real estate that was raised in 2012. 

Reporting and investor communication

One of the primary reasons that fund managers pay such close attention to portfolio monitoring is to ensure that they are able to provide accurate, up-to-date reporting to relevant stakeholders on how their investments are performing. 

Quarterly and annual reporting for LPs

It is standard practice for fund managers to provide detailed updates to their LPs once per quarter on the status of their portfolio performance. These quarterly reports may include updates on many of the statistics outlined earlier in this article, including fund-level metrics like IRR and TVPI and company-level metrics such as revenue and burn rate.

In addition, many fund managers also provide annual reports to their LPs that bring additional detail and context to the metrics found in quarterly reports. These annual updates might include audited financial statements, a summation of the past year, an outlook for the year to come, or other analyses. 

Transparency and compliance

Fund managers are often responsible for managing large sums of money that belong to other people—namely, their LPs. Maintaining a regular reporting schedule is a key way that fund managers develop trust in these LP relationships. An LP is typically more likely to invest additional capital with a fund manager if they feel confident in the transparency that the manager provides. 

Many LPs also have certain mandates around the types of funds in which they invest. And many funds have mandates of their own around the types of companies they’re able to back. Accurate portfolio monitoring helps fund managers make sure that both they and their LPs remain in compliance with these mandates, as well as with any relevant laws or regulations related to fund accounting, fund governance, or related subjects. 

Custom dashboards and real-time monitoring tools

Members of various teams within an investment firm might be responsible for compiling quarterly and annual performance reports, including individuals who work in investor relations, fund administration, and finance.

Historically, these reports have been built using information pulled together from various spreadsheets or other disparate sources of truth.  In recent years, however, a growing number of firms have begun to rely on real-time monitoring tools to maintain constant visibility into portfolio performance. In some cases, LPs might also be granted access to custom-built dashboards where they can access up-to-the-minute performance information on their own time, obviating some of the need for regular formal reports.

ASC 820 valuations

ASC 820 is an accounting standard used to determine the fair value of investments for reporting purposes. The fair value of an investment as defined by ASC 820 is similar to the fair market value of an investment as defined by Section 409A of the U.S. Internal Revenue Code, in the sense that they are both ways to assess the value of a private investment, but these two regulations approach the valuation process in different ways. The ASC 820 standard prioritizes quoted prices from recent transactions that have occurred on active markets. 

ASC 820 is part of the Generally Accepted Accounting Principles (GAAP) outlined by the Financial  Accounting Standards Board in the U.S. As such, it is considered the standard method of valuing private investments for the purposes of reporting those values to investors in a formal financial statement. 

Exit strategy monitoring and assessments

Throughout their ownership of a private company, most fund managers are constantly surveying the market for potential exit opportunities. Helping to strategize for and assess these potential opportunities is one of the primary aims of portfolio monitoring. 

IPOs, M&A, and secondary transactions

The most common exit pathways for private funds and their portfolio companies are initial public offerings (IPOs), mergers and acquisitions (M&A), and secondary transactions. Each of these pathways offers fund managers the opportunity to sell some or all of their position to a new owner and generate cash that they can then distribute to their LPs. 

Depending on a company’s financial performance and other key variables, it might be better suited for one of these exit types than for others. Portfolio monitoring can also influence the timing of an exit. For instance, if a company is far exceeding its financial expectations, then it might be able to expedite its exit timeline. 

Distribution waterfall models

A distribution waterfall model is a common tool used by investors and their portfolio companies to plan for the financial impact of a potential exit.

If a company has multiple stakeholders, those stakeholders might own different classes of shares or hold different rights to be paid out in the event of a liquidation. A distribution waterfall demonstrates the order in which the proceeds of an exit or other liquidity event would be distributed among these various levels of stakeholders, allowing investors to visualize the potential result of different exit outcomes at different valuations. 

Scenario modeling

Distribution waterfall modeling is one way that private investors project and plan for potential future outcomes for their portfolio companies, a broader practice that’s known as scenario modeling. When forecasting these future scenarios, firms typically consider a wide range of potential results, with the goal of remaining prepared for all reasonable potential outcomes. 

Investment firms often deploy a range of tools in their scenario modeling, including Excel spreadsheets, software that’s custom-built for the investment industry, and bespoke  financial models. Some of the variables that scenario modeling might account for include exit timing, exit pricing, valuation multiples, potential acquisition opportunities, and interest rates. 

Due diligence 

If and when a portfolio company begins negotiations around a possible exit, it’s likely that any potential buyers or other new investors will want access to the company’s latest financial information and other relevant operational details. With consistent portfolio monitoring, investment firms can have this information readily available to help facilitate the due diligence process and keep any potential transaction on track. 

Benefits of portfolio monitoring

In many cases, a VC or PE fund  will actively manage its portfolio for a decade or more before fully realizing all of its investments. There are several reasons that effective portfolio monitoring is a critical need for private investors throughout this period of company ownership. 

Decision making

At its crux, the purpose of portfolio monitoring as an investor is to ensure that you have comprehensive, accurate information about the current status of your investments in order to inform future decisions. Armed with better information, investors may be able to operate more confidently and make more effective decisions. 

Risk mitigation and management

Part of good decision making as a private investor is to manage your exposure to risk. Investors can use the insights gleaned from portfolio monitoring to maintain visibility into the status of their broader portfolios and be aware of any overly risky scenarios that might arise. 

Optimizing financial performance

The goal of operating a private investment fund is typically to generate the best financial return possible for one’s investors. Maintaining up-to-date knowledge of how a fund’s investments have progressed so far is often a key ingredient in trying to optimize financial performance in the future. 

LP relations

Most LPs desire transparency and timely information from fund managers. Accurate portfolio monitoring is the only way that a fund manager will be able to provide the level of timely detail that their LPs need. 

Effective portfolio company support 

Portfolio monitoring allows investors to stay up to date on any major developments at their portfolio companies, whether good or bad. Timely and effective monitoring can provide an early warning if a company is deviating from its goals and allow the fund manager time to work with the company’s executive team toward implementing any desired changes. 

Efficient portfolio monitoring from Carta

With a suite of tools designed to simplify fund operations, track performance, and streamline reporting, Carta is the most efficient way to manage and monitor a portfolio.

Here are some of the new features and functionality improvements on Carta's Fund Administration platform, designed to increase transparency and simplify LP reporting:

• Investments dashboard: Allows customers to track investments across their funds and analyze the performance of individual companies in more detail.

• Portfolio events feed: Helps investors stay up to date with recent activities and changes across their portfolio—such as equity issuances, updated valuations, and new funding rounds.

• Audit confirmation tool: Streamlines the annual audit confirmation process, so it's easier to keep up with compliance obligations and avoid costly delays.