At BFP we invest in early-stage emerging VC managers. Following our recent post about Seed to Series A graduation rates as a measure of performance, in this article we take a look at how LPs analyze track records and some key VC performance metrics beyond common multiples.
The reason why this is important is that, especially in the early stages of the life cycle of a fund, the most frequently used performance metrics (MOIC, TVPI, DPI, IRR) may not be very reliable. This is due to the fact that these multiples are used as standard metrics, but it is challenging to use them to compare funds that have different strategies in relation to:
- Reserve Strategy
- Deployment Pace
Hence it is key for emerging managers to understand how LPs assess track records and which other metrics provide a deeper level of understanding of the potential.
How LPs Evaluate Track Records
Generally, the key question that a LP is trying to answer when looking at a track record is whether the performance is the result of a systematic, repeatable approach or not. To do this, the analysis of the track record has four different layers:
Is the investment experience of the manager coherent with the new strategy? To check this, LPs will have a look at aspects such as:
- Amount deployed: Is it comparable with the fund size the manager is trying to raise?
- Attribution: Have the investments been sourced and/or led by the manager?
- Decision Making: What was the role of the manager in the IC?
- Stage: Is it similar to the stage focus of the new fund?
- Period: Is the timespan of the investment made still relevant?
- Strategy: Is it similar to the current focus?
- How does the performance compare with industry benchmarks?
- Is the fund mature enough for the multiples to be reliable?
- How are the multiples expected to change in the next quarters?
- What are the main drivers of the performance?
- How much do they contribute to the overall value?
- How many are they?
- What does the performance look like without them?
- How much of the fund can they return?
- Which milestones do they have to achieve to return the fund?
- How likely are they to become unicorns?
- How consistent is the performance across cycle?
- How have the top deals been sourced?
- What is the relationship with the portfolio founders?
- Is the performance driven by one big hit?
- What is the value composition of the performance by deal？
Which other VC performance metrics should LPs track?
Given the consideration made above, there are two groups of metrics that could be used to further assess the performance: fund level metrics and portfolio level metrics.
Fund Level Metrics
Fund level VC performance metrics refer to the fund as an aggregate and represent a macro view of the performance:
Graduation Rate: we wrote an article on the Seed to Series A graduation rate recently, at the same time, opposite to the graduation rate, it is interesting to consider the ratio between the companies that have not raised a follow-on round and the total number of companies in one year. This metric is particularly important for LPs in the Chinese market.
Hit Rate: Number of winners / Number of Deals
- The hit rate is a way to evaluate the picking skills of the manager.
- A high hit rate does not guarantee a strong performance as in VC it is not enough to select great companies, but also to invest a good allocation in them
- The critical aspect is to define what winners are and for this there is no standard definition. For instance, a deal can be defined as a winner if
- The valuation of the company is $1b+
- The multiple of the invested amount is higher than 10x
- The deal is returning 1x the fund
MOIC & TVPI progression
- It is quite interesting to check how the multiples are evolving over time. The purpose of this is to identify early potential inflection points, which for LPs can be a great way to both invest in underrated managers and buy secondary stakes.
- In this exercise, it is crucial to take into account the nature of the underlying assets. For instance, the TVPI progression of deep tech funds is usually slower than traditional software funds, due to the fact that deep tech companies have longer product development cycles. Consequently, the inflection point of the J-Curve for deep tech fund will be achieved later.
MOIC & TVPI without top and bottom investments
- This is one of the most useful metrics to assess the repeatability of the track record.
- Basically, if the performance holds without the top performers, then this signals a systematic approach.
- A very simple investment strategy for fund allocators could be simply to filter funds based on TVPI and TVPI without top drivers.
Value Contribution of top investments
- Typically the top drivers should return each at least 1x the fund.
- The higher the value contribution of top investments, the higher the sustainability of that performance is.
To explain this concept, let’s imagine a VC fund whose performance is driven by many small multiples. In this case, the value of the fund does not rely on an established, mature company, but on many small startups which potentially could all be written off. This is what typically happen in accelerators, that invest extremely early and achieve high markups in a short time (e.g. when the companies raise a seed round), but such markups could eventually not be sustained in the future, as early stage companies could fail.
Ownership by dollar invested
- We believe that at seed stage, ownership matters. It is important to track the ownership per dollar and entry valuations.
- Number of Deals with Top Co-investors
- On a qualitative basis, strong co-investors or follow-on investors are a signal of the quality of a deal.
- How many founders come from underrepresented groups?
- Which experiences do they have?
- What is their educational background?
- Are they all second time founders?
- All these metrics help the LPs understand if the fund has a sustainability / diversity angle and how they are executing on that
VC Performance Metrics: Portfolio level
Portfolio level metrics provide an overview of the performance of the managers from the perspective of the results of the underlying assets. The concept is basically to assess bottom-up the market value of the portfolio, especially of the top companies as they will determine the performance of the overall fund. Some examples of the main metrics that LPs look at are:
- Overall level: Sum of the revenue of all portfolio companies
- Value Drivers: Revenue of the top companies Growth: For both metrics mentioned above, LPs will check the growth on a monthly, quarterly and annual basis.
- Ownership: Does the manager have significant ownership in the value drivers?
- Runaway: What is the liquidity situation of the portfolio? Which companies are at risk?
- Cash burnt: How capital efficient is the portfolio?
At the very end, investing in emerging managers can be a science as much as an art. The track record is only a small part of a larger evaluation. However, we hope this article can guide young GPs to better prepared themselves in their fundraising discussions.