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The art behind building a successful venture capital fund portfolio

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Having a clear investment thesis, picking strong teams with large addressable markets, and spreading risk effectively are key aspects towards building a successful venture capital fund portfolio, say leading African tech investors.

For the latest episode of Disrupt Podcast’s “The month in VC” series, produced in partnership with Katapult Africa, Kalon Venture Partners, Hlayisani Capital, and ARM Labs Lagos Techstars Accelerator we discussed the mechanics of putting together a portfolio.

Key to building a strong portfolio is having a clear investment thesis, says Philip Gasaatura of Katapult Africa.

“Your investment thesis or strategy is your “why?”. Having that is saying “this is what we are about”,” he said.

Brett Commaille of Hlayisani Capital agrees with Philip on the importance of a thesis.

“It is critical. You can be broad in many aspects but to add value you really do need some commonality between your businesses, whether that is stage, or you focus on a certain sector, or you focus on a certain type of entrepreneur, there are many things that you can use as the key part of your thesis,” he said. 

“But that’s the thing that allows you to be efficient from a team perspective because you build your team to deliver value around that thesis. And you are evaluated against that thesis. If your fund is really to broad and goes all over the place then there’s a good chance that you end up struggling to add the right kind of value to your businesses, and to be efficient from what is generally a very small VC team.”

There are some general expectations many VCs have – especially those in more developed markets – when it comes to how their portfolio is going to shape up – one huge success story that returns the fund, a handful do pretty well, a handful perform averagely, and a handful fail. But Gasaatura says it is important not to think that way from the beginning.

“Every startup that you invest in is a potential exit, and how can you best support them to get there. Companies on the continent are different to those in Europe and the US where the ecosystem is much more mature. Here there is a bit more to do to see them get to the end, because you want the entrepreneur themselves to also benefit just as much as you do,” he said.

Commaille also pleads caution when it comes to these types of expectations.

“We are certainly not on the American side where we have one investment that returns 100 times, seven failed completely and two or three “walking dead”. Because the American markets are far more liquid, the return multiples that you get are potential far higher, so we need to have a slightly more balanced approach. At the stage we invest in we don’t have that many failures – failures are possible, but far less likely. We do have more businesses that are likely to perform at an average level, and just be a decent business. But the bulk of our businesses gain value,” he said. 

“The question is can we find two or three that really perform well, and that can be 10 times money back or more. That’s the key that we would like to do, and depending which one of the investments, and how large your investment is, you could end up paying back your fund from that investment. So getting your success metrics right in your fund is really key for both your investors and your fund manager to do well from that fund.”

Clive Butkow of Kalon Venture Partners is in agreement that Africa-focused VC firms don’t have the luxury of assuming one or two companies are going to return the fund.

“If you can get two home runs and get 100 times return on capital then that would be more than enough in getting our investors their 30 to 38 per cent IRR, but typically we don’t want eight to fail and two to succeed. We at least want to get to second or third base on most of the companies, where we can get a two or three times return on capital, with at least two of them having an absolute blinder,” he said.

That said, then, what are the key things a VC is looking for when it comes to investing? Gasaatura says there are three of them, starting with team.

“You are looking at the founding team, how they know that industry, how well they know themselves. Are they the team that you believe can get themselves to a Series A. But beyond that it is also about route to market. Is there a potential market outside their home market? Because sometimes you find that a lot of startups that you have invested in at early stage will most likely stay in their home market, so the larger the market the better,” he said.

“The third one we look at is the potential for job creation, and those that have been helped by this startup being invested in.”

Commaille says Hlayisani looks for startups that are solving for a real need in a large potential market, but agrees team is crucial.

“This is a market that needs to grow – if you don’t have it domestically then it needs to be a problem that is experienced by multiple markets. We then look at the solution and make sure that it is a scalable solution for each of these markets and that it can go beyond the borders of just South Africa or whichever starter market that is. We obviously want a really solid business model, which means you have to make money from addressing that need, and you need to demonstrate how you can make money,” he said.

“The most important part of all of this is the team, and actually understanding who is going to be putting this entire business model into play. And we are looking for the exceptional. Building businesses is incredibly difficult so we are looking for people that are experienced, resilient, tough, and who just have that something extra that gives us the confidence to know that through all the setbacks they are going to keep pushing.”

How does a VC go about spreading risk? Most take a portfolio approach, which Commaille says means not putting too much of any one fund into one investment.

“We’ve got limits on how much we can do. We also like to spread things in terms of the kinds of investments we do – in a couple of different sectors, or within the businesses making sure we’re not overly exposed within just one market. We like to get variation,” he said. 

“We also invest very often on a milestone approach, which means we provide an amount of funds to reach a certain milestone or goal, whether that is revenue or new market or product, and then we provide the next amount of funding. That just gives us an ability to, if something is wrong or failing, press pause, and then we still have funds to support the company in looking at a new market if we don’t use up everything on something that may not be the right approach.”

Butkow says Kalon also follows the portfolio theory, as well as getting its hands dirty.

“We’ll have some early stage, some late stage, and some going into the growth stage. Obviously it is higher risk the earlier you go in, but that’s where we roll up our sleeves and help the teams get to the scale-up, to minimise that risk. We see ourselves as the entrepreneurs behind the entrepreneurs.”

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