A shortened version of this article first appeared in Forbes.
Market downturns can be a paradox in venture capital and private equity circles. Historically, they have presented some of the biggest venture opportunities and most iconic venture returns. It’s a time where smart and bold investments can pay off big. But it also means risk and uncertainty for portfolio companies—especially those that haven’t lived through a downturn before.
Investors must be dual-focused during market downturns. They need to ensure that their big fish investments are supported and managed properly through choppy economic waters, while also having an ear to the ground for good investments with strong upside potential.
This article discusses the first priority—why strong portfolio management is critical right now—and how firms can set their founders up for success.
Why is portfolio company management important in an economic downturn?
For many founders and young management teams, this will be their first time navigating a prolonged economic downturn. They require coaching and guidance to ensure they can manage the many pressures they will face for the unforeseeable future.
Many companies are struggling with higher prices for goods and services, rising interest rates, staffing shortages and retainment issues, lower consumer and business spend and, as a result, tighter budgets. In short, many portfolio companies—especially those in earlier funding rounds—are focused on remaining solvent and above water.
“Founders need to figure out how they’ll get to cash flow positive and break even with the cash they have in the bank now,” explains Danielle Graham, co-founder of The Firehood and General Partner at Phoenix Fire. She recommends that startups revisit their plans, review their operations, and evaluate every single dollar they are spending through conversations with their co-founders and investors.
That formula helped create some of today’s most successful companies during the 2008 recession, including Uber, Lyft, Pinterest, Snowflake, Slack, and Square. All of these companies identified and seized significant market opportunities during a downturn, while also staying financially and operationally disciplined.
This is where strong portfolio management is critical. While founders and management teams remain focused on keeping their business afloat, investors are in a position to provide guidance and market insights. This 10,000 foot strategic perch allows them to coach portfolio companies toward operational efficiency and discipline, and also watch the market to identify potential competitive advantages, investment opportunities, and strategic hires for their founders.
“We think more broadly about the entire portfolio [during a downturn],” adds Graham. “That’s instead of each partner on the fund thinking about their individual companies. This elevates our team’s view and thinking beyond ‘your deal versus my deal’ and helps to build a more holistic portfolio perspective.”
This dual focus on high-level strategy and hands-on coaching is only possible with strong portfolio management processes in place. The best investors—those that will come out on top through uncertain times—have the operational talent required to help their portfolio companies pivot and streamline. And they have the foresight and processes in place to coach and guide companies through strategic shifts and toward market opportunities. Together, the result is proactive portfolio management that helps to create strong, capitalized, and agile companies that can withstand and thrive during a downturn.
What strong portfolio company management looks like in a changing market
Strong portfolio company management boils down to operational and strategic guidance. And that can be broken down further into four key activities that collectively make up a strong portfolio management strategy.
1. Confront hard realities and communicate proactively
When it comes to communication, proactivity is key. Investors should be asking their portfolio companies the hard questions—in thoughtful, collaborative ways—rather than turning a blind eye to how founders and management teams are adjusting their strategies to meet market uncertainties.
Kevin Zhang, Partner at Bain Capital, expects his team to double down on systems and processes to streamline their communication strategies with portfolio companies. This is driven both by a necessity to be more hands on, and due to more time being freed up from a slowing investment market.
“I feel like we have more time to think about how we can create more scalable systems for having touchpoints with people in our ecosystems that we care about,” explains Zhang. Examples of these systems include a portfolio company newsletter, events, and more consistent founder conversations.
The type of communication you have with portfolio companies during a downturn is also important, adds Zhang.
“From a portfolio management standpoint, and working with our founders and teams, I think we have to be honest about where the next round of funding might come from, what milestones we have to achieve, and the dollars we’ve raised to date,” he explains.
Communication, therefore, doesn’t need to just be regular. It also has to be transparent and speak to the challenges that everyone is facing in today’s market.
2. Ensure sustainable business models
During an economic downturn, companies need to get back to the fundamentals of running their businesses effectively. That means shifting focus from a high-cost, high-growth strategy to customer success and retention, churn reduction, and sustainable revenue generation.
“All companies need to adjust to become more resilient by building up a war chest and tapping into their in-house talent so that they have contingency plans in place,” explains Ameet Mehta, Founder and Partner at FirstPrinciples.
Recessions have a tendency to weed out companies with unsustainable business models and short cashflow runways. To survive, companies need to be operationally efficient, and be able to tighten their belts in key areas like controlling expenses, managing cash flow, and building sustainable unit economics.
“Besides having a sustainable business model, being lean is the best way to survive,” explains Colin Keeley, Founder of Indie PE.
What does being lean mean in 2023?
“Manage cash and runway, make the necessary cuts, hire with more caution, and be aware that there is less likelihood of follow-on funding in the near term,” says Graham. “We recommend that founders consider holding off on follow-on funding to avoid lower valuations or potential down rounds.”
Coaching on operational efficiencies and fundraising are critical during a downturn. Portfolio management plays an important role in helping companies transition from an era of cheap money and high risk-taking to one of austerity and lean management. Investors that prioritize hands-on coaching will help their founders navigate this transition.
3. Watch out for market opportunities
While portfolio companies focus on streamlining operations, investors can play a pivotal role in ensuring that, when opportunities do arise for smart investments, founders are well positioned to seize them.
Historically, fewer companies take leaps into new markets or products during economic downturns. Instead, they retreat and focus on their core business model and customer pool. This shrinks the competitive landscape, opening opportunities for bold companies with strong financial backing and operations.
Apart from the initial monetary investment in the company, this is the biggest value that investors can offer a founder. While founders stay laser-focused on ensuring that their business runs smoothly, investors can employ a long-term market analysis and investment strategy that helps portfolio companies build for the future by seizing market opportunities that others are afraid to jump on.
There are many ways to do this from a portfolio management perspective. The most popular include:
- Offering access to a network of service providers, subject matter experts, market analysts and financial institutions. This ensures that portfolio companies have all the resources they need both operationally and financially to identify and seize new market opportunities.
- Turning to that same network to make introductions that support business development in portfolio companies through closing key deals, hiring leaders and top talent and further fundraising.
- Leaning into the expertise of investors who are ex-founders or ex-operators who have taken companies through downturns. These individuals should be hands-on with giving founders advice on planning their financial, go-to-market and product strategies.
In all cases, the goal is to ensure that the portfolio company is supported operationally and financially so that they can make smart investments to grow—regardless of what the wider economy is doing.
4. Getting the tech stack in order
The venture capital feeding frenzy of 2021 has ended. The changing economic climate has altered the tempo at which most investors close new deals, freeing more time for relationship management and getting their houses in order operationally.
“As VCs, in 2023, we won’t need to move as fast to close a deal,” explains Graham.
During this slow period, it’s critical that platform leaders take the time to get their tech stack in order. And a strong CRM should be right at the top of the priority list for firms who are serious about strong portfolio management.
Ensuring strong communication, operational support, and investment guidance across a large portfolio of companies—both on a one-to-one and one-to-many basis—is no easy feat. To do it effectively, investors need a strong relationship intelligence CRM that can reliably deliver relationship insights, automated outreach to company contacts, and reminders to regularly engage with portfolio companies.
Bain Capital, for example, is planning to collect and analyze more data this year to keep tabs on companies that show strong performance through economic headwinds.
“You may see us incorporate more data-driven signals about companies into our pipeline management to highlight companies that show a spike in their core business performance,” explains Zhang.
To do so, Bain Capital is leveraging Affinity CRM as their core data and workflow hub. It’s a place where their team can collaborate and share data about their portfolio companies, thereby tailoring their management and outreach practices more effectively.
Managing portfolio companies in an economic downturn requires a different mindset than during boom times. Investors need to look inward and find ways to leverage their internal resources and technologies to help their portfolio companies survive and thrive.