Portfolio construction trends and best practices with CEO Anubhav Srivastava of Tactyc

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Khaji, and this week we're joined by Anubhav Srivastava, founder and CEO of Tactic. Tactic is a next generation platform for VCs to build and forecast portfolios. Anyone who's listened to this show before knows that portfolio construction is one of the things I really like talking about. And Anubhav provided his data-driven insights on what he's seeing on how emerging managers are modeling portfolios around things like the number of companies, reserves, recycling, and follow-ons.

0:31We really hope you enjoyed my conversation with him. This episode is being brought to you by Grasshopper Bank. Privately owned and headquartered in New York City, Grasshopper Bank is built to serve the business and innovation economy. As a client-first digital bank, Grasshopper combines technology and years of industry expertise to provide clients with a best-in-class banking experience. Grasshopper's digital solutions are tailored for venture capital and private equity firms, startups, and small businesses. In addition, they also work closely with fintech-focused banking as a service and commercial API banking platforms.

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1:50Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Anubhav, it's so great to see you. And there's so much to talk about in this year, given all the turbulence we've seen in the market. You see a lot of data and work with so many emerging manager. So I'm excited to really dig in to this conversation. But maybe a good place to start is what Tactic is and what really inspired the start of the company.

2:26Thank you. Yeah, I'm a big fan of the podcast and everything you do, Samir. So thank you so much for having me. Tactic is the first forecasting and planning software for VCs. So what that means is if you are looking to raise a fund and you want to do a portfolio construction exercise, you can use Tactic to build a fund model in about 10 minutes. saves you weeks worth of time. It's a market-tested model that you can then share with your LPs. That's just a start, though. After you build a fund model and tactic, you can upload your actual portfolio investments. You can do your standard portfolio management.

2:58But now there's a layer of forecasting on top of it. So we will help you think through reserve analysis, probabilistic investment outcomes. What does your TVPI look like, not just to date, but what it might look like 12 months from now, 36 months from now? What we're really doing is we're disrupting the traditional portfolio management space. Funny enough, VCs invest in the forefront of pretty much every technology out there. But if you look at the VC tech stack on its own, it's incredibly archaic. It hasn't changed in about two decades. And I would say traditional portfolio management tools are, for lack of a better term, mostly bean counting.

3:37They're just tracking what we've done. And I think LPs are demanding a lot more. And I'm sure we'll talk about this. They're demanding a lot more data-driven methodologies. And that's what we're enabling GPs to do. In terms of my own experience, I'm a Wharton MBA, worked on Wall Street for a few years, worked at a VC myself in LA for five years. All of that to say, I probably spend more time than is healthy for anyone to spend in Excel and in spreadsheets. And so this was a pain point I saw. And we had first released Tactic as a general financial modeling tool. but uh the the most popular use case ended up being venture portfolio construction we just we just blew up we had gps reaching out to us saying how do we use your tool to do portfolio construction for my fund and that's what led us to actually pivot into building a tool specifically for gps we we did a study or a survey rather on twitter a while back of what what stack people are using and one thing that was a staple in everybody's stack was excel in fact most of the portfolio management and portfolio construction strategies that we've seen have all been done through like Google Sheets or Excel, and that's how people do it.

4:46Portfolio construction can be very dynamic and it changes. And every time you make an investment, your reserves. Tell us a little bit about some of the problems. You mentioned you were at a venture firm for five years, presumably using one of those rudimentary, archaic ways of doing portfolio construction. What did you see as the major pain point? And why is portfolio construction in your mind so important to do through a tool like this? There's a lot to unpack there. So yes, I did portfolio construction in Excel, like pretty much every GP before me. And there's nothing inherently wrong with that approach.

5:20I just want to be very clear. It doesn't matter what tool you use. You can use Tactic, you can use your Excel. At the end of the day, it's a process that's more important than the tool you use. What I've realized is portfolio construction models were viewed as, one, a necessary evil, like, oh, I just got to get through this because I have to show my LPs this. And then two, once your fund is launched and you've actually started deploying, that Excel model would never see the light of day again. It was just this theoretical exercise that people would just put away. We started working with some incredibly data-driven managers, and we saw that that's not how they viewed the world.

5:55That's not how they used the construction process. So one, they would invest a lot of time stress testing their construction model. So just the process of building a model was much more rigorous. And then two, the construction model actually tied back in with active portfolio management. So one year after your fund is launched, they would actually look back at the construction model and see, OK, how are we tracking to our reserves? How are we tracking to our TVPI? How are we tracking on pacing? And if not, has the market evolved? Are we over-investing, under-investing? And that actually creates this powerful feedback loop where they would then start changing their strategy in response to what the market was saying.

6:32And they would rebuild their construction plan again. So construction was not just the static one-off activity. It was this constantly evolving process that would actually carry through the lifecycle of the fund. We were incredibly impressed by the returns of these managers and the way they had this data-driven workflow. But they had a team of people doing this. This is not possible or this is not practical for most emerging managers to be doing that because you don't have an army of associates running around doing this stuff. So we actually crystallized this exact workflow into Tactic. So you can build that construction plan.

7:05You can then have this feedback loop that ties back together with how should you change your active deployment process? What should your new construction strategy be? And that's what we crystallized in the software so every GP can be empowered. Since you mentioned the empowerment of GPs, I want to shift to maybe the other side of the table and look at the limited partners. Things have obviously changed so much over the last year and a half, really stemming back to November of 2021, when we started to see the first signs of the macro picture having some level of dislocation. And today we're in a world where raising a fund is exponentially harder than it's been a long time.

7:47especially if you're a fund one and fund two. Since you sit in the intersection of LPs and GPs, with the information and the empowerment that you're giving GPs, I'm curious if you've seen any change in the LP behavior as it relates to the type of information they're asking for, especially when it comes to things like portfolio construction. We get feedback from LPs in a variety of ways. I just want to say up front, first of all, we hear it from the GPs themselves. They come back to us saying, hey, my LP is asking for this analysis or this question. How do I answer that with Tactic? And then sometimes we hear from LPs directly who have been given access to Tactic, and then they ask us those questions.

8:27So here's what I'm seeing, and I will say a lot of this is, I would say, generalized, anecdotal, but I'll put it out there. We're seeing, first of all, fundraising velocity is actually not that dissimilar to what it was at the start of the year. Maybe that's specific to Tactic's data set, but just to give you some stats, on average, we see about 70 to 80 new funds being modeled on the platform every month. That number is actually still the same. If anything, it's actually even slightly higher. But the distribution of that is very different. So if you are a first time emerging manager, in January, you might have been thinking about raising maybe, you were contemplating maybe raising$100 million,$70 million.

9:08You are no longer doing that. Now that number has been downsized to, let's say, 40 million, 50 million. And those GPs are resigned to the fact that we're going to be raising for the next couple of years. We're going to try and see through this downturn. On the flip side, if you're an established manager who's on fund two or three and has a reasonable TVPI, if you have a DPI, that's great. But I mean, that's still some ways away. But if you have a reasonable TVPI, you're having an easier time raising funds. So, you know, 83 % of LP capital this year has gone to 7 % of managers. That's a scary statistic.

9:46And so where is that capital going? It's going towards where there is an established track record, where we can back this because they've done this before. We don't want to increase our risk profile. So we're actually seeing a reasonable strength and resiliency when it comes to sort of the established manager on their$200 million,$300 million fund. But it's the emerging manager. That's really where I think the bottom has completely fallen off. And I think there's actually more pain to come at that point. So that's where we see, I would say, it's sort of an interesting story, but there are two different stories that are happening in the market, I think.

10:18you're hitting on this general shift of investors moving to a risk-off posture, and that's across all asset categories within VC. That's resulted in fewer allocations, smaller allocations, and then maybe an inclination toward backing more established managers versus emerging funds, which, of course, we think, and I think you would agree with me, that emerging managers are a critical part of the early-stage funding ecosystem. With all the GPs that you've worked with, have there been any commonalities of the GPs that have been successful raising this climate? And this is, again, a very general anecdotal stat, but I've seen multi-sector GPs fare better than single sector specific.

11:05And that's, I think, maybe coming down from the LPs as well. So if you're focused on a single sector, if that ended up being crypto or blockchain, that's obviously an edge case. But even if you're focused just on, let's say, health tech or just fintech, even those GPs are having a tougher time as opposed to more generalist, diversified GPs. So I think there's a sector play here as well. LPs are looking to diversify which sectors their assets are invested in. Secondly, I think what these LPs are looking for is clarity of execution. And by that, I mean the GP needs to be very clear in terms of what that fund strategy is around reserves, around check sizes.

11:40And let me unpack that a little bit. just in general, when it comes to emerging managers, they fit in sort of two buckets. There's either funds that have less than 15 % reserves or funds that have, I would say, 50, 55 % reserves. Those are the two diametrically opposite spokes that you see when it comes to reserve strategies. If you are a less than$50 million fund, you usually fall into that first bucket. If you're a greater than$50 million, let's say$100 million fund, you kind of tend to fall in the second bucket. Eventually, they're both solving for the same thing, which is a critical point of about 35 to 55 deals.

12:17That seems to be the point, that seems to be the ideal portfolio size people are solving for. And this obviously eventually cascades down into your check sizes. So sub$50 million funds are looking to invest 500k checks into pre-seed or seed companies. They're trying to get to a 5 % watermark of ownership. A$100 million fund is usually looking to get to a 10%, sometimes maybe even 15 % ownerships. All of that to say, GPs need to be very clear in which path they're doing. So we've seen some GPs kind of muddy the waters a little bit. Hey, we're going to be at 35 % reserve with about a 30 % portfolio company, check sizes, somewhere in the middle.

12:56They tend to sort of struggle because then LPs, I think, struggle with where in the risk profile do I put you at? So we're seeing that LPs are demanding sort of clarity of thought in terms of what your strategy looks like around reserves, around check sizes. So then you can, you know, you can execute based on that. Because many of your managers, I would assume that the bulk of the managers, especially the emerging or the entry point is somewhere in the seed spectrum, pre-seed, seed, post-seed, many of them may be modeling something different than what they did earlier this year in terms of valuation.

13:28Now, series B, C, and D, we've seen Cooley's report just came out. You saw massive devaluation, those rounds series a same thing, maybe not to maybe to a lesser extent than the late stage seed. It seems like it really depends. We're still seeing some rounds done at a$25 million note, right? Or a$25 million post money safe. And then you're, you're seeing some that are done in the single digits, depending on, you know, the background of the entrepreneur, the company, the location of the company, What are you seeing trendline-wise in terms of how people are modeling their portfolios in terms of initial valuation at the pre-seed seed level today versus maybe 10 months ago?

14:09So one we're seeing actually, funny enough, initial valuation is one thing, but the other thing we're seeing is liquidation preferences coming back into play. So I think we're seeing more term sheets going out when they prefs, even at the seed stage. And that may be a counter to the valuation. So valuations are definitely coming down. We're definitely seeing in terms of modeling about 15 % to 20 % discounts. Again, this is highly sector specific. We've seen blockchain and crypto on our portfolio sometimes marked down by 60, 80 percent in terms of valuations for what they're seeing, what they expect to be the next 12 months to look like.

14:44But in general, I would say it's about a 15 to 20 percent decrease in valuation. And with LICPREFs coming into play, I think they're looking to offset that valuation risk with a little bit of downside protection. Let's talk about that for a second. So when you say liquidation preferences, not just the 1x, you're talking about a multiple liquidation preference above a 1x? Yeah, we're just starting to see that. I mean, I've had more funds, as a funny thing, I've had more funds ask me about how to deal with liquidation preferences and tactic in the last month than the last 11 months combined. And people are asking not just for 1x, but 2x liquid prep.

15:17So we're starting to see a lot more of that. But if I had to guess, I think that's going to be even more in the next quarter. You know, at the early stages, companies in general shouldn't take more than a 1x. I'd rather take a lower safe or a lower valuation. Yeah, I'm with you. I completely agree with you. Yeah. What else are you seeing, I guess, from a trendline standpoint from a reserves? Because the markets have changed. Now it's not as easy to go from C to Series A, Series A to Series B. oftentimes in these situations, you have companies that are going to have to hit more milestones to get to the next level of capital.

15:51Has there been any changes in terms of either the check sizing or what people are factoring in terms of dilution for companies given the changed environment? A couple of things that we're seeing. First of all, so in tactic, you can actually put a graduation rate on every single deal. So you can say, what's my conviction level that I believe this company is going to go on to the next round? And over time, you can actually come back and change that conviction level based on the company's performance or based on the market. Across the board, conviction levels of these graduation rates have also fallen down by about 20%.

16:27So folks are saying that my companies are going to have a harder time raising that next round. If they were to raise the next round, the round size is probably going to have to be smaller. So that's obviously something you would expect. The other thing we're starting to see is partial exits. So folks are already starting. If you've had some DPI or some reasonable TVPI, I should say, folks are starting to already put into place mechanisms to do a partial exit to realize, convert some of that RVPI into DPI. We're seeing a lot more of that happening. This is obviously happening for funds with vintages in, I would say, 2018, 2019, because you've had a reasonable runway to collect that RVPI.

17:05but that's definitely something we're seeing. Reserve side, we've seen a slowdown of reserve deployment and this may be across the board, but we had a lot of, a lot of our clients have reserve capital for their deals and then they just never did it. They just never quite deployed as much as they wanted to. Now, maybe that's a sign of like, let's just see how the market shakes out. Let's revisit this six months from now and see how much we want to reinvest in. But we've seen a lot of reserve just sitting there and not being deployed. And again, that may be one of those things where that might change next quarter.

17:38They're waiting for a better round. But even in the following side, we've seen a lot of reserve just sitting. It could be a function of the time between rounds being significantly longer than what we saw in 2020 and 21. Certainly where in certain cases, we were seeing rounds that were spaced out no more than six months, feed to series A. And it does seem like we've normalized that to something that we've historically seen closer to 12 to 18 months. That's true. That's true. The other thing I would just, if I can just add one more point there, when it comes to reserve strategy, I think earlier there was a de facto, there was a de facto decision that if we invest in the seed, we are going to follow on in the A, if we are a reserve deploying fund.

18:21That was just meant to be like understood. That's no longer the case. We're now starting to see GPs actually look into what KPIs are we tracking for this company? How does their cash flow, how does their runway look? How does their operating metrics look? How do their ARR look? What is the trend line on that? So taking a deeper look into those actual operating metrics to inform that reserve decision-making process. We didn't see this, I would say, you know, nine months ago even. People were collecting all this data, but they were not acting upon it. And I think now they're actually taking a look at all of this operating KPI data they've collected and using that as a decision-making process for the reserves.

18:56Something I've always been curious about is whether there is an ideal portfolio construction for sub$100 million seed funds. And there's so many different flavors, a lot of companies lower ownership, there's fewer companies with high ownership, there's no reserves, there's high reserves. And I'd love to hear, given all the data that you've seen from the fund managers, have you seen anything that has understanding that we're not talking about DPI, but overall TVPI. Has there been anything that you've observed that has lent itself to higher return performance? So I have a pretty firm opinion on this, and this is based solely on what I've seen in our portfolios work through.

19:42And that is that I think the most important metric a sub$50 million fund should be solving for is the size of your portfolio, number of deals you can do. I think if you're a seed or a pre-seed fund, and if you're looking to make 20 investments, that's too low a number. This is still a power law curve. And so you're still looking for that return the fund. You're still looking for that one or two deals that can make an entire portfolio. And that's just the risk nature is high in the pre-seed seed levels. The only way to spread that risk out is to have a critical mass of the number of deals you can do.

20:14Now, that does not mean that you show your diligence level should be lower, you should be letting more deals in. It doesn't mean that, but it just means that the volume needs to be high enough that it can sustain a portfolio of at least 35 companies. That's what we've seen. If not higher, frankly, closer to 50 companies. Where we have seen concentration and greater ownerships, that's usually a conversation for funds that are larger than 70 million, touching 100 million. That's when you're starting to get into, I want a 10 % ownership, on information rights on all this stuff. But if you're a pre-seed seed fund, you should just be solving for, in my opinion, you should just be solving for number of deals as that gives you the greatest likelihood of actually getting, snagging one or two return the funds.

20:59If you look at a lot of the funds that have been raised the past several years, a large majority have raised a small amount of dollars, meaning that the numbers are high in terms of the new emerging managers, but many are raising these funds that are 5, 10, 15, $20 million, which many would refer as nano funds. With those, it sounds like what you're saying is, if I have this right, more companies, perhaps low ownership, but a little bit more flexibility of being on the cap table without having to be a lead. Is that something that you've seen consistently across? A couple of things that we've seen here.

21:34If you are, as you said, like I said, a nano fund, which let's define that as a sub$15 million fund or$20 million fund. Here's what your strategy looks like today. You are solving for about 25 to 30 investments, which means you're probably going to be doing pre-seed or seed checks of 250k to maybe 500k checks. Follow-on strategy, we've actually seen a couple of things. You could try and do this out of this same vehicle, but we've also seen these opportunity funds come through. We've seen SPVs come through there, where you're saying, you know what, my$15 million nano fund vehicle is only going to be an initial investment vehicle.

22:07As and when these companies raise a follow-on, we're going to do that with SPVs or with an opportunity fund. And that may be a separate conversation, but we've seen this very commonly. And I think that works well. It especially works well if your LP classes are similar. So then you can provide a comprehensive view across both those vehicles. But your check strategy looks 250 to 500K on the initial check size. Follow-on, you're following on about half the time. You're not following on everything. You're following on about 50 % of the time. And your follow-on check size is to maintain your prorata.

22:37That's it. You're following on for the next one round to maintain your pro rata, which ends up being about another 300 to 400k of check for that next round that you're doing. That, by the way, with those parameters, you're probably talking about a 40 % reserve ratio already if you have a reasonably high graduation rate. So it depends, again, on where you're following in the spectrum of pre-seed, seed, and series A. But in general parameters, that's what we've seen. And when you say, just to clarify, when you say 50 % follow-on rate, is it 50 % of the opportunities that have graduated to, let's say, a Series A?

23:12That's correct. What are you finding, I guess, in those scenarios that are driving those decisions to follow-on or not? Now, of course, there's things that you're not aware of that are very qualitative about the company, the performance. Is there anything that you can extract from a valuation standpoint that's driven any level of decision-making on those follow-ons? Great question. And this is something we've worked really hard to quantify this decision-making process. So going back to what I was talking earlier, when we looked at those really successful managers and how they were doing this, first of all, they were taking emotions out of the equation when it comes to the follow-on reserve sizing.

23:49So follow-on decision-making is one of those things where we've seen a lot of non-quantitative factors come into play. Hey, we really like this founder. We really like the team that they're doing. We love this space. so let's just go along with it. That process can sometimes cloud your judgment on whether or not to do the follow-on. So what we've seen, a quantitative workflow, here's what that looks like. One, when that decision point comes, you kind of do another thesis. You do another diligence. Is this company still on track? Is our original thesis intact? If it's not, if the company has pivoted, are we on board with that new thesis?

24:27Is the TAM still big enough? Is the eventual likely exit still big enough. So they still compute what an eventual exit looks like in relation to the new TAM. And if that number pencils out, then there's a second question like, okay, how much should we invest in this follow-on? Should we invest all the way? Should we invest half the way? And that depends on what step up or the valuation of the next round looks like. But the key thing to note is that you want to do another re-evaluation of the company and its potential journey ahead at that point of the follow-on. Around pre-seed and seed, you get a lot of pivots.