Effective risk management practices at a venture capital firm can translate into millions—and even billions—of dollars in profits. On the other hand, ineffective risk management strategies can be both a disaster for the VC firm and its portfolio companies. Major areas of risk in venture capital (and questions typically asked by risk professionals when assessing risk) include:
- Technology: Are there research and development issues that may delay the launch of the company? Does the company have strong Information Technology security protocols in place that protect its intellectual assets?
- Disruption: Are there any unforeseeable events (e.g., a recession, a sudden spike in the cost of energy, etc.) that could doom or delay the introduction of the product?
- Market: What is the market for the product or service like? Are there many competitors? If there’s a lot of competition, is there time to build market share before funding runs out? Is it the right time to launch the product or service (i.e., many products or services that are successfully launched today might not have been successful a decade ago)? Are there other major barriers to entry?
- Financial: Will the portfolio company have enough capital to reach the end stage of selling the product or service—allowing the VC firm to profitably exit the investment? Are the unit economics (the direct revenues and costs associated with the business model for the product or service) feasible? What is the overall financial condition of the company? Are strong accounting and auditing practices in place?
- Management: Does the portfolio company employ the right people to ensure that it will meet its goals? Do the founders have a strong track record of success? Is the company’s management receptive to feedback? Is it transparent about its financials and staffing issues? If the VC firm deems that changes are needed, are the company’s founders amenable to bringing on experts, as needed?
- Legal: How will government regulation affect the company and its products and services? Are there any potential patent or copyright infringement issues?
Major duties of venture capital risk managers include:
- identifying, analyzing, assessing, and ranking all risks by using the scorecard method (which uses a mathematical formula to assess and identify the top areas of concern), software models, and other tools
- working with financial professionals to conduct a complete audit of the target portfolio company to assess whether it will have the necessary funding to bring products or services to market
- meeting with general partners and the board of directors to create a risk management strategy that defines the risk appetite the firm has for each investment, and drafting an investment diversification plan that reduces risk if serious issues arise regarding a specific investment
- designing and implementing risk management protocols
- implementing and monitoring stress tests, back-tests, and sensitivity analysis for portfolio companies and firm assets
- meeting with portfolio company founders during the life-cycle of the investment to assess previously identified risk-related issues and identify new areas of concern
- keeping up-to-date on market developments and assessing their potential positive or negative effects on portfolio companies