Residual Value

The residual value of an investment is the current market value of the investment, which will include the original invested capital plus all unrealized gains and losses. Residual value is an important metric for performance reporting and is included in many popular venture capital performance metrics. Let's unpack what residual value is and how to model it in venture capital fund models.

Realized Gains and Losses #

Realized gains and losses are the gains or losses of an investment that have happened, and represent the difference between proceeds received from an investment and the total amount invested in that investment. They can come from exits (M&A, IPO, secondary sale), revenue sharing, writeoffs (reducing value of investments to zero as they fail), and other types of cash flows that bring cash into the fund.

Unrealized Gains and Losses #

In the time between when an investment is made and and proceeds, it's possible that the market value of an investment will change. That change is an unrealized gain or loss,

Calculating unrealized changes is not necessary in building a model to understand the overall performance , valuable for understanding value in a portfolio before exits have happened.

Modeling unrealized involves estimates around the changes in the value of individual investments.

To do this, we typically have to create a way to forecast and/or track the share prices of investments over time, from the price originally paid to the current price, so that we can calculate the new value of the investment. The difference or change in value will be tracked as an unrealized change in the value of the portfolio.

Unrealized gains = increase in value
Unrealized losses = decrease in value

The key for portfolio analysis is to separate out the value of the gains (losses) from the original investment value and track them separately. Modeling unrealized is straightforward when tracking known investments, hard when forecasting

• If doing performance tracking for a known portfolio, it is straightforward to track unrealized gains and losses: current value of your invested capital in each business, summed across all investments.
• If forecasting, it can be hard to do, even if forecasting using an average cap table approach where you are forecasting intermediate rounds of funding.

Easiest way to forecast unrealized gains and losses is to use the fund IRR to estimate the increases in unrealized gains. It’s not entirely right (the value will only change when rounds happen, which isn’t every year, and it won’t be a consistent ratio per year), but it provides some insight.

Residual Value #

The residual Value of a portfolio is the total value of the portfolio of unexited investments.

Residual value of an investment (and portfolio) = value of original investments into a company + sum of unrealized gains and unrealized losses

Residual value changes in a few ways:

• Increases when an investment is made
• Increases when a company raises a new round at a higher share price (unrealized gain)
• Decreases when a company raises a new round at a lower share price (unrealized loss)
• Decreases when a company is written off (realized loss of the value of invested capital and any changes in unrealized gains or losses)
• Decreases when a company exists (realized proceeds from the exit are recorded, value of invested capital decreases as the original investment value is existed, unrealized gains or losses go down as the unrealized change is decreased since the unrealized now became realized)

The best way to model and track residual value is to break it down into two components: invested capital and unrealized changes

• Change in Invested Capital per period = new invested capital - value of invested capital exited - value of invested capital written off
• Change in Unrealized Gains (Losses) = sum of unrealized gains and losses for all companies
• Change in invested capital per period per period + change in unrealized gains per period = Change in residual value per period

Sum all of the changes in residual value per period to date, and that is equivalent to the residual value of the portfolio at the end of the period.

Note: be mindful of whether you are tracking residual value gross or net. The Foresight venture models report residual value gross, but calculate net metrics using the net realized values.

Do you need to forecast unrealized gains and losses? #

For an overall forecast (total, not forecasting per year) you can just do realized proceeds, by either potential method:

• Invested capital * gross exit multiple = proceeds from investments
• Forecasting entry valuation and ownership %, exit valuation and ownership %, to calculate proceeds

For a forecast per time period (year or quarter), based on a capital deployment schedule of when investments are made:

• Start by forecasting when proceeds occur based on average hold periods and proceeds per average company (same potential methods as above)
• If valuable, use graduation rates (% of companies that raise more more rounds), failure rates (% written off) and exit rates (% that sell or exit) by stage and time, with changes in valuation, to forecast when invested capital is written off and exited, and if exit, how much the proceeds are