Investment Controlling

What is investment controlling?

Investment controlling (German: Beteiligungscontrolling) refers to the ongoing monitoring and steering of company holdings by the investing investor. A related term is portfolio monitoring, above all at venture capital funds. Investment controlling comprises three steps. First, it is determined what information the portfolio company supplies, that is, the company in which the investor holds a stake. Then this information is evaluated using metrics and plans, and when deviations occur, the investor takes action.

The bearers of investment controlling are funds for venture capital (risk capital for young growth companies) and other equity funds, family offices, holding companies and corporations with subsidiary and minority holdings. The federal government, the states and municipalities also steer their enterprises, such as municipal utilities, through investment controlling. Many municipal codes prescribe an annual investment report for this. Private investors base their investment controlling on the rights they have negotiated in the participation agreement, shareholders' agreement and articles of association. For the portfolio company, investment controlling is the counterpart of its own reporting (management reporting): what the investor evaluates, the management must supply.

Legal framework: what the investor can demand

The difference from controlling within a company's own organisation, which supports the management in planning and steering, is distance. The management of a portfolio company is not subordinate to the investor. What it learns and can influence depends on its position as shareholder and on its contractual rights.

• Statutory right to information: Under Section 51a of the German Limited Liability Companies Act (GmbHG), every shareholder of a GmbH (German limited liability company) can demand information on the affairs of the company and inspection of books and records. The right operates on request and does not deliver a regular report.
• Contractual information rights: monthly and quarterly reports, annual budget and annual financial statements with fixed deadlines, regulated in the participation agreement or shareholders' agreement (information rights).
• Participation rights: consent requirements for certain measures as well as seats or observer status on the advisory board.
• Right to give instructions: The shareholders' meeting of a GmbH can give instructions to the management (Section 37(1) GmbHG). As a rule, only a holder of the majority of votes can enforce this.

A minority investor from a funding round therefore steers above all through information, consent requirements and conversation with the management. A corporation with a majority holding, by contrast, can make planning requirements, reporting formats and measures binding. Investment controlling accordingly reaches to different depths.

Metrics and reporting in investment controlling

A functioning investment controlling rests on a fixed reporting package that each holding supplies in the same format and with the same definitions. A tiered approach is common:

• monthly: revenue, result, liquid funds, net burn and runway, deviation from plan, for software companies in addition ARR, new customers and cancellations,
• quarterly: detailed evaluation with commentary from the management, updated forecast to year-end, status of agreed measures and current shareholder structure,
• annually: annual financial statements, budget for the following year, multi-year plan and an assessment of the financing requirement.

Net burn is the monthly cash outflow after deducting income, runway is the reach of the liquid funds in months and ARR is the recurring revenue extrapolated to a year.

Formula: Runway in months = liquid funds / monthly net burn

More important than the number of metrics is their comparability. In practice, five to ten figures that are defined identically across all periods suffice. Figures without a statutory definition such as ARR, churn (cancellation rate) or adjusted results are particularly vulnerable. Their calculation should be fixed in writing once and then retained.

Valuation of the holding at the investor

Investment controlling also provides the basis for the valuation at the investor. Funds regularly value their holdings at fair value, that is, at the value that could probably be achieved in a sale on the reporting date. This is how they report to their own investors; international valuation guidelines of the private equity industry are widely used for this. Reference points are the last funding round, the development of the metrics since then and comparison values of listed companies. Weak quarterly figures of a holding can therefore lead to write-downs in the fund.

Early warning signals and escalation

The task of investment controlling is less looking back than the early detection of developments that endanger the capital, valuation or continued existence of the holding. Typical early warning signals are:

• a runway of under twelve months without a concrete financing plan,
• repeated revenue misses against plan with constant or rising cash outflow,
• rising cancellation rates or falling gross margins,
• late or incomplete reports and subsequent corrections of reported figures,
• departures at management level, breaches of loan conditions (covenants) or extended payment terms with suppliers.

The duty of early crisis detection lies with the management of the portfolio company (Section 1 of the German Corporate Stabilisation and Restructuring Act (Unternehmensstabilisierungs- und -restrukturierungsgesetz, StaRUG)). The investor's investment controlling supplements it but does not replace it. Escalation levels are common for the response. At the start is the conversation with the management, followed by tighter reporting, such as a weekly liquidity forecast. After that come an agreed action plan and finally decisions on bridge financing, a realignment or a sale.

Investment controlling in a follow-on round and exit

Investment controlling is the basis for the decision whether an investor invests further in a follow-on round (follow-on investment). Existing investors who have been able to follow their holding reliably over several quarters decide faster and on a more robust basis. New investors often ask the existing ones about their experience of planning reliability and reporting quality.

In an exit, the reporting history becomes part of due diligence. If figures in the data room deviate from values reported earlier, the company must be able to explain the differences. Reporting that is consistent over years reduces the review effort and supports the credibility of the planning on which the valuation rests.

Worked example: runway and plan deviation in investment controlling

An investor holds a minority stake in a software company. The participation agreement requires quarterly reports and provides for monthly reports as soon as ARR is more than 10% below plan for two quarters in a row. At the end of the second quarter, the company reports liquid funds of EUR 3.6 million.

• Planned net burn: EUR 250,000 per month, planned runway: 3,600,000 / 250,000 = 14.4 months
• Actual net burn: EUR 320,000 per month, that is, EUR 70,000 or 28% above plan
• Actual runway: 3,600,000 / 320,000 = 11.25 months
• ARR at quarter-end: EUR 5.1 million against EUR 6.0 million in the plan, that is, EUR 0.9 million or 15% below plan; in the previous quarter the deviation was 12%
• Consequence: The contractual threshold has been exceeded twice in a row, and the reporting frequency rises to monthly
• Time requirement: If the next funding round takes 6 to 8 months, only 3.25 to 5.25 months of buffer remain with 11.25 months of runway

Two signals coincide: growth lags behind plan while cash outflow rises, and the runway falls below twelve months. A concrete measure follows from the investment controlling: the investor and the management agree a cost plan and begin preparing the next round.

Distinctions: investment controlling, controlling and information rights

• Information rights: the legal basis on which the investor can demand information. Investment controlling is the evaluation and steering that build on it.
• Investor update: the regular report that the management sends to all investors. It is one of the sources of investment controlling, not the controlling itself.
• Management reporting: the company's internal reporting to management, advisory board and shareholders. It supplies the figures; evaluation and consequences from the investor's perspective are a matter for investment controlling.
• Controlling: planning, steering and control within the company itself, for its own management and with full access to all data. Investment controlling looks from the outside and depends on agreed information.

Common mistakes

• Metrics without a contractual basis. Information that is not agreed in the participation agreement can later only be requested. Scope and deadlines of reporting belong before closing.
• Inconsistent definitions. If each holding calculates ARR, churn or adjusted result differently, the figures are comparable neither over time nor between holdings.
• Only earnings figures in view. Liquidity, order backlog and cancellations show problems earlier than the annual result.
• Reports without consequence. If plan deviations are reported but no thresholds and measures are agreed, the reporting remains without effect.
• Reporting deadline too late. A monthly report that arrives six weeks after month-end is hardly suitable for steering any more.
• Overloaded reporting packages. Extensive catalogues tie up capacity in small finance teams and become a compulsory exercise without informative value.

Frequently asked questions

What distinguishes investment controlling from group controlling?

The perspective. Group controlling steers the parent company and subsidiaries as an economic unit, with joint planning, uniform reporting formats and usually the right to give the subsidiaries directions. Investment controlling looks at the individual holding, including a minority holding without management power, and in groups is often part of group controlling.

Which metrics belong in the reporting package?

At a minimum liquidity, cash outflow and runway, revenue in a budget-vs-actual comparison and the most important drivers of the business model. For software companies these are usually recurring revenue, cancellations and customer acquisition costs; for other business models, for example, order intake and gross margin.

Can a minority investor demand inspection of the bookkeeping?

Yes. Section 51a GmbHG gives every shareholder a right to information and inspection, regardless of the size of the holding. The management may refuse it only if there is reason to fear use for purposes foreign to the company with a not insignificant disadvantage to the company. Refusal requires a shareholders' resolution.

How is a holding valued in the investor's annual financial statements?

If the investor reports under the general rules of the German Commercial Code (Handelsgesetzbuch, HGB), for example as a holding GmbH, the following applies: acquisition cost, reduced by extraordinary depreciation in the case of an expected permanent impairment (Section 253(3) HGB). If the reason later falls away, the amount is to be written up again, at most to acquisition cost. If the investor is a corporation, such write-downs generally have no tax effect because of Section 8b(3) of the German Corporate Income Tax Act (Körperschaftsteuergesetz, KStG).

A distinction must be made from the fair value that funds report to their investors. It can be above acquisition cost. Separate valuation rules also apply to regulated investment funds.

Who bears the effort for reporting?

The portfolio company. It prepares the reports with its own finance function, which is why scope and deadlines should fit its size. A reporting package that arises from the regular monthly closing causes little additional effort.

The Roemer Capital view

We see investment controlling from the side of the company that reports. In fractional CFO mandates, we set up reporting so that monthly closing, planning and investor reporting rest on the same figures and definitions. The metrics that an investor wants to track after closing are already built into the round's financial model. This way, no second set of figures arises alongside the plan.

Before a follow-on round, we evaluate the reports of the past quarters as an investor would: planning reliability, development of cash outflow and runway, stability of definitions. Our yardstick for starting a process is a runway of 12 to 18 months. The investors' investment controlling shows early when this point is approaching.