How I Invest with David Weisburd - E10: Michael Kim | Founder of Cendana Capital on How Small VC Funds Can Return 200X+

Episode Date: September 18, 2023

Michael Kim, founder and Managing Partner of Cendana Capital sits down with David Weisburd and Erik Torenberg to discuss his thesis of creating a fund of funds at seed stage, insights into the changing landscape of VC from the 90s to today, and whether VC should recycle capital. Cendana Capital has invested in Forerunner Ventures, K9 Ventures, and IA Ventures. If you’re ready to level-up your startup or fund with AngelList, visit https://www.angellist.com/tlp to get started.

Chris Sacka's first fund, lowercase one, was $8 million in size, and it returned $204x. And that's DPI. That's distributed back. So these small funds can actually do quite well. We have a fund manager, Manu Kumar, at K9 Ventures. His first fund, which was before Sundana got started, was $6 million, and it's returned $100x. So these small funds can actually bring back

material amounts of return. You know, we're excited to have our nano program, you know, just to give you a flavor of that. We invested in Nicole Wishoff's first fund that was only five million and we invested a million dollars into that. And we started working closely with Nicole. And then when she raised their twenty20 million fund, we anchored that with the $4 million check. Michael Kim, you've been a top VC LP globally for the past several decades and a top three guests. Eric and I have wanted to interview since starting the podcast. Welcome to the Limited Partner Podcast. It's great to have you on. You've had a very interesting background. You started out as investment banker at Morgan Stanley to then being a VC and now being a venture

LP. Tell me a little bit about your background and how that informs your day-to-day at Zendana. I grew up in a family where my mother was born and raised in Japan, although she was Korean, and my father is from Korea. And I grew up in West Virginia. So a small university town just south of Pittsburgh, West Virginia University, you know, my father was a professor there. And so I would travel internationally every year as a boy, I'd go to Japan and Korea for the entire summer. And so I was exposed to, you know, multiple cultures traveling abroad. And I had a really strong interest in international affairs. My father was a professor in international relations at the

university. And so when I went to Cornell as an undergrad, I studied international relations and I wanted to be a diplomat. So after Cornell, I went to Georgetown to the School of Foreign Service to actually get a master's degree and become a diplomat. One year into it, I had this epiphany that I'd rather be ultimately appointed to something as opposed to climbing up the government ladder. So I actually went into banking. And then I worked at Chase Manhattan Bank doing credit analysis. That was in the early 90s, like 92 to 95. I decided I wanted to go to business school. So I went to Wharton and then ended up at Morgan Stanley. So I was very excited to be in the M&A department at Morgan Stanley.

I thought I was going to just live in New York for the rest of my life, become a managing director and then become a partner at KKR Blackstone. One month later, that totally changed when there was an opening in San Francisco to join the technology M&A team. And so that was Morgan Stanley's small team focused on technology, on internet. And basically from 97 to 2000, that was the first internet bubble. And I was sort of in the middle of that, at least from an investment banking perspective. And that actually was the first time I'd met venture capitalists, that I worked with venture-backed companies, and then saw the process from startup to exit,

because there were a lot of IPOs in 1999. Then you mentioned you went on the VC and the LP side. Tell me about that. The shift toward moving to the LP side of the world was when Gavin Newsom, who was the mayor of San Francisco at the time, appointed me to the board of San Francisco's public pension fund. And at the time, it was about a $12 billion fund. Today, it's probably $35 billion. But I spent five years as a volunteer on that board and rotated through things like I was president of the board at one point, was the chairman of the investment committee. From my perspective, it was really the first time I was on the LP side of the table. And I turned 40 in 2008 and I decided I actually want to start my own firm. And there are a lot

of things going on in venture that we can talk about from the late 90s to sort of the late 2000s that really created this opportunity to go after seed funds let's talk about that what was the impetus 2008 that's when i started my career what was going on in 2008 that created this opportunity back in the day like in 1999 if you're starting a software company you needed to raise five million dollars right you had to buy sun microsystem servers you had to pay for software code, etc. And then with Amazon AWS and an open source software, literally you could start a software company now for an order of magnitude less, for $500,000. And so that was one dynamic. It basically became cheaper to start a company. The other is that the multi-stage firms were getting bigger

and bigger and bigger. And so there was actually an opportunity cost for those GPs, the partners at those firms to spend time on a small investment. And so they needed, with billion dollar funds, they needed to write $20 million checks. Just as a fun fact, back in the 90s, the typical first round was five on five. You would actually have two VC firms writing $2.5 million, getting 25% of a company each. And then those companies were off to the races. And that totally has changed. The dynamic has moved a lot toward the founder. If you measure it by dilution that the founder is taking for that first round, it was 50% back in the late 90s. And now, you know, it's closer to 20 to 25%.

Those were sort of the two structural changes and forces going on in the venture market. And that's when you started seeing like Union Square, True, Foundry start in the early 2000s. And then, you know, first round got going in the mid 2000s. And then by the end of the 2000s, you had people like Jeff Clavier, who was, you know, one of the original super angels and super angels are people who are using their own money to make investments in companies and as a full time job. So, you know, Jeff was spending his entire time building a portfolio of seed stage companies.

But that's sort of the broad history of how this opportunity that we saw around seed got created because more and more people were starting smaller funds to write those small checks that the companies were needing up front. And then, you know, our hypothesis around 2008, 2009 was that these smaller funds are gonna be de facto early stage venture.

How has your hypothesis changed as the market has changed in terms of these mega funds, multi-stage firms, more and more capital flooding the ecosystem? What has that done to your hypothesis and thesis? That's a really good question. I mean, I think it's multi-dimensional how things have changed. Just to give you some facts, the average seed round when I started Sendana back in 2010 or 11, you know, the average seed round was like a

million and a half. And today, at least in our portfolio, the median seed round from our fund managers is 4 million. And so back in 10 years ago, these seed funds were 40, 50 million. They were writing 750K checks, getting 10 plus percent ownership. Their fund sizes were modest. Our thesis at the beginning, and it has remained the same, is that smaller funds outperform. And importantly, we think that ownership is super important. And so, you know, you can see how these smaller funds 10 years ago getting 10 plus percent ownership makes for a good portfolio construction.

It's the winning formula because if one company is an outlier, you're returned more than a multiple of your fund. But, you know, because seed rounds are larger today at say 4 million, our underlying portfolio funds have gotten bigger as well so that's one dynamic the other one that i'd point out is that you know i'd say probably starting five or six years ago you start you started seeing a lot of operators and founders having side funds and that founders wanted other founders on the cap table. So a few years ago, we started,

I think, a pretty innovative approach, which is our nano program. And that was really to go after these sub $20 million funds. Basically, no institutional LPs were going after these small funds. And part of the reason why is because the person running that fund had a full-time job. Another element would be that, you know, I think the multi-stage funds largely were experimenting around seed investing. And so, you know, you saw them very active around 2015 and 16. If you remember, Greylock had their discovery fund, for example, Excel had started making seed investments. But I think that was a learning for them in that they weren't that engaged with each of those companies.

Because, again, there was an opportunity cost for them to spend time with these small checks. And so I think they perhaps took some body blows around reputation because the biggest question was, well, if they're not leading the Series A, what's wrong with the company? So it would be a negative signal as those founders were raising their series A's. Obviously, they're quite smart. And so today, they have established programs. They have dedicated people. And I'm talking about the multi-stage firms focused at seed. And so we can talk a lot more about this, but they've actually had a pretty significant impact, I'd say, on pricing and valuations, and it's become more competitive. The other fact is that when I started Sendana, there were probably 15 to 20 seed funds that were maybe institutional quality. And today there are over 2000 seed funds

just in the US alone. Now, 95% of them are probably tiny funds. And again, maybe a lot of them are founders who use AngelList to have these side funds. But I do think that today compared to 10 years ago, Seed is definitely early stage venture. You mentioned the Nano program. Was that a success or was that just an experiment where you got to learn a lot? We just started it two years ago, so it's a little bit early. Our hope was that Chris Sacka's first fund, lowercase one, was $8 million in size, and it returned $204x. And that's DPI, that's distributed back. So these small funds can actually do quite well. We have a fund manager, Manu Kumar, at K9 Ventures. His first fund, which was before Sundana got started, was $6 million,

and it's returned 100x. So these small funds can actually bring back material amounts of return. We're excited to have our Nano program. Just to give you a flavor of that, we invested in Nicole Wischoff's first fund. That was only $5 million, And we invested a million dollars into that. And we started working closely with Nicole. And then when she raised their $20 million fund, we anchored that with the $4 million check. So we do 20% into these nano funds. There's another guy, Kevin Novak at Rackhouse Ventures. He was employee 21 at Uber. He was their chief data scientist, oversaw the entire data team. And as you know, Uber is really a software company. Very thoughtful guy, amazing domain expertise. He's actually a PhD in nuclear physics. He's an AI machine learning expert. Instead of going out

and raising a $100 million fund, Kevin wanted to start off with a $15 million fund. And so that was right in the wheelhouse of our nano program. We anchored him with a $15 million fund. And so that was right in the wheelhouse of our Nano program. We anchored him with a $3 million check. And today, he's operating out of a second fund that's closer to 50 million, and we continued on with them. So from our perspective as LPs, this is a good way that we create new names in our portfolio, new managers to work with. And then the Nano program can become almost an on-ramp to becoming a core position for us. Now, granted, we're not going to make all of our nano funds into core positions because some of them may want to stay small.

Some of them may not do well, quite frankly. But in general, I think it's sort of a good way for us to start working with really phenomenal people who are starting modestly and small, but yet we can be a very important part of their story and their capital base. I suspect you have the opposite challenge in terms of them not staying small. It's them wanting to go too big and raise multi-hundred million dollar firms and follow in the footsteps of a Thrive or a Forerunner or any firm that is really aggregated capital. And so at what point do these, from a fund size perspective, do they stop being interesting?

And how do you counsel these fund managers when they have the option to go big as to why they might want to stay smaller reasonably and how they should think about fund size? Yeah, that's a really good question so when we look back across our entire portfolio for the past 10 11 years there's been only two groups that kind of graduated beyond our scope first is forerunner and as you mentioned and you know the other is ia ventures in new york roger ehrenberg was the founder of that firm in the case of forerunner you know and this will give you a flavor of how we invest. You know, when Kirsten was raising her first fund, it was $40 million. And we committed to her very early $10 million. So we were a quarter of that fund. And we actually helped bring in other LPs that came on board. And by the time

she was raising her second fund, which was $75 million, we committed $26 million. So we became a third of her capital. But then as she became larger and focused a little bit more multi-stage, we decided to not re-up with her. We love Kirsten and Yuri and her team. We still talk to them all the time. But it just wasn't a fit for what we do. And as you know, Kirsten's current fund is 500 million and then a $500 million opportunity fund.

So that's totally out of our wheelhouse. But one thing that we did, and we can talk about how we work with our fund managers and our LPs, is that we introduced our LPs to Kirsten. And today, the University of Texas, which is our largest investor, is also a very large investor with Kirsten, also an investor with IA Ventures. So to get to the point and answering your question, the vast majority of our fund managers have not become multi-stage firms. And the two that have,

we maintain a great relationship, but we didn't continue on with them. But I think you're also asking about some of these nano funds and them getting bigger. I think if you take a step back, one thing that we've always talked about with our fund managers is portfolio construction, the right level of ownership given your fund size, because fund size does determine your strategy. And what I mean by that is, you know, if you're a $15 million fund, you're probably writing 500k checks. And then let's say your next fund, you want to be 50 million, then you're going to have to start writing one to $2 million checks, probably one and a half million dollar checks. So that's substantially larger. And it's one thing to be able to get a 500k check into a very interesting startup. It's a totally different dynamic to get

a much larger check and actually be the lead or co-lead investor into that startup so that's where we spend a lot of time diligencing is does that person have the credibility you know and that's networks domain expertise just even personality to work very closely with the founders and be their lead investor and so that that jump from writing small checks to writing lead size checks that's a pretty big uh leap that's actually where we spend a fair amount of time doing our diligence and and getting to know the fund managers because you know you can easily say hey i'm raising 50 million i'm gonna write two million dollar checks and that's something that's easy to say but to actually actually get the, to have that credibility,

you know, that's where we diligence. Hey, we'll continue our interview in a moment after a word from our sponsors. The Limited Partner Podcast is proudly sponsored by AngelList. If you're a founder investor, you'll know AngelList builds software that powers the startup economy. AngelList has recently rolled out a suite

of new software products for venture capital and private equity that are truly game-changing. They digitize and automate all the manual processes that you struggle with in traditional fundraising and operating workflows, while providing real-time insights for funds at any stage, connecting seamlessly with any back-office provider. If you're in private markets, you'll love AngelList's new suite of software products. And for private companies, thousands of startups from 4 million to 4 billion evaluation have switched to AngelList for cap table management. It's a modern, intelligent equity management platform that offers equity, issuance, employee stock management, 409A

valuations, and more. I've been a happy investor in AngelList for many years, and I'm so excited to have them as a presenting sponsor. So if you're ready to level up your startup or fund with AngelList, visit www.angelist.com slash TLP. That's AngelList slash TLP to get started. Back to the show. From the fund manager perspective themselves, let's say some other fund managers thinking about whether to stay at 70 million or raise more to 300 or 400. What is the calculus that they should be having besides the change in strategy that you just alluded to? From an expected value perspective, is it their multiples are more likely to be lower, but their downside is higher because of all the fees that will come in? What is the right way to think about the economic trade-off of raising a much bigger fund?

Philosophically, it depends on what you want to accomplish in life do you actually want to have 10x funds are you satisfied with having two to three x funds yet economically those two to three x funds can be much more valuable to you uh especially if they're larger so let me just give you some examples you know if you had a 50 million dollar fund and you 10x that, so that's 450 million of gain and 20% carry is 90 million of carry. So you've made $90 million if you did a 10x fund. But if you had a $500 million fund and you just 2x that, that's 500 million of gain, 20% carry is 100 million. So you basically got roughly to the same outcome, except with the $500 million fund,

you got a 2x. And with the $50 million fund, you needed a 10x. The GPs really do need to think, making simple assumptions, what the economic value of their carry is. And then of course, you have your management fees. For the people listening, management fees are basically a loan. What that really means is that you're calling capital from your fund to pay yourselves and run your operations. As an LP, we view that as a loan because you actually don't get carry unless you pay that back.

And, you know, it's not specifically, you know, a management fee payable, but what it is is that you typically don't get carry unless you return all of the called capital and so that's how you know i think fund managers should view their management fee and expenses as basically a a non-recourse loan what that also does on the downside if you're running a 500 million dollar fund and you're getting you know let's say two percent management fees so you're getting 10 million dollars a year of management fee you know over a 10-year period that's 100 million dollars that you're pocketing you don't get any

carry until you return that plus the rest of the fund so we think that actually is the best alignment of interest carried interest is what motivates, especially the smaller funds. I'll give you an example. So we have a fund manager in Los Angeles called Mucker, and their first fund was $12 million. They owned 7% of Honey when it was acquired by PayPal for $4 billion in cash. So 7% of $4 billion is $280 million on a $12 million fund. So you can do the math and figure out what the carry was. You know, that's life-changing money for the two co-founders of Mucker. So smaller funds can actually generate

substantial economic value to the fund manager. You know, obviously on a $12 million fund, you're not getting that much in management fee, right? So 2% is probably 240K annually. So, you know, those are sort of the dynamics between management fee, carried interest, and fund size. So it goes back to my original point, which is, what are you looking to do? Are you looking to just bang out 2 to 3x funds, which by the way, are not easy to do? Or are you really gunning for like that 10x plus kind of return?

It's a nice segue into your concentration. You have a very contrarian, a lot of institutions will not go over 10%. And it's not just for regulatory reasons, for other reasons. Why do you decide to pile in so much into your managers? That's something that we've done from the beginning, and it was very deliberate. And it really stems from our philosophy that ownership matters. i'll just give you a quick example so imagine you're a 60 million dollar fund and you own 15 of a company it sells for 100 million dollars you return 15 million to your fund you actually returned a quarter of your fund with a hundred million dollar exit and so this is actually why we've been saying from the beginning that the

seed stage investors actually have a higher probability path to generating three to five X kind of funds. As long as their fund size is small and they're getting relatively high ownership, initial ownership, which obviously gets diluted down over time, a small fund can actually do quite well with modest exits. Now, of course, everyone's hoping for the outlier exit, you know, billion plus. And in that example, I just gave you, you know, if a fund manager owns 15% of a company and it exits for a billion dollars, it's 150 million back to their, you know, $60 million fund. So that's a 2x fund returner. That mentality, that focus on ownership really translates to how we build our portfolios.

And when I started Sendana, you know, there are these very large venture capital fund to fund platforms. And in my mind, they were just based, you know, these were multi-billion dollar fund funds, and they were deploying it across a very broad spectrum of venture firms. So in a way they became index funds. And, you know, they serve their purpose. A lot of large state pension funds just want to check the box that they have venture capital. So they allocate to these very large venture fund of funds. We took the opposite approach. We wanted to find the best managers, have a concentrated portfolio. And again, to my comment about ownership, we wanted to have relatively high ownership in each one of those funds. And so, as I mentioned, in Kirsten's second fund, we were a third of her capital.

More recently, we've invested with Tim Chen, who also started off in our Nano program. He has a fund called Essence. First fund was $7 million. We did 20%. His new fund is $25. We did $10 million of that. So we're 40% of his capital. And we think he's a phenomenal guy. He's focused on software infrastructure, AI and machine learning and dev tools. A perfect example, I think, of a fund manager that we really look for. Someone who is not necessarily the most public person. He doesn't have a million Twitter followers. He does have a podcast, but it's really for a targeted audience. And I think he's built

out his firm smartly. And actually, Eric, it goes kind of back to what you're asking. Norman Mailer said basically, and this is in the context of sex, if you can get it in, it will work. And I think that's how fund managers, perhaps new fund managers are thinking about this. They start off modestly, you know, 5, 10, 15 million dollar funds. And if they build out a nice portfolio, one that LPs can start, you know, seeing the quality, whether it's co-investors or maybe you'll have some follow on investors, you know, from the top tier multistage firms, then you can go out and raise a 40, 50 million dollar fund. And then if you continue to build out the quality of that portfolio, then you can go out and raise a $40, $50 million fund. And then if you continue to build out the quality of that portfolio, then you can go raise a third fund of

say, you know, 80 to 100 million. So as long as you can get going, then, you know, I think fund managers recognize that they can build larger funds. And then in a way, in the past, I'd say eight years, that you had that path taken by a lot of fund managers. They've gotten bigger and bigger. But today, I think it's a little bit different. I think they're recognizing we might not get a 3X on this $150 million fund. So there's actually a lot of talk amongst our fund managers about actually scaling back their new funds, which I think is a very welcome trend. When I started Sendana, the median seed fund that we invested in was about 40 million in

size. And today, I think it's closer to 120. And we do have some, Ross Fubini at XYZ, Jeff Clavier at Uncork, who hit 200 million. But I think they're going to start scaling back because they recognize that they're not going to get an amazing multiple off of that. And again, ultimately, the wealth creation, the's something that's missing in the industry in general. That's something I'd like to personally see change. One of the things that you've done maybe more than any other individual in the space is bring true institutional capital into these crazy ideas like the nano funds and very early stage and esoteric strategies. What do institutions look to you for? Well, so here's a funny story. So, you know, we just finished raising a new fund.

We were oversubscribed, so we're very happy about that. Our target was 300, we raised 340. You know, my wife had said, you know, Mikey, it must be so much easier to raise capital now, you know, compared to our fund one. And the way I described it to her was, you know, in fund one, it took me 18 months to raise, 99.99% of the people I pitched said no. And today it is easier, but it's still 99% who say no.

So, you know, in a way, it's very much like a sales motion in that you have to build the top of the funnel and you just have to be talking to a lot of people. Now, to answer your question more directly, we have a variety of types of LPs, you know, university endowments, not-for-profit foundations, and large family offices. If you just take the endowment world, there are a lot of university endowments that are very interested in venture. You know, obviously the bigger ones like Yale, Princeton, Stanford, Harvard, they have full time teams, but the vast majority of university endowments don't have very large investment teams. And so in a way, they're outsourcing to us because they don't have the ability to cover these 2000 seed funds and make a few picks on the other end of the spectrum. You know, we have, as I mentioned, the University of Texas as our largest

investor, they have a different problem. They're so large that they have to write big checks. You know, if they wrote a $10 million check, it won't move the needle on their $60 billion endowment, right? And so because they have to write big checks, they couldn't access seed stage investing. So back in the day, Lyndell Eakman, who's now at Foundry, was the head of private markets for the University of Texas Investment Management Company. And he really wanted to access these small funds and work with us to be able to do so. So you're either understaffed or you have too small of a staff to cover the venture space or you're too large and your minimum check sides preclude you from basically seed stage investing now if you look at the

foundation world a lot of them basically don't have investment teams so you know a number of the foundations that we work with work with mike larson catherine campbell at cambridge associates in a way cam, who's been a partner of ours since the beginning, educates their clients, you know, these small foundations that don't have investment teams, investment staffs, and makes recommendations about it. So, you know, we're very grateful not only to Lyndall when he was at the University of Texas, but also Cambridge Associates because we've been working with them since our first fund. They saw us as a way of accessing seed stage investing for their not-for-profit foundations.

And then lastly, the family offices. I would say a lot of the family offices are very cutting edge. Oftentimes the capital was made by an entrepreneur. Maybe it was a few decades ago, maybe it's more recently. But there are people who took risks. And I think family offices are much more nimble. They're willing to push the envelope. And so we have a number of family offices that we work closely with. We talked off camera about essentially the co-invest that you provide to your LPs. We have as VC funds, we provide co-invest to our LPs. But you're actually bringing people into funds.

Could you explain the strategy on why you do that? You know, from the beginning, I wanted to be very different from how the traditional venture capital fund of funds were operating. You know, like I was saying, most of them are multi-billion in size. They're almost index funds. And my sense was that they were not working closely with underlying portfolio funds. Having come from a venture capital world as a GP, we work very closely with our portfolio companies. And so I wanted to take that same ethos and work very closely with our portfolio funds, as well as our LPs. The one way that we think of ourselves is that we're the lead investor into our portfolio funds. And it's similar to how a venture capitalist would

view themselves as the lead investor into a company. We work very closely with our fund managers. We work very closely with our LPs. We have a Slack channel. We have a WhatsApp channel. We're texting, IMing. We're talking to our fund managers daily. And think about that, that on the one end of the continuum, there are institutional LPs who just show up to the annual meeting once a year. We're very hands on. We're the lead investor. We actually want to be the trusted advisor to our fund managers where they would text us or call us at 11 p.m. and at night because they're worried about something or they wanted to work through a problem that they're they're facing. So that's the level of engagement that we want with our fund managers. We also have that with our LPs.

95% of our LPs are happy just being passive and we don't engage as closely, but we do have a number of LPs of ours that work with us and then they've set aside a pool of capital to make direct investments into some of our portfolio funds. So we kind of shepherd that process. We're introducing our fund managers to our LPs. We want them to go directly into these portfolio funds of ours. And that is very, very different than most venture capital fund of funds. And the reason why is that, you know, I think historically the traditional venture capital fund of funds were very guarded

about their relationships with their fund managers. And so they weren't introducing their LPs directly to their portfolio funds. But in a way, we had to actually evangelize seed stage investing 10 years ago. And so we took the opposite approach. We were very open. We wanted all of our LPs to meet our fund managers. We encouraged them to invest directly. And I think that ethos really is still how we operate today. One of the things I'm most proud about is that we've been very, very disciplined. We've stayed at seed and pre-seed. We've built out high conviction portfolios. And we've always wanted to be the lead investor. And I think that formula

has worked quite well for us. I think that ethos shines through. And there's a reason a lot of people consider you the goat in the space because of that background, that ability to see the world in a non-zero-sum way. I like to say, we try to create a trillion dollars of value. And if I capture 0.5%, it'll be a great business model. So I think that being able to really think holistically is very special. In terms of, you mentioned that you're a trusted advisor to your GPs. What does that mean? I can give you a few examples. So, you know, our first fund was from 2012 and the underlying portfolio funds there have already hit or about to hit their 12-year life. And so they need to know, what do we do? Do we ask for

more extensions? Or there's a whole world around secondaries where they can create continuity vehicles. As part of our new fund, we brought on Lexington Partners as an LP. And so they're like a $14 billion secondaries fund. They traditionally focus more on PE, but they have an increasing amount of venture activity and a smaller secondaries fund called Cline Hill. They're more like around a billion dollar kind of vehicle. We've gotten our fund managers in front of Lexington and Cline Hill, and we view that as a value added service.

We're trying to foster those relationships. Lexington, obviously with their fund size as you know a value-added service we're trying to foster those relationships lexington obviously with their fund size can actually buy uh an entire uh fund and do those gp led deals those continuity vehicles and then you know with klein hill some of the uh family office lps may want to get some liquidity so uh we work with klein hill and the fund manager to get liquidity and buy those LP positions. So that's one example. Another example, probably more, more quotidian, actually more daily is that, you know, our fund manager might say, Hey, we're looking at this founder. We've been tracking them for, for the last year, they're leaving the company, but then

the multi-stage firms are, they're offering her five five on 30 and we were hoping to do like a two on ten they call it 11 p.m and they're like should we write a bigger check to that you know multi-stage uh firm's uh term sheet or you know do we just write a very tiny check because we want to work with her with the founder or do we just walk and so those kind of dynamics and decision calculus is, it's not the case with every single one of our fund managers. We're not at that point yet. But a lot of them will call us and ask us for advice around that. Or just to give you another common example, they'll call us and say, hey, we're getting

a distribution. Should we actually distribute it back to LPs or should we hold on and recycle that capital? And what recycling means, of course, is that you're holding on to that distribution and using it for new investments. Generally speaking, just on that point, we believe fund managers should be investing

over 100% of their fund. Now, it's something that's not easy to do because you're kind of beholden to when you get distributions. We think the best funds actually are investing north of 100% of their fund and ideally closer to 120%. Tell me the math around that. So imagine you have $100 million fund and let's say 20% of that fund is used for management fee and expenses. So 2% management fee for 10 years is basically $20 million. And that's 20% of your $100 million fund. So if you're only investing

the remaining capital, that's $80 million out of $100 million fund. And if you want to get a 3x on that fund, you need a 3.75x on that 80 to get to a 3x fund, right? 80 times 3.75 is 300. So then you'll have a 3x fund. Obviously, if you're investing 100 million, all $100 million, because you recycled $20 million, then you need a 3x multiple on your investments. So that's the simple example of why recycling is important. And I think fund managers really need to focus on investing at least 100% of their fund. And again,

it's not easy to do because you are beholden on when your companies sell. But to the extent that you can retain the proceeds from your exits and then use it for new investments or fall on investments in your most promising companies. That's what I think institutional LPs want to see. And that's what we encourage. In terms of the secondary side, I think you guys are very forward looking on that. You have larger firms like TPG that have created these secondary structures and individuals like Klein Hill, like Michael, who I've known for a bit, and Matt Hoden at Lexington,

have been great partners to some of the top funds. I think that's really cool and very differentiated. In terms of where you see venture capital evolving, right now, we have the VC reset. We've been calling it the LP reset on the podcast. What do you see? And what is the opportunity today when there's blood on the streets? What should LPs be doing today? People are worried about this denominator effect. And what that really means is if you have your pot of capital and a certain percentage is allocated toward public markets and that public market portfolio shrunk by 30%, then suddenly your private markets portfolio, your private equity and venture is suddenly over allocated. And so managing that I think has been something

institutional LPs have been focused on for the past two years now. And I think it's kind of worked its way through because partly because the private fund side, the PE and venture capital funds, they've also been marked down a little bit slower than obviously the public markets, but it is coming down. So I think ultimately that denominator effect

was a little bit more psychological than actually practical. I don't think people, there was a tendency to want to cut back on things. I think the smarter LPs recognize that number one, you can't time technology and innovation. And number two, that amazing companies get started in difficult economic times. So obviously two, that amazing companies get started in difficult economic

times. So, you know, obviously Uber, Airbnb, Pinterest, Slack, they were all started post 2008, you know, within six to nine months of the global financial crisis back then. Then you've got to start looking at what kind of dry powder is out there. And dry powder means uninvested capital that's been raised by venture firms. There's over 300 billion in the US alone. And the question then becomes of that dry powder, how much is going to be used to support the existing portfolio companies of those large funds? Or are they going to be making new investments? And I think right now, the way we think about it is that going back to like March of last year, there's been this sort of period of price discovery. That means that the public markets were coming down. It wasn't clear

where they would settle. And just to use simplistic examples, public SaaS companies were trading at 20 times revenue, and they've come back down to their historical average of six to seven. Late stage investors were kind of waiting to see where that would settle. And I think right now we're at a point where people are past price discovery and are feeling comfortable that this is the range that companies will trade for in the public markets. And why this is important and how it trickles down is that, you know, the late stage investors for the most part have been relatively inactive. And then you get to the multistage firms, the traditional VC funds, they're wondering, okay, if the late stage guys

aren't making new investments, or if they do, it's at much lower valuations, then we need to come in to these companies at a more realistic and lower valuation. This is something we can talk a lot about, but the seed stage investors also face that, to a lesser extent, that downward pressure on valuations. Because to use a counter example, if you did your Series A in 2021, you raised $20 million on $100 pre. That today is probably more like a $10 million round out of $40 to $50 pre. And that is simply because public SaaS multiples went from 20 back down to six or seven. So I think that's the reset that you're seeing. I think in general and at a high level, when the Fed is raising interest rates, it just

becomes harder to get a return because that risk free risk-free rate is more attractive why would investors want to invest in something that's much much more risky than getting that risk-free rate so that's why i think you also saw institutional lps put at least a pause if not a slight pullback in their commitments to venture funds then there's also this other dynamic of the have and have-nots if you're sequoia you can always raise there's no question about that of the have and have nots. If you're Sequoia, you can always raise. There's no question about that. But if you're a newer fund manager, the last 18 months have been a very difficult time for new fund managers or fund one, two or three type managers to raise capital.

Venture capital is, if you look at the returns over the past 20, 25 years compared to the public markets, it's blown them out of the water. Venture capital is at least 2x where public markets are. So institutional LPs recognize that it's an important part of their portfolio. Yale, for example, has 25% to 30% of their entire endowment in venture alone. Not private equity, but just venture. I would say the typical endowment has probably 30% in both private equity and venture. So Yale is a little bit aggressive, and they've done extremely well. If you're a long-term holder and a long-term steward of the capital that you're managing, these institutional

LPs recognize that venture is important. And because they're going to allocate to venture, then it's easier for the haves to raise new capital than, say, a new fund manager. A hundred percent. And you mentioned Yale, Debra, really brilliant new CIO, Matt Mendelsohn. Would love to have him on a podcast at some point. But I think to your point, there's somewhat of a paradox where VC has done so well over so many years, but then nobody really gets the index. Either you're in the top quartile, as you've shown an ability to access, or Either you're in the top quartile as you've shown an ability to access or you're oftentimes in the bottom quartile. I think a lot of people fail to realize

how extreme the adverse selection is. If you're looking at, we had several weeks ago, David Clark from Vencap and what he found is that 90% of the funds that returned over 3X had at least one fund returner. Another way to say that is if you take out that fund returner, you're in serious trouble. A lot of LPs enter the venture capital asset class thinking that it's kind of like this and it's kind of like private equity, but a little more like bells and whistles. It should be looked on as almost

its own asset class. There's almost no corollary to any other asset classes. Yeah. And one element to that is that the standard deviation of returns in venture is much larger than, say, in public equities. And what I mean by that is if you look at the dispersion of returns in, say, a public equity manager, small cap, mid cap, large cap, whatever, it's a pretty tight range. I mean, you might have a few outliers who did particularly well in one year. But if you look at venture, that standard deviation is multiple. There are multiple standard deviations of return, meaning the absolute best fund managers generate almost all of the returns. And then the vast majority of venture capital funds are probably

one, one and a half X kind of returns. And from an institutional LP perspective, you got to think about substitutions and alternatives. And what I mean by that is small buyout, lower middle market buyout. That's probably a guaranteed two X, two and a half X in a much shorter period of time with a lot lower risk. And so if you're an institutional LP, why wouldn't you invest in small buyout over venture, especially if the vast majority of venture funds are going to get a lower return than those small buyout funds. And so that's how institutional LPs think. Yeah. And the truth of the matter is, if you don't have positive selection,

if you're not in the top managers, you probably should be in small buyouts. I was going to ask you, where would you put, let's say you had $300 million, $500 million today, where would you put your money? But obviously, you have your funds. So can you talk a little bit about your portfolio construction in terms of how many managers, percentages, and anything else you could share? Our portfolio construction, the way we think about it is that we have core checks, our core fund managers. And so today, we are actually tilting more toward pre-seed funds, which largely are sort of 50, 60 million in size. We will write up to 15 million to these pre-seed funds. So again, we're happy to being a third or more of a entire funds capital base. And then for

seed funds, which in our portfolio are roughly about 120 million in size, we're actually writing smaller checks we actually went from writing 20 million dollar checks a few years ago to 10 million dollar checks through these seed funds and it's largely because we think that the pre-seed funds have a higher probability path to generating 5 to 10x returns so one thing that I don't really advertise, but in my mind, we view our seed fund managers as the market beta. That's the market return. And then we view our pre-seed fund managers as actually the alpha, the extra return that we're going to get on top. And so I think of our pre-seed managers as 5 to 10x kind of fund returners and i view our seed fund managers as sort of 2 to

3x or maybe maybe 3 to 4x kind of fund returns so on a combined basis you know we're hoping to generate at least 5x for our investors now obviously that's not a guarantee or anything like that but that's sort of how we think about our portfolio construction and then the other element about our portfolio construction is that and it it goes back to some of my comments about the traditional venture capital fund of funds. They're index funds. They continue to re-up with a lot of names that probably aren't performing as well as they once did. We want to have the opposite approach. We want a fresh portfolio. And what I mean by that is we're actually adding new names to our portfolio all the time. So Nano is one example, you know, where we're adding these tiny little

funds into our portfolio. And then one thing I didn't mention is that we have a pilot program, and we've done this for 10 years where we invest $1 million into groups that we really like, but we still have some question about the sectors that are pursuing or maybe the geography that are located in. Both the nano and pilot, it's an on-ramp to ultimately becoming a core position for us. And again, we don't make all of our nano

or pilot commitments into cores, but at least it's adding new names. Every one of our fund of funds, we've added a lot of new names, but we're modulating that by capital. So Nano and Pilot, they're small checks, whereas the vast majority of our capital is being deployed to our core managers.

And then one more thing is that there are core managers that we've not re-upped with. So I think the total is, in our history, we've not re-upped with eight core managers. And it's a variety of reasons. Some of it's style drift. They're starting to do other things. That there's a lot of partnership issues and the internal culture has totally changed. This is actually one of the biggest risks that we focus on is partnership risk. Let's say we backed two GPs in their first fund and they decided in fund two,

they want to bring on a third GP. That totally changes the dynamic. And that's something that we watch very, very carefully. And to the extent that we are a trusted advisor with our fund managers, we actually take part in the interview process. So we've interviewed potential partners for some of our fund managers as they started building out their teams. In terms of, you mentioned basically refreshing your portfolio, you're borrowing from a management axiom, which is if you want to keep somebody, you should want to rehire them. And the test is if you had a decision to hire them again, would you hire them again? If not, then you probably shouldn't have that person in your organization. In terms of percentages, you mentioned you haven't re-upped

in eight core managers. For vintage, talk about time diversification as well as just how many managers do you have in a single portfolio? In our new fund, we'll probably have 14, 15 core seed funds. We'll probably have seven to eight core pre-seed funds. So right there, you'll have sort of like 21, 22 core positions. We'll probably have five or six nano and maybe three to four pilots. So again, those are the new names that we've added to the portfolio. Just to make it clear, we will add a brand new core manager. So we do have slots for new core managers. They don't have to be coming through the nano or pilot.

We might just start right off the bat as a core check into a fund manager that we've just met with. So I think that's a concentrated portfolio, but yet we have this sort of farm team. Some of them ultimately in our next fund might become a core position. And that's why I say it's a fresh portfolio. It's important to do because venture is not just rinse and repeat. It's changing all the time. And I think we've been fortunate to be

a little bit ahead of others in terms of seeing the different changes and taking advantage of that. Well, Michael, this has been a masterclass in learning about portfolio management and LP best practices and how LP is at value, which is a rare thing in and of itself. Thank you for taking the time to speak with Eric and I. What would you like our audience to know about Sendana? The way we operate, the way we invest, we've been very disciplined. People should know what we look for. And I think that that message has been broadcast loudly and broadly. What probably has not been broadcast that well, what we really look for and what we're really betting on are the people. And especially around that, you know, you have high integrity, high horsepower, et cetera, people who are going to

work really hard. We specifically, as part of our checklist, our mental checklist, we look for nice people. And the reason why is because our fund managers have to win in a very competitive situation. The founders have to want to work with our fund managers. And so if you're a total asshole, you might actually do well in the short term, but long term, you probably won't and it comes back to bite you. And so that's why we think of it as a very long-term game and we're really betting on the people. I studied evolutionary psychology

for my master's in psychology and niceness is actually very economically costly. So it's also a signal of high intelligence and high output. So there might be even more to that thesis than you might uh presently know. I feel like we could talk for 10 hours on a multitude of topics but it's no coincidence that your reputation precedes you and that so many fund managers wanted me to talk to you. Uh thanks so much for coming on the podcast. Absolutely, great to be here. Thank you for your time.

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