E10: Michael Kim | Founder of Cendana Capital on How Small VC Funds Can Return 200X+

Chris Sacca's first fund, lowercase one, was 8 million in size, and it returned 204x. And that's DPI that's distributed back. So, you know, 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, you know, 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 5 million, and we invested a million dollars into that, and we started working closely with Nicole, and then when she raised her $20 million fund, you know, 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 guest Eric and I have wanted to interview since starting the podcast. Welcome to a 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 Sandana.

I grew up in a family where my mother was born and raised in Japan, although she was Korean, and my father was 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. 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 and 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 and 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 start 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, and rotated through things like I was president of the board at one point, I 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 you know, 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 $5 million, right? You had to buy sun microsystem servers, you had to pay for software code, et cetera. 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 back in the late 90s and now 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 first round got going in the mid 2000s and then by the end of the 2000s you had people like Jeff Clavier, who was 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 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 to smaller funds to write those small checks that the companies were needing up, up front. And then you know, our hypothesis around 2008, 2009 was that these smaller funds are going to be de facto early stage venture.

How has your hypothesis changed as the market has changed in terms of, you know, these mega funds, multi stage firms, more and more capital flooding the ecosystem. What has that, that done to your hypothesis and thesis?

That's a really good question. I mean I think it's multidimensional how things have changed. Just to give you some facts, the average seed round, when I started Sandana 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, you know, 10 years ago, these seed funds were 40, 50 million, they were writing 750k checks, getting 10, 10 plus percent ownership. You know, their fund sizes were, 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 to 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, and so, you know, you saw them very active around 2015 and 16, if you remember, Greylock had their discovery fund, for example, XL had, 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. You know, obviously they're quite smart and so, you know, 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 2,000 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 Sacca's first fund, lowercase one, was 8 million in size and it returned 204x and that's DPI, that's distributed back. So you know, 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 you know, 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 5 million, and we invested a million dollars into that. And we started working closely with Nicole. And then when she raised her $20 million fund, you know, we anchored that with the $4 million check. So we do 20% into these nano funds. There's another guy, Kevin Novak at Rack House 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 $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 $3 million check. And today, you know, he's operating out of a second fund that's closer to 50 million, and we continue on with him. 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 you know, 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, 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. Right. And raise, you know, multi hundred million dollar firms and follow in the footsteps of a thrive or a forerunner or, you know, 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, 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. And this will give you a flavor of how we invest. 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 our 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 you know, 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 in answering your question, most of our, 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.

We.

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 two million dollars checks, probably one and a half million dollar checks. So those are, that's substantially larger. And it's one thing to be able to get a 500k check into a very interesting startup is 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, 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 leap. That's actually where we spend a fair amount of time doing our diligence and getting to know the fund managers because you know, you can easily say hey, I'm raising 50 million, I, I'm going to write $2 million checks. And that's something that's easy to say but to 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.angellist.com TLP that's AngelList/tlp to get started. Back to the show from the fund manager perspective themselves. Let's say it's another fund manager is 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 sort of the change in strategy that you just alluded to like from an expected value perspective, is it their multiples are more likely to be lower but they're like 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?

You know, philosophically it kind of depends on what you want to accomplish in life. Do you actually want to have 10x funds. Are you satisfied with having 2 to 3x funds yet economically those 2 to 3x funds can be much more valuable to you, especially if they're larger. So let me just give you some examples. You know, if you had a $50 million 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, you know 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, you know, 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, 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 non recourse loan. What that also does on the downside, if you're running a $500 million fund and you're getting, let's say 2% management fee, so you're getting $10 million a year of management fee over a 10 year period. That's $100 million 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, you know, 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 2-3x 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. And I'll just give you a quick example. So imagine you're a $60 million fund and you own 15% of a company. It sells for $100 million. You return 15 million to your fund, you actually returned a quarter of your fund with $100 million 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 3-5x 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, if a fund manager owns 15% of a company and it exits for a billion dollars, so 150 million back to their, you know, $60 million fund. So that's a 2x fund return. That mentality, that focus on ownership really translates to how we build our portfolios. And when I started Sandana, 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 multibillion dollar funds and they were deploying it across a very broad spectrum of venture firms. So in a way they became index funds and 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 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 our 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, who is not necessarily the most public person. You know, he doesn't have a million Twitter followers, he does have a podcast, but it's really for a targeted audience. And, you know, I think he's built out his firm smartly. And actually, Eric, it goes kind of back to what you were asking. You know, 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, you know, new fund managers are thinking about this. They start off modestly, you know, 5, 10, $15 million 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 multi stage firms, then you can go out and raise a 40, $50 million fund. And then if you build, 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. You know, when I started Sandana, 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, you know, Ross Fubini 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 economic value that's created for the fund managers is really from carried interest.

Yeah. And I think we have a migration. We talk. I think you mentioned off camera, 75% of your fund managers have tiered carry. So they do really well if their fund does really well. And I think that'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're, 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 2,000 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, Lyndall Eekman who's now at Foundry, was the head of private markets for the University of Texas Investment management company. And he, you know, really wanted to access these small funds and work with us to be able to do so. So, you know, 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, Kathryn Campbell at Cambridge Associates, in a way, Cambridge, 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. You know, oftentimes the capital is 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 you know, so we had, 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, you know, 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 of 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. You know, 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. On the one end of the continuum there are institutional LPs who just show up to the annual meeting once a year. Maybe they get quarterly updates. That's one type of level of engagement. Ours is basically the opposite end of that continuum. 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 11pm at night because they're worried about something or they wanted to work through a problem that 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 being, 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 funded funds. And the reason why is that, you know, I think historically the traditional venture capital funded 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 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 been had built out high conviction portfolios and we've always wanted to be the lead investor. And I think that 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, you know, we try to create a trillion dollars of value and if I, 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 are about to hit their 12 year old 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 Klein Hill. They're more like around a billion dollar kind of vehicle. We've gotten our, our fund managers in front of Lexington and Klein Hill and we view that as, you know, a value added service. We're trying to foster those relationships. Lexington obviously with their fund size, can actually buy an entire fund and do those GP LED deals, those continuity vehicles. And then, you know, with Klein Hill, some of the family office LPs may want to get some liquidity. So 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 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 the last year. They're leaving the company. But then the multi stage firms, they're offering her five on 30 and we were hoping to do like a two on 10. They call at 11pm and they're like, should we write a bigger check to that multi stage firm's term sheet or 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, 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 onto that distribution and, 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. You know, we think the best funds actually are investing, you know, 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, you know, 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 know 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're getting, 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, you know, 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 follow on investments in your most promising companies, that's what I think institutional P.S. 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 were worried about this denominator effect. And what that really means is if you have, you know, 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 is, 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, you know, 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 actual, 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, 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 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 and 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 6 to 7. 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, then you get to the multi stage firms, the traditional VC funds, they're wondering, okay, if the, 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. You know, 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 counterexample, 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 stats multiples went from 20 back down to six or seven. So, you know, I think that's the reset that you're seeing. And I think in general at a high level, when the Fed is raising interest rates, it just becomes harder to get a return because, you know, that 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 push 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. But if you're a newer fund Manager, the last 18 months have been a very difficult time for new fund managers or fund, you know, 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. You know, venture capital is at least 2x where public markets are. So institutional LPs recognize that it's an important part of their portfolio. You know, 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 of 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 the venture, then it's easier for the haves to raise new capital than say a.

New fund manager, 100%. And you mentioned Yale. They have a 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 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 Ven Cap, 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's absolutely, 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, you know, 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 2x2 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 an entire fund's 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 checks a few years ago to $10 million checks to these seed funds. And it's largely because we think that the pre seed funds have a higher probability path to generating 5-10x returns. So one thing that I don't really advertise, but in my mind, we view our seed fund managers as the market beta. You know, 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 3 to 4x kind of fund returns. So on a combined basis, you know, we're hoping to generate at least 5x for, 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 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, 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, we're modulating that by capital. So Nano and Pilot, they're, 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, you know, they're starting to do other things that there's a lot of partnership issues in the internal culture has totally changed. This is actually one of the biggest risks that we focus on is, 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 we're, we, that's something that we watch very, very carefully. And you know, 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 have started building out their teams.

In terms of, you mentioned basically refreshing your portfolio. You're. 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, 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, you know, 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, 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, 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 LPs add 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 Sandana?

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 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 to you. Thanks so much for coming on the podcast.

Absolutely. Great to be here. Thank you for your time.

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