Fund of funds: origins, evolution and deep dive with Michael Kim | E1890

These founders, as you know best with Travis, for example, they would walk through walls to get it done.

Right.

And so what you actually saw in, say, 2021 at the peak was a lot of tourist founders. My friend started a company, so I'm going to start a company.

Yep.

Or in the fund world, we actually saw a lot of tourist fund managers. They're like, hey, my friend just raised a $10 million seed fund. I'm going to do that too.

Yeah.

And I think now it's a lot of them have actually been flushed out. So that's why I'm saying it's a return of normalcy valuations. People know where the entry points should be. From public markets on down, the playing field is set and people are ready to go. On the offense.

We went from the ridiculous cappuccino to a nice flat white. You know, when it got ridiculous, people were like, having the foam wars in the cappuccino world, and you're like, there's about 4 ounces in here and about 8 ounces in height of cappuccino foam.

Right.

All that gets blown off in a bad market, and then you're just drinking the good stuff. The.

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All right, everybody, welcome back. This is the final season of the podcast Angel. I started. Oh, gosh, six years ago. And why are we ending this podcast? Well, we're rebranding it as Liquidity, and you can go check that out@liquiditypod.com because, hey, my world has expanded and my funds have gotten bigger, and I've got a big team here. I'm less of an angel investor than I was in my first decade of investing. Now I've got a fund, and so we want to have conversations about the larger space. And so for this final season of angel, and as we transition into the liquidity podcast, I'm going to bring on limited partners. What are limited partners? They're the investors in venture capital firms. So you might hear the terms LPs and GPs limited partners. They put money into venture firms which are run by general partners. Okay. There are different types of LPs in the world. So just to educate you on this, you might have a family office. Hey, some rich family made a bunch of money on some business and now they want to diversify their wealth. You may have heard of sovereign wealth funds, money coming out of the Middle East, Norway, all different countries that have large amounts of capital and they too want to diversify. Maybe be in private equity and venture capital, university endowments, of course you've heard of Harvard, Yale having these very large endowments, pension funds, CalPERS, you may have heard of them. And of course there's high net worth individuals that's, you know, sort of sits next to family offices. And today we're going to talk about fund of funds. Funds of funds. What's a fund of fund? We'll get into that today with one of the leading fund of fund managers, Michael Kim. He's from Sandana Capital. That's C E N D A. What do they do? They invest in seed stage funds. This is Michael's third appearance here in the this week in Startup Family. He was just on liquidity a couple of weeks ago and he was also on episode 1075 back in June of 2020. Michael, welcome back to the program.

Awesome to be here. Great to see you.

So I wanted to sort of explain to the audience what is a fund of funds? And so let's start with that. What is a fund of funds in the venture capital space and why do they even exist?

Good question. So fund of funds is basically a pooled vehicle, meaning that it brings, we raise our own capital and then we invest that capital into other funds. In fact, there are fund of funds for hedge funds, fund of funds for PE firms and I think over time have become more specialized. So you might see fund of funds for crypto funds for example. But you know, when I started Sindana in 2010, we were specifically focused on seed and pre seed funds. And that's, we remain true to that. So that that is our sole focus.

And now why would an LP choose to go with a fund of funds as opposed to say directly investing in a series of funds?

Right. There are a couple of reasons. One, the LP could be too large to invest in small funds. So let's say you have CalPERS and they have $400 billion. And so for any check that they write, it might have to be $100 million, but they can't write a hundred million dollars to a bunch of VC funds, especially the smaller seed funds. And so they outsource that access. And so they may create a vehicle with the, and invest in a fund of funds. And that's actually providing them the access to these, these strategies that they themselves cannot access. Related to that, of course, is that, and just to talk about seed funds, There are probably 2,500 seed funds now today in the, in the U.S. alone, probably another 2,500 outside the U.S. they don't have the staff or LPs like that, don't have the staff to go and meet every one of them. So in a way we're a filter. The other sort of end of the continuum is that you're a family office, you might have one or two professionals running it. Again, they're not going to be able to go and meet a sufficient number of seed funds in order to have a diversified portfolio. So, you know, there it's almost outsourcing actually in both cases. The fundamental thing is that they're outsourcing the heavy lifting. You know, one criticism of fund of funds is, yeah, it's an extra layer of fees. So at Sandana we charge one in 10, our fund managers charge two and a half and 20. So those fees actually stack. So our LPs are actually paying three and a half and 30. But what I would argue, and I think is a compelling argument, at least in my mind, is that let's say someone made a $5 million commitment to Sendana. One percent management fee is $50,000. They would not be able to hire a full time employee for $50,000 to go execute on a strategy. So again, it's basically outsourcing. I guess a secondary element to it is that that groups like to use fund of funds in order to educate themselves. And so for example there, back in the day there were funds of funds focused on China. And you know, it behooves an investor to have boots on the ground in China and you know, a university endowment here in the US may not have the resources or the time to devote. So they invested in a fund of funds in China, they got to know the names and then ultimately invested in a few of them directly. And so that also is sort of the Achilles heel, which is perhaps a cynical way to put it, of a fund to funds business, which is that your own LPs ultimately move on and start working with those portfolio funds directly. But you know, for us, we've from the beginning have been very proactively introducing our LPs to our fund managers. And I can talk a lot more about why and why we did that.

That is an interesting reason to invest in funds. I know people who invest in our funds often tell me, oh well, you've got your ear to the ground. You invest pre seed and seed. So we get this early signaling. We have some venture capital firms actually who have carve outs in their funds, very large ones, to put money into our fund. Yeah. So we're a feeder. And so in a way you're a feeder and an educator as to, hey, these are new funds. So when that does happen, do you outgrow funds? Because one of the things I've noticed, like I saw you had in your roster, Lear Hippo. I remember Eric Hippo from his Zif Davis days running PC magazine and all that great stuff.

Right.

You know, those funds have gotten much larger over time, I believe. So do people outgrow Sindana over time if their fund gets too big and then do you hand them off? And then how does the economics work there? Because I know you have some large LPs and how do you manage that? Because most people might consider that like an end run or you know, maybe you're, I don't want to say stealing, but you're, you're taking the relationship. So, so how do you look at it and how have you framed it with your LPs?

I mean, from the beginning we, we encourage that. And it's all, it's also partly because in a way I had to evangelize what seed stage investing was, what these seed VCs were. And you know, back in 2010, there weren't that many seed funds. There are probably 20, 25 seed funds. And a lot of institutional pieces are like, what is this? Is this a fad? You know, how are they going to compete against multi stage firms like Sequoia? And I had to make the argument over a long period of time that this is going to be de facto early stage investing. And so we've been very encouraging of our LPs and also non Sendana LPs to come to our annual meeting to hear our fund managers and hear their approach to investing. And so from the beginning, we've encouraged our LPs to invest directly into our portfolio funds. And a number of have. Now, to answer your question a little bit more directly, yes, there are groups that have sort of graduated from our primary focus. Whether they've become ultimately a multi stage firm like say Forerunner, or, you know, their fund sizes have gotten bigger and we have less conviction that they can be a 10x fund for us. And so in those cases, and those gps are still phenomenal, we've made introductions and the specific example would be, you know, we were the largest check to forerunner Kirsten Green. Her first fund was 40 million, we wrote 10. Her second fund was 76 million, we wrote, sorry, 75 million, we wrote 26 million. So, you know, a quarter and a third of her fund, we ended up not continuing with her because she got progressively larger. But also she was going to start writing smaller series A checks. And that's not what my LPs want from us. And so we introduced them to Utimco. Jemco came in directly. I believe that they are one of her largest LPs now and I think that's just great. We love Kirsten, we talk to her all the time. Her first two funds are performing spectacularly. And you, Timco is very happy that as a very large institution, going back to what I was saying earlier, they have 60 billion, they need to write 30, 50, $100 million checks. And with these groups that graduate in fund size and become multi stage firms, in a way we're a scout and we help enable that.

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Yeah.

What were micro vcs, which I think we call pre seed funds now.

Pre seed seed. Yeah. But yeah, let me give a super brief history lesson. So right behind me are all those loose sites from my days at Morgan Stanley's Tech Emanate Group when I was there in the late 90s and helped facilitate the first Internet bubble back in the day in 1999. If you're going to start a software company, you actually had to buy sun microsystem servers. You had to pay for software. Right. Software licenses. And so, you know, a software company. Back then the typical round was actually five on five with two firms coming in for two and a half each. You know, so they're getting 25% of the company. Amazon Web Services, open source software. Over time it became literally an order of magnitude cheaper to start a company. You can start a software company now for 500k. And so it became cheaper to start a company. The other huge dynamic is that the multi stage firms kept getting bigger and bigger. So when that happens, and it's happening still, is that the GPS of those firms, there's an opportunity cost for them to spend time with a 500k check. And so that's why you started seeing firms in the early 2000s like Union Square Ventures, Foundry. True. Get organized to actually make these decent sized checks. I guess they were called Series A's. Today they'd probably be seeds. And then in the mid 2000s you had someone like Josh Koppelman start First Round Capital. And then this is where it segues into sort of what we do in the late 2000s, if you remember that somewhat cringy term, super angel is basically individuals who are spending full time investing using their own capital. Know someone like you, someone like Jeff Clavier, you know, sort of the Gil Pina it was.

Yeah, there were like a dozen of us. Cyan Bannister.

Yeah, exactly. You started institutionalizing. What I mean by that is taking outside Capital. So you're now starting real LPGP kind of funds. And so Michael Dearing is another example, you know, Mike Maples. So those were sort of the OGs back in the day. And that's when you started seeing the institutionalization of seed. And so just taking one step back, you have these larger firms getting bigger. It's a lot cheaper to start companies that created this sort of opening. I wouldn't say it was greenfield, but I'd say there was an opening for newer type of firms to come in. And fortunate for us, we were pretty early to see that trend. And I think today, with 2,500 seed funds, seed rounds being 4 million, I think seed is de facto early stage investing.

So why is seed stage and pre seed stage so appealing to LPs? We see a lot of movement recently after this super cycle you and I lived through. You were actually a VC before you had the fund of funds. I remember. And so there was this crazy super cycle. I happened to time it perfectly. I became a Sequoia scout and had my angel of syndicate, like, I think exactly as the super cycle started. So a lot of my success, I, I put on timing. And obviously you learn a lot because of timing both ways. Getting your butt kicked and kicking butt. Maybe you could talk a little bit about how the, the seed stage and early stage kind of carved a niche for itself and then became sought after. Because I remember in the beginning it was highly criticized. People would be very derogatory about Ron Conway and say, oh, spray and pray. There's no strategy here. Chris Sacca is just winging it. And then all of a sudden, you know, people started making contact with the ball and maybe knocking the ball out of the park. So maybe you could just tell us how the Market now, the LPs perceive the pre seed stage, specifically in seed stage.

Yeah, absolutely. You know, I think what it comes down to, the actual knocking the ball out of the park, is really the anecdotes that you hear about the kind of returns that those guys have generated. So Chris Sacca's first fund was 8.25 million. His DPI is 204X. He was a seed investor in Twitter, Instagram and Uber. He's also, by the way, a seed investor in Stripe. So very good access. Was able to get checks into those rounds very early on. And LPs hear about this and they're like, hey, my venture portfolio is like 2x. How do I get some of this 200x? And so I think it really comes down to the anecdotes in terms of returns. And I think fundamentally they also realize that if you're a university endowment and you want to get into an absolute blue chip multi stage firm, you may not get the access today that you think you might have. And I mean that on two levels. One, you might not actually just be able to become an LP in a Sequoia benchmark, Greylock, Excel, usb, et cetera. But secondly, if you do get in, then a lot of these platform firms like Andreessen have multiple vehicles, right? They have growth vehicles, they have non US vehicles both early and late. And so you might give them $100 million, but maybe 10% of that is for early stage ventures. So I think university endowments today, and I've heard this from a number of university endowments just within the last three, three or four months, they realize now that commitments to these bigger platform firms is actually not getting them early stage exposure.

So they're starting to unpack it and saying, wait a second, where are our dollars actually going? And when people raise larger funds, which has I guess been the big trend of the last five to 10 years, why do venture firms, if performance goes down with bigger funds, why do they raise bigger funds? And if bigger funds have less, let's call it different. Different patient, right. Like they just, they're non differentiated compared to each other. Like when I'm on the boards of companies and they get to that B or C round, they, they literally just take all the offers, put them into a Google sheet and they just have like, okay, here's the rights they're asking for, checkbox, check box, here's the valuation, here's the price per share they're willing to pay. And really the column that matters least is the brand name there. So why do all these GPS gravitate towards getting bigger and bigger and bigger and then which ones have stayed disciplined and stayed small? I mean maybe you could talk a little bit about the GP dynamic there.

Yeah, I mean the best known examples of that, of people showing discipline amongst the multi stage firms is benchmark Union Square Ventures. Those two groups have consistently remained small. You know, First Round Capital was very consistent, sort of like the 165 market. Now I think they've raised over 400 for their most recent fund. So you know, why do GPS want that? Well, they think that they have a bigger team. Everyone in a benign way of thinking about this. I think firms think about how much capital per partner. And so you know, if it's 50 to 80 million per partner, then suddenly if you have 5, 5 GPS. Because you want to cover different sectors, then you're looking at a $400 million multistage fund.

Yeah.

So I think that's the benign way of looking at it. The not so benign way of looking at it is that, you know, management fees, they get a lot. If you have a $500 million fund and you're getting 2%, that's $10 million a year.

Yeah.

In fact, over 10 years, that's about $100 million.

Yeah.

Of management fee. And that could be very tempting. Right.

Especially if you then launch a new fund every two, three, four years.

It stacks.

It stacks. And so now you're talking about 20, 30, $40 million just coming in a year. And that's why VCs have fancy offices. That's why you might see them be in some top tier office space in New York. They launched their London office and you're like, wow, this office is insanely beautiful. It's like, yeah, well, they have management fees. But the perverse thing that happens is, and I think maybe we could just. Permission to speak freely here, because these are businesses run by humans and humans, then if they make a lot of money, which can happen in the lottery system that we have here, you place bets, someone like Chris Sacca might go at some point, you know what, I'm going to retire. And then it comes out of retirement, says, hey, I'm going to do carbon, lower carbon, which I'm lucky enough to be an lpn and I want to do things that are, you know, save the world. And I feel really proud of doing every day. And I'm not going to look for the next Instagram stripe or, you know, Uber. I'm going to look in a different pond and I'm going to try to do a different mission, as is his want. But you start having these fees come in, man. What does that do to a GP's hunger and sharpness in your mind?

Yeah. So here's, here's some of the math around that. Let's say you're running $1 billion fund and you only get a 2x on that. You get $1 billion profit. You get 20% carry, that's 200 million of carry. Contrast that with a $50 million fund. Let's say they 10x it, they killed it. Right.

Wow. Got cut out of the park. Yeah.

500 million of value, 450 million a gain. 20% of that is $90 million.

Right.

And so even with a 2x on a much bigger vehicle, you know that GP stands to get over 2x the amount of carry. And so actually I think the larger funds recognize that they're not going to be 5x funds, they're going to be 2x maybe and they will make a good amount of carry if it all works out.

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Of the things I wanted to touch on to your question earlier is who's enabling this? I think if you looked at it historically, a lot of these really big funds, billion dollars and over, you know, say 10 years ago, and just to throw out a name like nea, strong firm, strong partners. But the sizing of that fund, one would think that's never going to be a 10x fund. But again to that math I was just talking about, it doesn't need to be a 10x fund for them to do very, very well. But from an institutional LP perspective, and this is probably more about state pension funds. So again at CalPERS they need to write $500 million checks, they need to write $250 million checks. So an NEA like vehicle is an easy way for them to make a 250, $500 million commitment. Check the box and say I have venture or State of Ohio, you know, their pension fund, they need venture because it's part of their asset allocation. But they're not geared as an investment team to go and hunt down every new High alpha, high potential fund manager. And so they'll give capital to groups, especially at the later stage, like an insight, like a nea. And again, no aspersions on any of those firms. They're great firms.

It's a viable strategy.

Structurally.

It's structurally different.

Structurally different, yeah. So that also gets to a philosophical question, which is, do you want to be the highest TVPI fund or highest DPI fund, or do you just want to be top quartile? And there is actually something to be said about a fund manager who is top quartile. Maybe not the best, but just top quartile. Three or four funds in. Back in the day, there were probably five firms that might have had consecutive 3X funds. A little bit different now because of the markups people saw in 2021. And we can talk about that. But consistency and the fancy phrase in the LP world is persistence of returns. Right, Persistence of returns.

Got it.

Are they showing consistent, persistent returns over time? Do each of their Funds generate a 3x? If you can find that magical combination. And maybe INSIGHT has this, maybe NEA has it, where an LP can deploy big dollars. Check the box that they have venture, and they are consistently, let's just say, a 2x. There is a demand for that kind of product.

Interesting. So there's massive pools of capital in the world working backwards for that. Those folks feel the need to have venture exposure. It is one of the more established categories for having, you know, a diversified portfolio. You have equities, you have commodities, you have real estate, and then you have this private equity thing, and then you have this venture thing, which I guess sometimes people put into private equity. There's a kind of a. An interesting discussion to be had there. But within venture capital, you could be going after the alpha or you could be going after the beta. The beta is the average venture returns. And I guess you could then compare it to the beta of the market returns, and then you have the alpha of the returns. The earlier you get, the greater the chance at alpha, and the later you get, the more money can be put to work. But you're probably going to be chasing beta. And then people might want that. They might want the exact average in that category. Correct. Is that, is that how the market has played out now?

Yeah. A long time ago, I was on the board of San Francisco's Employee Retirement System, which today is a $35 billion public pension fund. Back when I was there, it was about 12 billion. And asset allocation is something that is, you know, sort of untouchable, meaning that you spend a lot of time working with consultants thinking what is the appropriate asset allocation between all those different asset classes you mentioned? And then you stick with it because the mentality of a Harvard or a San Francisco employee retirement system is we're looking at it as a 20 to 30 year time horizon. We don't want to be subject to the vicissitudes of the market. We're not going to change our asset allocation every year. You kind of just stick with it. And so that said, you know, these institutional LPs, do you have asset allocation? They have allocation to venture and they need to fill it. They actually have to fill it. So how are they going to do that? Well, you know, investing in iconic, investing in insight, investing in any, any of these large groups, you know, actually fulfills again that sort of market demand for that specific product. Now those aren't necessarily going to be the highest tvpi, DPI kind of funds. And so it really is sort of that philosophical approach that you have. And I think maybe David Swenson at Yale, he was the longtime CEO there, CIO there, he has over 50% of his endowment in private funds, both private equity and venture. And I think of that, I think 30% is venture, which is astronomically high compared to any other endowment. And they have phenomenal results. So Yale is special because they historically have been able to get access to the best and highest alpha kind of venture funds, whereas a newer entrant to venture, again, they can just check the box off. And also I'm not trying to gloss over fund of funds, fund of funds also provides that access. Like if someone wants early stage exposure, some seed stage exposure, we are actually the perfect vehicle to do that.

Let's talk a little bit about beta in the early stage space. Y Combinator I guess is and techstars were the two funds that maybe tried to scale this up in a major way. Their returns as well are kind of returning to the average historically. Or when you're investing in four or five hundred startups a year, like those companies, firms I think peaked at, can they actually return alpha or is it more the industry looks at and goes, yeah, that's a great way to get the beta exposure to the space and maybe there's an outside chance of alpha occurring.

That's a really good observation. I think when you have hundreds of companies a year and you own 6%, 7%, that's actually a pretty good starting point. But ultimately you're an index of high quality companies and then you apply the power law. So most of them Won't return capital or just be one X's. But if you can catch on to one of those two sort of outliers, you know, like an Airbnb stripe, you know, you can have or stripe, you can have phenomenal returns. And I think that's what institutionalities are going in, eyes wide open, saying, okay, YC is very high quality. They have amazing screening, but ultimately it's an index with an option for a potential outlier. And they've done very well. And, you know, Gary Tan is an amazing leader of them.

Yeah, it seems to me like this is a great strategy, one I've kind of studied a bit, which is, hey, you know, once you get to 100 investments a year, which is what we're at, 100 new ones a year, we have to make a decision, oh, do we go to 200, 300, 400? Well, only if you can maintain quality. Right. And so if you see the quality stop, start dipping off, well, then you don't want to go to that 200, you know, you want to stay at 100. And so this is the thing, you know, in my fourth front, I become super vigilant about. It's just looking at the hundredth person we invest in a year, the 99th. Did we fill a seat or did we make a thoughtful decision? You know, and I think that's where I watched maybe some other funds that tried to get to scale, whether it was 500 or Techstars or whatever, and not disparaging anybody. But I did see companies that maybe we said no to in that early stage, you know, wind up in some other programs. And I just thought, wow, this is what you have to be realistic about, is of the application pool, are you keeping it to. In our case, we've kept it to 50 basis points. So 1 in 200 applicants get accepted into our programs. I think YC's, I think Gary said it's 1.25 right now. And so really, you know, just being hyper vigilant in order to have, hey, we got the beta. Because like you said, you keyed on it. Are you a high quality index or a low quality index? That's, I think, super key. But then that optionality, I mean, if the funder in hits Airbnb or Stripe Bingo. If it doesn't, well, then maybe you got the beta. So this beta with an option of alpha, kind of like a pretty perfect package, I think.

Yeah. Not to talk about our own book, but fundamentally, with a fund of funds, you are getting a lot of companies. So in each One of our fund of funds, we probably have a thousand companies and you know, Overall we have 4,000 portfolio companies. 130 of them are unicorns. Maybe in reality it's like half of that or 2/3 of that. But you know what I think is impressive, and it's a real testament to our fund managers, is that those unicorns in our portfolio, they were all from the seed stage. They weren't entered at a late stage valuation. This is when the companies are getting going initial product, market fit, and our fund managers are working with them and the founders are phenomenal and they've become something very valuable. So with the fund of funds, you do have also that sort of index. But what I would say is, and this gets back to your alpha beta observation, in our own portfolio, we have seed funds and we have pre seed funds. And I don't go advertising this to our LPs or to our fund managers, but I think of our seed funds as the market beta. High quality market beta for seed funds, which in my mind means that they have a higher probability of getting to 3 to 5x, but I think our pre seed managers actually have a higher probability of being 5 to 10x.

Got it.

So if you balance it right, and we in general try to get exposure equally to both seed and pre seed funds, you know, market beta 3x, the alpha from the pre seed funds, 5x, that generally gets us to a 4x. And historically our funds are generally 3 to 5x. Our first two funds are.

And diligencing. It's a lot of work and diligencing fund managers, critically important. I remember a decade ago, somebody said to me, you know how many unicorns you have? I said, I got seven. How many investments have you done? And I said, I think I'm at 125, 150 or whatever. And said, oh, I have got 15. And I said, oh, what are the 15? Looked at me, he had like four or five of the same ones I had. I said, oh, I don't remember you investing in that. He said, I bought secondary shares.

Yeah.

I said, when did you buy your secondary shares? He goes, I just bought them this year. I said, well, they're already a unicorn. He's like, yeah. He goes, but you know, my LPs don't know that. And I just put it on my. I got 15 logos. You have seven. I have twice as many unicorns as you know. And I said, wow. Oh my lord. You could literally game the system. I could go buy SpaceX, Anduril, whatever is the hot company of the moment on the secondary market. Put the logo on my website or wherever, Crunchbase, Pitchbook and maybe people don't know, but real LPs, thoughtful LPs, you are actually looking. When did that bet get placed?

Yeah, you valuation. Yeah, totally.

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To your question about diligence, the primary focus for us, and let me set the stage here in that we view each of our fund managers as a collect, as a specific unique network. And so at Sandana, we view our portfolio managers as a collection of networks. And you know, I think it's important because if you're a fund manager, how are you going to win a deal? Let's say you're, you're a seed fund manager, you're competing for a hot deal, some something that a lot of people are also putting in term sheets for. Why are you going to win? Is it your domain expertise? Is your network? Are you a good person? Does the founder really want to work with you? And I'm talking specifically about where our fund managers are writing the largest checks. So, you know, smaller funds, they can slide in with a 250 500k check. I'm talking about more like 2 to 3 million dollars checks. Why would the founder pick you? And so, you know, as I mentioned, domain expertise, networks, maybe you're a great guy to hang out with. Those are reasons that a founder may pick you, but ultimately they are entrusting you with their baby. And so you have to come through on actually providing value. And I know that's, that's been a thin meme for such a long time with VCs, how can I add value? How can I help you? Well, we actually asked that question. So as part of our diligence, which the bulk of it is to talk to founders, we will ask them, how has this person helped you post investment? How does that contrast to the other investors that you have on the cap table? You know, because you know, you might have multistage firms, you might have individuals, you know, you might have a super angel like Elad Gill or solo GP like Elad or Lockheed. Each of them bring a different thing to the table. So what we try to understand is what is the fund manager that we're looking at? What do they bring to the table and is it legit? Do they just talk the game or are they actually, you know, rolling up their sleeves and helping them? And so I think for founders it behooves them also to due diligence and actually talk to founders of other portfolio companies and say, hey, how did Jason help you? Is he responsive? Does he even respond to your texts? That little thing actually is very reflective of how a fund manager operates. And if you're a founder and you're stressing out about a major issue, whether I should hire a product manager or you know, should we launch this feature now? How do we tweak our product roadmap? You kind of want to know now. You don't want to wait a week because the guy is in Aspen or some on some place on safari.

Silent retreat for 10 days. Yeah. Not helpful to be on a silent retreat when a founder needs advice.

Yeah, yeah. It also goes back to your original, one of your original questions, which is if they're making so much management fee, how much hustle do they have left? And I've seen cases for sure where founders have or GPs have made, you know, life changing money and they've kind of started taking it easy. It almost becomes a lifestyle thing for them. But to the credit of some of our other fund managers, I would say they are amongst the hardest working, they're the most humble. And I'll give you two examples. You know Manu Kumar at K9 Venture Pre Seed fund.

Yep.

He's made a lot of money because he's been a very, very successful investor. But he is amongst our hardest working fund managers. It's his nature. He's a PhD in CS. He loves tinkering, he loves working with very early stage companies. Another guy, Eric Renal at Mucker, they've made life changing money through their funds. Oh by the way, their first fund was 12 million. They returned 19x in cash because of their investment in honey. And he could take it easy, he could go out and raise $500 million funds. He hasn't done that. He stuck to his knitting. He showed discipline, very humble guy. We love him, we love Manu. And those are examples of where Manu.

A great guy for, you know, he's. I know him from the early days. He was always super hardworking and everywhere and you have to be able to differentiate. You didn't dive into the point about the networks but you did dive into the value add. Oh yeah, the value add. I understand. Super easy to figure that out. You just talk to the founders, hey, was there an instance where they helped you post investment? And you know, I always tell the founders, like up to you to tell us, you know, hey, how can we be helpful and we'll be there for you and if you need us to get out of the way, we can get out of the way too, you know. And we try to set up massive lines of communication. What I found is like if you open up massive lines of communication and you check in with people and you stay positive, then they're going to be willing to share with you. So we have a slack room for everybody. We have their sms, we have their email, right. We have them in our database. We have a primary contact at the firm, we got a secondary contact with her. We run events, we try to have them show up for stuff. You know, we'll do a webinar about an issue that's pressing in the industry just so they have like lots of touch points with us, just ways to, you know, open up to us. And I always tell them at some point things are going to blow up. And when things get the gnarliest, that's when I can be the most helpful because I seen the most gnarly crazy stuff you would not imagine. I've seen companies like on the precipice of insanity. Call me then because you know, I've seen it all and here's my phone number. And when you just give them your phone number and say call me anytime, weekends, nights, it's all good. I pick up the phone, I'm a normal human being for sure. Or I'll text you back.

And when we say we want to be the lead investor, that actually is getting to what we think of ourselves as. We're not just the largest check or amongst the largest checks. It's really how we work with our fund managers. So we do a lot of the same things that you described. We have a Slack channel, we're emailing, we're on the phone constantly with our fund managers. Our goal is that they will call us at 11pm when they have a big issue that they want to work through. And we try to be very responsive. But also, let's talk about the network.

Piece because that to me you alluded to, hey, these networks don't overlap. So there is a network for yc, obviously there's a network coming out of Waterloo, Stanford, nyu, Columbia, you know, South America, Australia. There's a network. I know a bunch of these networks because we've overlapped with them at times. There's the all in podcast and this Week in Startups network. And we know people apply for us for funding and they have nobody on their captable that we've ever seen. And you're like, wow, this is as proprietary and pure of a source of startups as possible. Like people listen to all in and like, yeah, I have a startup, I'm in this weird location you never heard of and this is the first time we've ever talked to a venture capitalist. It's really weird. So how do you determine the networks, the overlapping, the not overlapping? I'm very curious about that.

Yeah, I mean you mentioned different universities and geographies. I'd also for sure add different companies. Right. So just to give an example, we recognized that we didn't have anyone from the Stripe network and so we were looking for someone who was credible, who was going to raise a fund. We went with this guy, Dieta Van Loemen, he's a Dutch American guy here in San Francisco. He raised a $15 million fund. We anchored it with three. He was employee 27, I think at Stripe and he also was the first head of Stripe International. So a lot of operating experience and so that's something that we thought was very unique to our networks. Lockheed Groom is someone who I like a lot and unfortunately for us, he was raising multi stage firms. But we actually brought Lockheed on as a member of our advisory board. And from time to time I get texts from him saying, hey, you ought to talk to this guy. Or I'll text him and say, what do you think of this gal? And he'll be very responsive with that. So you know, a collection of networks. That's how I think about what we've created the other element, Jason, I think that's important to recognize is that networks have a shelf life. And so what I mean by that is when you look at some of the data about fund one being the best performing fund and then subsequent funds decline over time, the easy answer is, oh yeah, they just got bigger. They start off with a $10 million fund, now they're managing a $300 million fund. So of course the returns are going to be worse. But I think also an element of networks. And the dynamic here is that if you're raising a fund one, you are going to go after the low hanging fruit in your networks. And in fact that's why your LPs are betting on you. Because you have this network, you kind of exhaust that by fund two or three. And so fund managers have to be always building their reputation, their market position and creating new network. It's a dynamic thing. We don't just sit and run, think, oh yeah, this is a stripe guy or uber guy. You know, those networks over time you know, evaporate or get weaker or you've already harvested for all the low hanging fruit that was available. You could also say that quite frankly about domain expertise. Yeah, right. You could be a great product manager at Google. You might have, you know, great insight into say, software infrastructure or whatever product and that's what you're selling yourself and that's the value prop of your fund. Like I have this network, the Google network, I have this deep domain expertise. I built all these products.

Yep.

That domain expertise evaporates probably faster than networks, right?

Absolutely.

What I learned, technology goes so fast.

People are like, what do you know about running startups? And it's like, yeah, you know what, I've been an investor now for 10 years. I have now become disconnected in some ways from starting a company from 0 to 1. But then in another way because I'm sitting with founders and I ask them thoughtful questions, what's working at your company, what's not? You then become a super router of information. So, you know, I'm shocked now by this incredible trend of efficiency in the market. I think we should maybe talk a little bit as we wrap up here about just the market today. Because the two trends I'm seeing that are just absolutely giving me hope and make me super motivated to do more investments and spend more time with startups today than in my, I guess now going into my 11th, 12th year of investing is that they're so efficient and I'm watching them build global companies so fast. The Google, Facebook Uber Airbnb, Global Playbook is like really well known now and then the ability to do more with less that we saw with cloud computing or you know, wework abstracting office space, ad networks.

Copilot and Copilot Copilot is going to help this, especially around software development.

Maybe we double click on what startups will look like 2024 going forward in your mind and what you think the game on the field is. Especially as it relates to when is a great opportunity to invest in companies and then how much capital are these companies going to need? How many people are they going to need to hit various milestones? 10 million, 25 million, 100 million in revenue?

It's an awesome question. So let me start off by giving you some statistics from some metrics from our data today this median seed round in Our portfolio is 4 million on 14. The median precede round is 1 and a half million on 7 pre 8 and a half post. The really interesting statistics around this is that the average age of a company by the time they go raise their seed round is now two years.

Wow.

Ten years ago it was like three months.

Yes. You started with your seed round.

Yeah, yeah. A related stat around that is that 75% of our portfolio companies that have raised the seed round have revenue when they raise their seed round. And 10 years ago it was less than 20%. And so bottom line companies are more mature, they have initial product market fit in the form of actual revenue. And I'd say that revenue is probably 100k to 400k. ARR.

Yeah.

Just use that as a metric.

That is just such an extraordinary point to just pause on what a radically different world it is just a decade later. I remember when we started it was zero revenue or maybe like one or two customers who are trialing the product and you were raising your money to kind of get this product to revenue. It's so often now that I'm meeting companies doing their pre seed seed round and they're like, yeah, we got 17 people. We figured out a way to bootstrap this to the first 10k a month in revenue, 20k a month in revenue with people coming to our accelerator with 25k a month in revenue. They haven't raised any money. Maybe they did a friends and family round, they raised 100k or something. It is incredible how quickly people can get to not zero to one in terms of product market fit, but zero to one customer, zero to 10 customers.

It's extraordinary for sure. You know, if you look at all the news stories about Venture financings, you know, I think those are kind of ridiculous because they're always these sort of catastrophic doom and gloom stories like oh yeah, venture is down 70% but they're using 2021 as the high water mark. Yes, the answer is Yeah, I mean 2021 and early 22 was, were outlier years actually in our data. If you look at the CAGR from valuations and round sizes across our 10 plus years of data, it's like 7, 8%. And that would suggest that today, you know, the four on 14, the one and a half on seven, that's actually where it should be. So I think we're actually back to normal. And here's the other interesting I think observation, which is seed rounds have been persistent now at 4 million a couple of years ago, pre 21 there were 3 on 9, today they're 4 and 4 and 14. So then the question is why is it still 4 million? You know, and I think part of it is because these companies are more mature. They actually have the initial product market fit, they're going through the sales motion, they're going, you know, they're starting to get that down. So you know, the punchline here is seed is the new Series A.

Absolutely.

And the special thing that we told our LPs at our annual meeting is that pre seed is the new seed precede. There's a lot of implications for that. So we are actually.

What are those? The pre seed is the new seed.

So a pre seed stage company, you know, is basically a founder with a PowerPoint. They don't have product market fit, they don't have anything. Our pre seed funds are smaller, they're about 50 million in size, they're getting much more ownership for smaller checks. And so the conclusion from one piece of analysis that we did, we looked at the mortality rates of our pre seed portfolio fund managers and the mortality rates of our seed fund managers. It's identical, it's 9%. And so if you're writing a 600k check to get 10% at a pre seed stage company or a million and a half to get that same 10% at a seed stage company, and yet the mortality rate is identical, that suggests to us that pre seed stage investing actually does not engender much higher risk. With that insight, we made the case to our LPs in December at our annual meeting that we are going to focus even more on pre seed funds. And so the question I think at the high level that you're asking is what does 2024 look like? And Beyond I think seed stage investing will still be the larger now perhaps more incumbent seed funds competing to write a $3 million check into a $4 million round. But they also have multi stage firms with active programs with formal programs competing against them. And so you know, seed stage investing is super competitive. There are fewer pre seed funds. So it's less competitive, perhaps a little bit more collaborative.

It's more work, I can tell you that. It's a lot more work.

I was about to get to that.

Yeah.

So our pre seed managers actually spend a lot of time with people who are still at companies and they are working with them after work to figure out is there an idea here, is there something that we can iterate on? And then they'll actually work with these people, you know, say at a Google or, or a databricks and say yes, this actually will work, I will fund you. So that person quits after three months of you know, iterating and then our PC manager comes in, gets 10 to 15% of that company for a relatively small check. Yeah, that is the beauty. But that also means. Exactly to your point, it's a lot harder work.

Yeah.

You got to just be granted you're just like getting deal flow from all your friends, all. Everyone's pitching your inbox, your pipeline is full. The pipeline for pre seed managers, they have to create themselves.

They're manifesting it.

Yeah. Yes. It's an order of magnitude harder. Yeah.

I did this experiment, this Foundry University 12 Week Pre Accelerator because so many of the people coming to us were people like you're describing. Hey, one of us is full time. The other two are still working at Uber or Doordash or wherever. Google.

Right.

And we kind of got a prototype and we actually got one person using it, a friend of ours. And you know, some CFO at some other company wanted this of software. We're testing it with them and we're wondering should we incorporate? Should we get a cap table going? And we're like yeah, you should, yeah, let's, let's talk about it. And about half the people in the program who we accept, we have 2000 applicants, we accept 200. Half of them are not yet incorporated. And we're like would you like 25 or 100k to get this party started? Would that help you get off the fence? And it turns out 60% of people ask us for that kind of a check size and we're like okay, if that's the check size you want right now, you don't want to go out and do 20 meetings and try to raise 500 or a million. We're more than happy to give you 25, 50, 100k just to get the party started, as long as we can invest a little bit more later. And so, yeah, I'm super excited about this space.

Jason. I'm wondering what the demographics of people like that are. And I'm not necessarily specific to what you're seeing, but just in general, because, number one, it's a major leap for a person to leave a cushy job and start a company. Right? And so that, to me, suggests either that they're relatively young or they've already made enough dough that they can take that risk.

It's sort of truly, it literally is that you'll have people who are in school or, you know, just entering the workplace. They either have their first job or they're doing consulting, or it's somebody who's, you know, been at it for 10 years. They've made it. They, you know, they have. They own their house, they're paying their mortgage, they're in their 30s or 40s. And, you know, there's this really interesting trend when I came into the industry, like, oh, yeah, you know, it's the Zuckerberg quitting Harvard that creates the huge company. And it turns out that's not actually the case. In my experience, it's the third time founder, like Travis Elon, et cetera, Mark Pincus, whoever it is, Evan Williams, they had two or three companies under their belt. They're in their 30s or 40s, they have their nest egg, and they're swinging for the fences. Now they got a really good idea. They've got a talent pool they can tap. So their first five employees are picked from their top 25 employees of all time who are like, yeah, I'll go on another adventure with you, Travis Cloud Kitchens. Yeah, let's do it. You know, and you just watch the alumni from one company go to another. And, yeah, it kind of bifurcates exactly as you're saying. There's, like, people right out of school, they're coming out of Waterloo, they're, you know, going to school at night or they're finishing up their degree. They've been doing consulting, they worked at one startup, it failed. Boom, and they're ready to get going. So I really feel like those kids.

Or young adults, I should say, have nothing to lose. The only valuable asset they have, aside from their horsepower, their brain, is their time. And so if you're a young person post college, is it better to go and climb up the Google ladder or actually jump in and start companies. And there are good reasons that you may actually want to get the training, get some actual domain expertise before you launch a company. So it's not all black and white. There's not like a line in the sand.

One of the great things is that the ladder has been pulled up in a lot of those companies who are sitting here in the early part of 2024, Microsoft, Google, everybody, all of a sudden doing what I call the gentleman's layoff, the gentleman's riff where it's like, oh, yeah, no, we just reorganized, but we got rid of 15% of the people. Oh, we did performance reviews. We got rid of 8% of the bottom 8% of performance. This is still happening. So the efficiency that we're seeing in startups is happening at big companies. They're cutting and then they're not adding people. And when they do add people, by the way, yeah, they're adding people in India, they're adding people in their Latin American office, they're adding people in their Portugal office, their Canadian office. It may not be the Silicon Valley elites, as they were called in the Ivy League elites or the developer elites. So where those people go if they can't get a gig, start a company, which I think is part of the great moment in time we're in. You know, this is what I love about a down market. You know, it's sad to see people lose their jobs, but it's inspiring to see those same people who got laid off and who are, you know, got a little chip on their shoulder, oh, you don't want me? Okay, maybe I'll make something myself. Maybe I'll be the next Google. Maybe.

So on that point, I think coming out of a recession or a downturn in the economy, or certainly a non zirp kind of era, I think this is pretty well known. But, you know, post Lehman Brothers bankruptcy In September of 2008, within the next nine months, Uber, Airbnb, Pinterest, all those companies were started. And it was not because it was certainly not because it was a good time to start a company, but it's because those founders were actually, it kind of filtered out the type of founders. These founders, as you know, best with Travis, for example, they would walk through walls to get it done. Right. And so what you actually saw in say, 2021 at the peak was a lot of tourist founders. You know, my. My friend started a company, so I'm going to start a company.

Yep.

Or in the fund world, we actually Saw a lot of tourist fund managers. They're like, hey, my friend just raised a $10 million seed fund. I'm going to do that too.

Yeah.

And I think now it's a lot of them have actually been flushed out. So that's why I'm saying it's a return of normalcy valuations. People know where the entry points should be, you know, from public markets on down, you know, so I think the playing field is set and people are ready to go on the offense.

We went from the ridiculous cappuccino to a nice flat white. You know, all that foam on the top of that cappuccino. You know, when it got ridiculous, people were like having the foam wars in the cappuccino world. And you're like, there's about 4 ounces in here and about 8 ounces in height of cappuccino foam.

Right.

All that gets blown off in a bad market and then you're just drinking, you know, the good stuff. The good stuff. The actual liquid here. And yeah, I think it's a great time for the market. Listen, Michael, you're so candid and got so many great insights with all that great data. Really appreciate you and thanks. We'll see you all next time on the pod. Bye. Bye. Hey, everybody. I talk to a lot of founders here on this Week in startups and as an investor, and they tell me the same thing over and over again. They want two things from me, more FaceTime and money. They want me to invest in their companies and they want to spend time together. So we've been working here on a new meetup program. We call it Founder Fridays and Founder Fridays are an event by founders for founders. This is an event that is hosted in cities by people like you. If you're listening to this Week in startups, you're a founder. So what are you going to do at Founder Fridays? You're going to get together with other founders in your community. It could be four or five of you. It could be maybe up to 30 of you in a location. Pick a cafe, pick a co working space. I like to go to a great Mexican joint or maybe a dim sum restaurant. You know, you can do shared food, have a couple of cocktails. Maybe you do it on a Friday, you get together and you host it. Now, why is it important for founders to get together? Shouldn't you be at home just focusing? Shouldn't you be in the office just focusing on your startup? Well, if you get together with other founders, true founders who are in the arena building, like you are, you're going to get a lot of value from that because you can trade notes with that other founder about what's working at your startup and what's not working. The truth is, if you're facing a problem, there are hundreds of founders out there who have probably solved it already. And instead of you banging your head against the wall when you sit there and you talk to three or four founders, you're having some dim sum, you're, you're splitting a quesadillas, some fajitas. Somebody say, oh, you know what? I had that same human resources problem. Oh, I had that same technical problem. Oh, I had that same marketing problem. And they might tell you about a tool or a service that'll solve that problem for you. This happens over and over and over again when I do Founder Fridays with our portfolio companies. Now, we're going to give you that same experience. But here's what I need you to do. I need you to host this in your city. So you're going to go to this weekinstartups.com meetups. That's it. And you'll see a landing page where you can sign up and you can say, I want to host in my city. Now, your city may already be hosting, so you can just join that person. And what if you go to this event and you learn some go to market strategy that 10x's your growth that might unlock funding, or you might be talking to somebody and they say, hey, I'm a marketplace too. I'm not a competitive marketplace. Your marketplace is for used cars. My marketplace is for hairstylists. Whatever your jam is, whatever you're working on, but they give you some technique that you didn't know about to increase your supply side or get more demand in your Marketplace and you 10x your business. I see this happen all the time. And founders are like mutants, right? And I'm like Professor X here. I'm trying to put on Cerebro and find all the founder mutants in the world and then have you get together and do your own little meetup. And here's what you're not going to have to deal with. You're not going to have to deal with a bunch of service providers trying to sell you software or services. And you're not going to have to sit through a bunch of passive speakers. You can listen to this week in startups and get the greatest speakers in the world on your own time. And you're not going to have to pay for a ticket to a conference or get on a plane or fly somewhere? No, this is about having an intimate experience with five, ten, maybe two dozen other founders in your city. Please go to thisweekinstartups.com meetups if you are a founder. This is for founders by founders only. If you are not a founder, this event is not for you. You can start your own meetup for lawyers, accountants, recruiters. This is for founders by founders. We vet everybody to make sure you're a founder and if you host it, it's a non commercial event. Our first Founder Friday will start on February 2nd, so please mark your calendars and we're going to do these on a rolling basis. You can join an existing meetup if it's already occurring in your city or you and one or two other founders can start your own. 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