20VC What It Takes To Raise A VC Fund & Investing in First Time Fund Managers with Michael Kim @ Cendana Capital

Host Harry Stebbings welcomes Michael Kim, founder and managing partner of Sendana Capital, a fund of funds that invests in seed funds, to discuss the venture capital landscape and the intricacies of LP investment in VC funds. Kim shares insights from his journey, beginning at Morgan Stanley, transitioning to Rustic Canyon Partners, and ultimately founding Sendana Capital. He highlights the importance of a robust seed ecosystem, the significance of fund managers leading deals, and the critical role of portfolio construction in early-stage investing. The conversation also delves into the evolution of seed investing, the benefits of innovation for the economy, and the potential pitfalls of LPs investing directly in startups. Kim emphasizes the need for discipline and focus in fund management, rather than pursuing asset accumulation, to create long-term value for investors.

• Michael Kim is the founder and managing partner of Sendana Capital.
• Sendana Capital invests in seed funds and has a prominent portfolio including SoftTech, Freestyle, Founder Collective, Collaborative Fund, Lira, and Hippo Ventures.
• Michael was an original partner at Rustic Canyon Partners, a VC firm with $1 billion under management.
• Beezer Clarkson at Sapphire Ventures facilitated the introduction to Michael Kim for the interview.

"So joining me in the hot seat today, I'm delighted to welcome Michael Kim. Michael is the founder and managing partner of Sendana Capital, a fund of funds which invests in seed funds, and it seems we've stalked his portfolio with our previous VC guests who include soft tech, Freestyle founder, collective collaborative fund Lira, Hippo Ventures, and actually many more."

This quote introduces Michael Kim and his role at Sendana Capital, highlighting the connection with previous guests and the impressive range of seed funds in their portfolio.

• Michael graduated from Wharton in 1997 and joined Morgan Stanley's technology M&A group.
• He participated in the first Internet bubble and then joined Rustic Canyon in 2000 for nine years.
• Simultaneously, he served on the board of San Francisco's public pension fund, gaining LP experience.
• This experience included asset allocation, evaluating and monitoring managers, and understanding LP perspectives.
• Venture capital firms were growing, and it became cheaper to start companies, leading to the emergence of smaller funds.
• Sendana was founded to cater to the new class of micro VC funds that were emerging due to these market changes.

"But while I was doing that, and I was always based here in San Francisco, I was also on the board of San Francisco's public pension fund. And that at the time was about twelve, $13 billion. Now it's about 2020, 1 billion."

This quote explains Michael's dual experience in VC and as an LP, providing the background for his unique perspective and the eventual founding of Sendana Capital.

• The seed funding environment has changed significantly, with more institutional quality seed funds emerging.
• Initially, seed investments were considered a fad, but these smaller funds have proven to outperform and represent early-stage venture capital today.
• The proliferation of seed funds is beneficial for entrepreneurs and the economy.
• Innovation from startups has contributed to the Nasdaq, and the Great Recession facilitated the rise of the shared economy.

"By 2005, you had groups like Union Square Foundry. True. By 2007, eight, you had groups like Steve Anderson at baseline, Mike Maples at Floodgate, Michael Dearing at Harrison Metal. So you started seeing this emerging group of smaller funds focused on doing the first round of investment."

This quote highlights the trend of smaller funds emerging to focus on early-stage investments, indicating a shift in the venture capital landscape that Sendana Capital is a part of.

• The growth of seed funds and early-stage capital has made it an ideal time for entrepreneurs.
• The availability of various funding sources, including accelerators and corporate VCs, has increased.
• The success of startups is critical for the economy, with many Nasdaq companies being venture-backed.
• Startups are a source of innovation and job creation, with the shared economy rising post-recession.

"Certainly a lot of different sources of funding aside from seed funds through accelerators, corporate vcs getting more active. So I think there's a plethora of early stage capital available to an entrepreneur."

This quote emphasizes the positive impact of the diverse funding landscape for entrepreneurs, which is conducive to innovation and economic growth.### Taxonomy of Early Stage Investment

• Definitions of angel investors, super angels, and institutional quality seed funds.
• Composition of seed rounds in the U.S., typically ranging from $1 to $3 million.
• The concept of "party rounds" and their potential drawbacks.
• Importance of having institutional seed funds for the next round of financing.

"Angels, I think, are individuals who as a hobby, invest in early stage startups, super angels, which I don't think most people talk about anymore, but super angels are ones who are using their own money and doing this as a full time profession." This quote explains the difference between angel investors, who invest casually, and super angels, who invest professionally using their own funds.

"The absolute worst scenario... are these party rounds... when the company needs to raise their next round of financing, there's no one necessarily on point, especially if the financing is a difficult one." This quote highlights the problems with party rounds, where a large number of individuals invest but may not provide the necessary support for future financing rounds.

• Challenges of LPs investing directly, such as adverse selection.
• Sendana's approach to direct investments at the early growth stage.
• The dynamic between LPs, fund managers, and access to high-quality deals.

"I do think that there are substantial issues with lps investing directly. First and foremost is adverse selection." This quote identifies adverse selection as a significant risk when limited partners (LPs) invest directly in startups, suggesting that such opportunities might have underlying issues.

"We do have a direct investment fund... We think that technology and market risk are largely mitigated." This quote explains Sendana's strategy of investing directly in more mature companies through a standalone fund, aiming to reduce technology and market risks.

• The process and dynamics of seed funding to Series A and B rounds.
• The role of large venture capital firms and their focus on ownership.
• The limited access LPs have to high-quality early-stage deals.

"High quality firm like Sequoia, comes in with a $10 million Series A. They're not going to make room for anybody else." This quote illustrates the competitive nature of venture capital funding, where top-tier firms like Sequoia dominate investment rounds without leaving room for others.

• Sendana's criteria for evaluating fund managers, including ecosystem, high-quality entrepreneurs, and co-investors.
• The focus on robust seed ecosystems in specific geographic locations.
• The importance of follow-on capital from larger VC funds.

"The first filter that we use is ecosystem... we're focused on the Bay Area as well as New York." This quote outlines Sendana's emphasis on strong startup ecosystems as a primary factor in evaluating micro VC fund managers.

"If you're the go to seed fund in Cleveland, we are not likely to take a look because there aren't that many larger VC funds that are based in Cleveland." This quote indicates Sendana's preference for seed funds in areas with a significant presence of larger VC funds, due to the challenges of attracting follow-on capital in less prominent locations.## Portfolio Construction

• Portfolio construction is a key focus, specifically targeting General Partners (GPs) who lead deals and write the largest checks in seed rounds.
• GPs with credibility to organize syndicates and partner with entrepreneurs are preferred, often being ex-entrepreneurs themselves.
• The ability of GPs to facilitate the next round of funding by working closely with companies on operational and performance metrics is crucial.
• Intangibles such as discernible edge, networks, reputation, experience, and long-term motivations of GPs are critical in the selection process.
• The goal is to identify long-term platforms with the potential to become the next major players in early-stage investing, like Sequoia.

"So what we mean by that, we specifically look for GPs who are leading their deals. They're writing the largest checks."

This quote emphasizes the importance of selecting GPs who take the lead in investment deals by contributing significant capital.

"They have the credibility with the entrepreneur to organize that syndicate and ultimately be a partner to the entrepreneur in helping build the business."

The quote highlights the necessity for GPs to have strong relationships and credibility with entrepreneurs to effectively support and guide business growth.

"How do we get a sense that particular GP has a discernible edge? What kind of networks the group have, what kind of reputation do they have in experience?"

This quote addresses the evaluation of intangible factors that contribute to a GP's potential for success, such as their unique advantages, network, and reputation.

"We're looking for long term platforms. We're looking for the next sequoia in early stage investing."

The quote reflects the ambition to invest in GPs who have the vision and potential to become significant, enduring forces in the venture capital ecosystem.

• Dave McClure from 500 Startups advocates for a diverse portfolio, citing the rarity of unicorn startups.
• The debate centers on whether it's better to have a heavy investment in fewer deals or a spread-out investment across many deals.
• Michael Kim argues that ownership percentage in a company is crucial for meaningful returns, especially since seed funds typically don't invest in all funding rounds.
• Seed funds aim to establish significant ownership early on to compensate for dilution in later rounds.

"Dave is a very smart person, a very nice person, and I love talking to him. He and I have publicly disagreed many times about his portfolio construction and my thoughts on what the right approach is."

Michael Kim acknowledges Dave McClure's perspective but indicates a history of disagreement on the optimal portfolio construction strategy.

"Ownership of a portfolio company, that is extremely important."

This quote underlines Michael Kim's stance that having a substantial ownership stake in a company is key to achieving significant returns from venture investments.

"Small 1% positions imply that you're required to have billion-dollar exits in order to move the dial."

The quote explains the challenge with having minimal ownership in companies; such positions require exceptionally high-value exits to significantly impact fund returns.

• There has been a concentration of VC funding into top-tier funds, with large funds like Andreessen Horowitz raising significant capital.
• The current market dynamic is described as a division between the 'haves' and 'have-nots', with top-tier funds able to raise funds easily.
• Institutional Limited Partners (LPs) may have exhausted their capital allocations for the year due to re-ups in top-tier funds.
• Michael Kim suggests that newer funds should engage with institutional LPs during the second half of the year to be ready for investment decisions early the following year.
• Studies indicate that returns on private equity investments can increase post-recession, with successful companies like Uber and Airbnb founded during economic downturns.

"The absolute top tier can raise at will."

This quote captures the ease with which the most successful VC firms can secure funding due to their established reputations and track records.

"A number of LPs I know have already spent their budget or have already allocated their budget to these re-ops."

Michael Kim notes that many LPs may have already committed their available funds for the year, largely to established funds.

"What that means specifically for newer funds, I guess the have-nots. I would say that they should spend the second half of this year meeting with institutional LPs."

The quote advises newer funds on strategy, suggesting they build relationships with LPs to position themselves for investment consideration when more capital becomes available.

• Seed investing is viewed as having an asymmetry of risk, with the potential for significant upside through outlier successes.
• The discussion about which market segments are most exciting remains open, with an interest in continuing the conversation about opportunities in seed-stage investing.

"I think one important element of seed investing, our hypothesis is that it's actually an asymmetry of risk."

This quote introduces the concept that seed investing carries a unique risk-reward profile, with the possibility of high returns from exceptional companies.## Seed Investment and Risk

• Seed investors can achieve substantial returns with successful companies like Uber.
• Even in less successful outcomes, seed investors often recover some capital.
• The mortality rate in Michael Kim's portfolio is less than 10%.
• Long-term, steady-state mortality rates are expected to be 25-30%, not 80%.

A seed investor in Uber has done extremely well, but if a company exits for 100 million to a billion dollars, the seed investor does very well on the downside, we actually think that risk is a lot more limited.

This quote explains the potential for high returns in seed investment and suggests that downside risk is often overestimated.

What I mean by that specifically is that a seed fund that invested, let's say, a million dollars into a company, the team builds out the product, never gets the market fit that's required. So they need to sell. They can sell the company for a few million dollars, and the seed investor gets some capital recovery, if not a profit.

Michael Kim clarifies that even if a company does not achieve market fit, there is still an opportunity for seed investors to recover their investment through a sale.

I will tell you that through our portfolio of 700 companies or more, our mortality rate right now is less than 10%.

This quote provides empirical evidence from Michael Kim's own portfolio to support the claim that the risk of total loss is lower than perceived.

And I do think that the longer term, sort of steady state mortality rate is probably 25% to 30%. But I don't think it's 80%. But we'll see.

Michael Kim provides an estimate of the longer-term mortality rate for companies, which is significantly lower than the often-cited figure of 80%.

• Michael Kim's favorite book is "Catch on the Rye" because of the iconoclastic protagonist, Holden Caulfield.
• Maintaining discipline in investment focus is a challenge for Michael at Sandana.
• Michael wishes for more rational and transparent behavior from LPs (Limited Partners).
• His preferred reading materials include Techcrunch, recode, Pando, and Harry Stebbings' podcast.

So, your favorite book and why catch on the rye.

Michael Kim's favorite book is "Catch on the Rye" due to its thought-provoking protagonist.

I think maintaining discipline on what we do. We are only focused on seed funds and also making these direct investments.

This quote highlights the importance of discipline in investment strategy for Michael Kim and his firm, Sandana.

I think most lps are social proof investors.

Michael Kim criticizes the tendency of LPs to follow social proof rather than making independent, rational investment decisions.

I read Techcrunch, recode, Pando, and actually I listen to your podcast.

Michael Kim shares his go-to sources for staying informed about the tech and venture capital industries.

• Michael Kim values thoughtfulness and humility in venture capital partners.
• Building a long-term platform and generational shift are key to a VC fund's success.
• Michael has great respect for Jeff Clavier and the Softtech team's approach to investing and mentorship.

In terms of Jeff as a GP, extremely thoughtful, he's french and very successful.

Michael Kim appreciates Jeff Clavier's thoughtfulness and humility despite his success, countering stereotypes.

One element that's particularly attractive about what Softtech does and what Jeff has done specifically, he has sought to build a long term platform.

This quote emphasizes the strategic importance of building a long-term platform in the venture capital industry.

If you look at the absolute top tier VC funds, they've done a phenomenal job of generational shift and the older generation handing off to the younger generation.

Michael Kim identifies generational transition as a hallmark of the most successful venture capital funds.

• Michael Kim aims to maintain discipline and focus to generate alpha for investors.
• Sendana is focused on seed funds and direct investments, avoiding the temptation to grow too large.
• Long-term success is seen as dependent on discipline and specialization.
• Sendana has no interest in becoming a multi-billion dollar asset gatherer.

My fundamental objective is to make our investors as much money as possible.

Michael Kim's primary goal is the financial success of Sendana's investors.

I think the key to long term success is discipline and staying focused on what you're best at.

This quote outlines Michael Kim's philosophy on achieving long-term success through discipline and focus in their investment strategy.

We have zero interest in becoming a multi billion dollar asset gatherer and living off our fees and having swanky offices.

Michael Kim expresses a clear disinterest in scaling Sendana to a point where it loses its focus on performance and becomes fee-driven.

• Harry Stebbings expresses respect for Michael Kim's achievements with Sendana.
• Harry promotes the 20 Minute VC platform and other services, such as DesignCrowd.

A huge hand to Michael for giving up his time to be on the show today.

Harry Stebbings thanks Michael Kim for his participation in the podcast and acknowledges his contributions to the venture capital industry.

And if you're also loving the 20 minutes vc and do not want to miss a thing from us, then you can add me on Snapchat at htebings or you can sign up to the newsletter on the twentyminutevc.com.

Harry Stebbings promotes the 20 Minute VC platform and encourages listeners to connect and subscribe for updates.