Limited Partner Unlocked: Michael Kim Cendana Capital on the Emerging Manager landscape, fundraising, and the need for liquidity

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Kaji, and on this week's episode, we continue our series of LP Unlocked conversations with Michael Kim, founder of Sindana Capital. Sindana focuses on investing in seed stage VC funds across the globe. The firm has also invested alongside managers in co-investments and recently launched a partnership with Klein Hill for a secondaries fund. As someone that's been a student of the VC landscape for decades, Michael brought many unique insights to the conversation, including the traits he's observed from successful seed fund managers, how to foster trust with LPs, and his view on fund sizing.

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2:05This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Michael, it's so great to see you and thanks for being on. It's great to see you. It's been a long time. It has been a long time. Speaking about a long time, it's hard to believe that Sindana has been around for 12 years. And you and I were talking right before the show, the number of seed funds, or back then we called them super angels, micro VCs, whatever the nomenclature was, but there was only about 25. Today, there's over 2 ,500 seed funds. But maybe we go back to the origin story of Sindana.

2:39And you had been a direct investor. What did you see in the market at that time that represented a gap in the LP world? You know, we can even go back further. So back in the 90s, I was at Morgan Stanley's Tech M &A Group. You can see the loose sites that we got from the deals we closed. And back then, you know, a software company needed to raise$5 million to get going. They had to buy Sun Microsystem servers. They had to pay for software licenses. And thanks to AWS and the cloud, thanks to open source software, you know, you can start a software company for literally an order of magnitude less for$500 ,000.

3:16It sort of started the opening in the early 2000s for firms like Union Square Ventures, Foundry, and True, and then mid-2000s like First Round Capital. In the late 2000s, you saw these super angels, people who were using their own capital but spending 100 % of their time investing, start to institutionalize. Horsley Bridge actually was very early to that. They backed Mike Maples and Steve Anderson and Michael Deering, for example. Then you have sort of the next layer of guys like Jeff Clavier, who was pretty well known at the time and started institutionalizing himself. So, you know, that was sort of the context and the dynamics.

3:54Venture capital writ large, you know, the multistage firms were getting bigger and bigger and bigger. And so there was an opportunity cost for those GPs at the multistage firms to spend time with these smaller checks. And so I think that was sort of the driving forces behind the rise of seed funds. I launched it in 2012. It took me almost two years to raise the first fund. So we were up and running by 2011 and 12. We started talking to groups like IA Ventures, you know, Roger Ehrenberg, prolific angel, phenomenal investor, Kirsten Green at Forerunner, had a thesis, had made pretty interesting investments at the time, like Warby Parker, for example.

4:33and they started institutionalizing, but most institutional LPs at the time did not know what seed stage investing was. When I was raising my first fund, the common reasons people were passing on me were, you know, your sole GP, it's a fund of funds, there's extra layer of fees, it's the illiquid asset class. This is coming out of 2008 and 2009. And then what is seed? Is it a fad? You know, why wouldn't the multi-stage firms just dominate here? So So there are a lot of headwinds. Today, after 12 years, people have started understanding and appreciating what seed stage investing is. And our thesis from the beginning was, it is de facto early stage investing.

5:15Yeah. And we'll get into the evolution of seed and how you think about pattern recognition and what you've learned in terms of lessons back in these managers and some of the things you can extract. I do want to go back to your fundraising cycle. This was right after the GFC. So it was actually hard to raise. And what typically happens after these periods of resets, people tend to go toward this perceived flight to quality, meaning I will back things that have been around with long track records. And while there were folks like the Steve Andersons and Michael Derings and Mike Maples and Jeff Klavy and others, it's still early.

5:53And it was still unproven that, number one, you could raise these really small firms and get these great returns. Number two, many of them, there were solo GPs, which for a lot of LPs was something that you shouldn't do because it's key man risk. Tell us a little bit about the thesis that you had that you were going out to LPs and maybe talk about that first investment. The thesis that we're talking about is, as I mentioned, that seed stage investing will become de facto early stage venture. And thankfully for us, that's played out. I think one of the core elements around that whole investment thesis is that if you find fund managers who get relatively large ownership for their first check and potentially can even build on that, they need more measured returns.

6:43So$100 million exit to a fund that owns 15 % of a company and that fund, let's say, is$60 million. You just return a quarter of your entire fund. And meanwhile, of course, the multistate firms are getting bigger and bigger. And so$100 million exit would not move the needle for a billion dollar multi-stage fund. In fact, our first investment was to Roger Ehrenberg at IA Ventures, spent a lot of time with him, talked to a lot of the founders that he invested in. Roger had a specific point of view. And back then, he was calling it big data, if you remember. And I thought that that was a very interesting take in the investing world.

7:25It was an interesting organizing principle. And then adding to that, Roger had a portfolio construction where he wanted to have 25 to 30 companies. He wanted to own 10 % or more and then actually would build up. So one of his major successes is TradeDesk. And this is a company where when it went public, iAventures owned 17%. 100%. But if you look behind the curtain, things weren't always up and to the right. The company had some difficulty. And Roger and also Eric Paley at Founder Collective, which was also an investment that we had made, both stepped up and were able to increase their ownership.

8:06So I think both of those fund managers, Roger and Eric, really have an investor mindset. And so one perception of VCs is that they're dreamers, they want to change the world. I think that's great. And that helps you think through what could be possible. But just as importantly, you have to be an investor, you have to be able to get sufficient ownership. And there's a lot of elements that sort of fall from that, including the credibility. And that gets into sort of some of the areas that we look for when we diligence a new fund manager. Yeah, and you mentioned a number of names, and certainly Roger, who has been, you know, one of the legends in the industry from the day he started IA.

8:51Obviously, he's doing his own thing now with his sons. For example, Eric and David over at Fabric Collective, you had Kirsten Green, and they were real craftsmen in terms of how they approached investing and helping companies. And since then, the seed market, as you mentioned, has institutionalized, it's grown, probably grown more than you and I could have imagined in terms of the number of funds and number of firms come into market. Last time we counted, it was like 2 ,700. And that's probably missing a lot of the really, really small ones. You've been through so many of these discussions and sitting on LPACs.

9:27What have you noticed, I guess, behaviorally in terms of the characteristics of these people? You mentioned one thing, the investor mentality. Are there other commonalities that you've seen that have made some of the managers the most successful? Yeah, I mean, I think table stakes is grit, determination, and hustle. Deal flow is not just going to come to you. You have to have a point of view, and then you have to go find what you want. sort of underpinning all of that aside from high, you know, high horsepower and grit determination and hustle is that you have to have domain expertise. You have to have a certain base set of understanding about how things work.

10:07This is sort of a cliche now, but contrarian thinking, you have to think, well, just because it's being done this way, doesn't mean it can't be this way. And then the other even sort of like mind expanding dynamic here is that you have to be able to really get a good grip on what the TAM is, the total addressable market. So like when Uber started, you know, everyone was like, oh, that's just, you know, a replacement for black cars. And no one saw the vision. And maybe Uber ultimately stumbled into it. But, you know, where you could crowdsource drivers and really have network effects. Again, maybe that was partly luck and partly experimentation, but to be able to see something beyond the corners is a special skill.

10:51That vision, the ability to do that is predicated on high horsepower, grit, determination, hustle, and domain expertise. Another thing we should do is just juxtapose between now and 12 or 13 years ago. Of course, the level of competition has increased. We've talked about it as a seat is institutionalized. And we've also seen the change in the size of rounds. I think back then, it was atypical to see a seed round done in that$1 million, maybe $1.5 million, and sometimes even less. And today, seed rounds are typically$3 to$5 million. Pre-seed might be in that$1 to$3 million range. And so a lot of firms have had to evolve their business models, bigger fund sizes, more competition.

11:43I'm curious in terms of what you've seen the most successful managers do in involving their own strategies as the market has evolved over the last 15 years. So we looked at our portfolio data over the past 12 years. And, you know, today, as you mentioned, and this is Sendana portfolio data, the median seed round is 4 million on 18 and a half post. That basically is where Series A's were being done around 2012. And then when we look at where pre-seed rounds are done today, the median in our portfolio is 1.5 on 8.5 post. And that is actually almost spot on where seed rounds were being done in 2012.

12:23So we've been telling our LPs that pre-seed is the new seed. And I think the refrain that seed is the new A, that's been around for a while. But I think we are really emphasizing a focus on pre-seed, partly because of the dynamic you talk about. If there are 2 ,700 seed funds out there, most of them are not going to be writing big checks. They're not going to be leading in deals. Let's say 10 % of them. So that's 270 right there. And in order to do that, and if the median seed round is$4 million, they're going to have to be able to write$2 million to$3 million checks. And then if you have 30 portfolio companies, that's almost$90 million, right?

13:033 million times 30. And then you'd want to have some reserves. So fund sizes have gotten bigger. So you can see a group like that having a fund size of$150, maybe$180 million. Not even that long ago, first round capital, Union Square Ventures, those funds were generally around the$150 to$165 million mark. They're a little bit larger now, especially first round. But I think the seed market has definitely changed. The high-integrity fund managers who are leading the deals and really thinking about how to optimize their portfolio, they need 15 % ownership, 12 % to 15 % ownership. They need to write$3 million checks, and they need to have diversification of their portfolio companies.

13:49So that math checks out to about$150 million. And then the question then becomes, going forward, in a non-ZERP world where exits are much more difficult, where the unicorn exit is actually a true outlier, and maybe$500 million exit is a great outcome, You know, then you can do sort of the reverse math and say, if I owned 8 % at exit at$500 million, you know, you're getting back$40 million. That may not even be a fund returner. You're having this confluence of market forces where, yes, seed rounds have gotten bigger, and we can talk about why. But then also the exit opportunities becoming fewer and smaller.

14:36Yeah. So going back to a little bit of the pre-seed, which used to be the old seed in terms of size, and what we see about pre-seed right now is typically it's almost at inception. Maybe there's a product with very little revenue. The multi-stage firms, while they're doing seed, they're usually doing big seed, and it's the more obvious seed, right? So entrepreneur that's a repeat entrepreneur in a fairly hot sector. And getting that type of ownership of, let's say, 15 % to 17 % has actually been really hard for a lot of seed stage investors because of the inflation of the valuation and their fund size.

15:11In cases where you are seeing some of your managers get that 15 % ownership, and of course, they'll be diluted down to maybe 10 % or somewhere around that by the time the company goes public or gets acquired. it's still you have to convince the entrepreneur to take your money in many cases. As the firms that you've backed, what are you looking for in terms of their ability to show that in their thesis they're going after, let's say it's a sector, maybe it's a geo, or maybe it's just a thematic area where they have domain expertise, what are the necessary ingredients for these folks to be able to win that 15 % without taking on adverse selection?

15:51Yeah, adverse selection is super important because, you know, especially in 2021 and 22, why raise a pre-seed fund? Why not go straight to seed and raise the$3 to$5 million? We were really cautious with our pre-seed fund managers saying, you've got to really think why and how you're getting this 15 % ownership with this founder. The best answer that we hear from our pre-seed managers, as you said, pre-seed is like inception stage investing. It's a founder with a PowerPoint. That generally is true, but I think our pre-seed managers are actually spending T-minus two, T-minus one, meaning that they are working and iterating with people who are perhaps employed at Google or the big public tech companies or at the later stage private companies.

16:39and thinking through and understanding, does this person have the vision and the ability to create an alternative or something totally different? And so because they're devoting that time, basically sweat equity, and I'm talking about from the GP side, they're spending the time with that potential entrepreneur. I think there is sort of moral suasion where the entrepreneur, if they decide to go out and pull the trigger, quit the company and take the risk of being an entrepreneur, they would want to work with the person that helped come up with the idea. So we're seeing a lot more of that. And that's sort of been the playbook of our best pre-seed managers.

17:15You talked a little bit about pre-seed and seed, of course, seed being the old, what used to be a series A in terms of the size of the rounds, the traction of the companies, often the valuations we were seeing in the 20s, even in today with the reset. It wasn't uncommon for me to see seed rounds even done at a 30 cap in 2021. But today, downstream financing is harder. So we saw almost an unnatural level of graduation rates from seed to series A, and series A to series B. I think that is now going to regress. And some companies are going to need more capital to get to the milestones necessary to go from pre-seed to seed, seed to Series A.

17:57How are you thinking about that component of it? And do you think that means that the managers that you're backing should have more reserve capital to account for the fact that the bar is much higher for the downstream capital? Part of the reason why I think the median seed round today is$4 million in our portfolio is because founders want to have a little bit more cushion. From the get-go, over 10 plus years ago, the seed round was supposed to provide 18 to 24 months of runway. Back then, before the public companies like Google and Salesforce and all the others started paying their engineers$500 ,000, in general, the seed stage companies could do that and get away with a million or two as a seed round.

18:41Today, there is obviously inflation. Wages are much higher. It does cost more, but it'll be interesting to see how AI plays out. And, you know, for Copilot, it's a good example of how you may need less developers to generate the same amount of code. So I think there'll be productivity enhancements. For better or worse, today we're kind of stuck at$4 million. And again, that drives what kind of seed funds are going to be formed. Because, as I mentioned, you know, if you're going to lead a$4 million seed round, you need$2.5 to$3 million check to do that. And then that aggregates up to seed funds that are over$100 million.

19:16The other comment I'd make is that there's a bifurcation of what seed is in that, as I mentioned, our fund managers, the median is$4 million on 18.5 posts. When you talk to groups like Excel or Index, and I had conversations with them, and they'd say, oh, yeah, we're active seed fund managers. We have a separate seed fund. They're talking about like five on 30, seven on 33. That's a totally different league. And then the way you can kind of titrate that is they are focused on repeat entrepreneurs, very credentialed ones, whereas I think our fund managers actually are starting to work with ones who are perhaps more first-time fund managers.

19:59And I think it's an open question on whether someone who is highly credentialed and maybe the second or third-time entrepreneur is actually going to outperform a first-time fund manager or a first-time entrepreneur. The data is not completely clear on that. And I've seen some of the data in terms of first-time entrepreneurs versus second or third. In many cases, the first-time entrepreneur actually has done incredibly well versus their second or third act. And I don't think there's any clear conclusions we can come on that, but it is very clear there have been some great companies by people that have started companies for the very first time.

20:36This concept of a seed round being$4 million and pre-seed being$1 to$3 million, depending on the type of company, it does suggest, of course, these rising fund sizes for seed managers to be able to get the ownership, to have the reserves. I'd love to get your take on fund size and the correlation to returns, because one of the things that many people think is as you get bigger fund sizes, it's going to have an inverse correlation to returns. But at the same time, you have to balance it between you have to prosecute on a strategy and prosecuting on that strategy might require you to raise 150 versus 110.

21:15So how do you evaluate that when you look at managers increasing fund sizes? We had our annual meeting in December and we told our LPs that we are actually focusing even further on pre-seed, even further on funds that are under$100 million and funds that are like funds 1, 2, 3, as opposed to fund 8, fund 9. And we have a lot of data around that. Smaller funds outperform larger funds, both on TVPI, DPI, and net IRR. You can argue that, well, if you had a$5 million fund and you had one big hit, of course it's going to do well. But that's not a real fund. One way that we addressed that is that we created that nano program in 2021, which was because over the years, a lot of founders want other founders on the cap table.

22:00AngelList enabled people to be able to start a fund that AngelList would administer. I think that also led to the blooming of the number of seed funds out there because basically anybody and their sister could have a seed fund and AngelList could help facilitate that. In terms of how we think specifically about fund size, a long time ago, I used to say we look for fund managers who lead their deals. And we modified that view. It's a little bit more nuanced. In general, we now say that we look for fund managers who punch above their weight relative to their fund size. So we do have a number of$25,$30,$40 million funds.

22:39They're not going to be able to lead their deals. But we want to see that they're getting meaningful ownership. We did an analysis of our portfolio, and we compared fund size to initial ownership and figured out a ratio from that. Generally speaking, for our seed funds, it's about 10 % of fund size. So if you had an$80 million seed fund, you should at minimum be getting 8%. And so you can see that if you get larger, like$150 million,$200 million, you're pushing 15%, 20 % ownership. That may actually be very, very difficult to do. So the fund manager really needs to have a story of how they're going to build up their position.

23:14In a way, they're subject to the vicissitudes of just how the company is doing and whether there's an opportunity to buy up. If Sequoia came in and took the entire round, the lead seed investor may not be able to get in a super parada, for example. When you think about the nano, maybe you can just describe the nano fund. What is the nano fund? What are the characteristics? Because my assumption is most of the nano funds are not leading deals. Oh, yeah, for sure. For us, we defined it as sub$20 million. One element of this is that if we're investing in a$150 million seed fund, we want the fund managers to be working full time, right?

23:50But as I mentioned, a lot of operators and founders have full time jobs, but they might have a side fund. So basically, it was going after the sub$20 million side funds. And people like Ahmad, actual operators who are really much in the deal flow, and other founders want them on the cap table. The program that we started was actually to invest 20 % into those funds. So$15 million fund, we would write$3 million check, for example. Right. And for these folks, some of them that go on to be successful and they show that they can execute on a strategy, they may grow bigger. And one of the things that I often get asked, and I'd love to ask you this question, is when is the right time to grow fund strategy?

24:34And how do you know you're ready for it? because there are certain managers I like at$30 million, but I don't like them at$75 million. Yeah. I mean, we see this all the time where, just to use a nano fund as an example, they might be running a$20 million nano fund, nano-sized fund, and they're writing five to 700K checks. It's a material change from going from that kind of check size to a$3 million check. Because when you're smaller, you can come into a hot round where it's oversubscribed and the founder wants you to be part of their cap table. You can slide in a 500k check. It's a totally different game if you're going to write a$3 million check and lead it.

25:17And so we spend a lot of time assessing the credibility of that fund managers to be able to write that larger check. And what I mean by that is that we spend a lot of time talking to founders. If Samir had this$50 million fund, could you have envisioned him writing, you know, leading it around with a$2 million check? And if they say yes, you know, that's a good proof point. We've had many cases where smaller funds do want to get bigger. And then when we start talking to founders, they're like, ah, maybe, you know, they're pretty valuable at$500K. I'm not sure I would necessarily want them to be the lead investor for my seed round.

25:53And so that's how institutional LPs and that's how we really try to diligence the credibility of a fund manager to execute the portfolio construction that he or she is trying to sell. Because ultimately, LPs are buying a portfolio and the fund manager's ability to execute on that portfolio. So you really got to get a sense of, can that person actually do what they want to do? Another element is that we met with this one group that were three operators, very, very well-known, highly credentialed. They came out of the box saying, hey, we want to raise$200 million. And I said, well, so how are you going to get a 3X on that?

26:32And this is just a few months ago. They were like, we're going to get a Decacorn and five unicorns. And this is out of a portfolio construction of 25 companies. And we're like, that's pretty unrealistic in this world. And then sure enough, they came back to us and said, you know, we thought a lot more about portfolio construction. I think we're going to target 80 to 100 million. At least they had self-awareness and they took some advice to heart. And I think they'll do quite well. I think it's great advice. And if you actually look at the math, and I'll make it very simple and extract recycling for a second.