This morning, five-year-old Cendana Capital, which has made a name for itself by backing so-called micro funds, is taking the wraps off a new, $50 million fund of funds — roughly twice the size as its first $28.5 million pool.
No doubt that’s good news to Cendana’s existing managers – including Freestyle Capital, IA Ventures, K9 Ventures, Lerer Hippeau Ventures, and SoftTech VC. It’ll also undoubtedly be seen as a boon to the many entrepreneurs and operators who are entering the market with hopes for their own seed-stage funds.
Yesterday, StrictlyVC caught up with Cendana founder Michael Kim to talk about the new fund and his one big concern about today’s market. Our chat has been edited for length.
Congratulations on the new fund.
Thank you. We were targeting $30 million so this was way oversubscribed. We hit our hard cap.
Your first fund must be performing well.
Our net IRR was 24 percent as of June, and we expect performance to improve from there.
Who have you backed with your newest fund?
We’ve invested in five funds so far, four of which were [investments in managers we’ve previously backed], including PivotNorth Capital, SoftTech VC, Forerunner Ventures, and Lerer Hippeau Ventures. Our new investment is MHS Capital, founded by Mark Sugarman. He spent seven years investing his first, $34 million fund, and he wound up with sizable stakes in some great companies, including OPower, Indiegogo, and Thumbtack. We think we’ll eventually invest in roughly the same number of core positions as we took in our first fund, which is 10 or 11.
Will other new managers have a shot at getting a check from you?
Yes, though I do think it’s becoming harder for new entrants to compete. At this point, the incumbents really have the credibility to lead the best deals. And the ownership levels a fund can get are important, both because seed stakes get diluted and because the average venture exit is between $50 million and $100 million. If you own just a few percent of a company that exits at that range, it doesn’t really move the needle.
When you set out to raise this fund a year or so ago, you’d also set out to raise a $25 million fund to make direct investments. Did that come together?
We raised $17 million.
Have you been getting asked, or have you been trying, to make more direct investments in the portfolio companies of your fund managers?
We get involved in a subset of A deals, as well as subset of those companies that go on to Series B deals, where the tech risk is largely mitigated and the companies are generating tens of millions, if not hundreds of millions, of dollars.
But are your portfolio managers calling you and saying, Hey, it’d be great for you to kick in a little capital so this other guy doesn’t get the position, or are you proactively seeking out these stakes?
We proactively work with fund managers and entrepreneurs so we can react quickly if there’s an opportunity to invest. We’ve made three investments [from that $17 million fund] already, and in each case, the round was way oversubscribed but we got in because of our fund managers’ relationships with the founders and because the companies thought we could add value. We invested in Casper [an online retailer of mattresses], for example, and we helped them get on CNN a few days ago because my friend is a producer there, and they sold more than they ever have that day.
Of course, there are cases where Sequoia will come in and do a Series A and not let anyone else in. It’s very competitive, but [we can keep up].
A lot of people point to Sequoia as having the sharpest elbows. Who else tends not to want to share the Series A pie?
All the top tier firms are very focused on ownership, and rightly so if they feel like a company has high potential. From what I can tell, Accel is similar, but it’s behavior that makes sense and that seed managers need to negotiate by having a close relationship with founders and [hanging on to their] pro rata rights [if they can].
There’s concern that the market has been good for so long that a downturn, maybe soon, is inevitable.
Even if the public markets correct by 20 percent, the most vulnerable sectors are the late-stage companies and investors. Hortonworks [which is going public and expected to command a public market value below what it was assigned during its last financing round] is a perfect example.
Seed-stage funds are best-positioned for a downturn because if valuations come down, public tech companies will need to focus on growth, and they’re likely to use some of their tens of billions in cash to acquire it. And seed funds can exit companies at much more modest valuations and still get capital recovery.
Everything could also freeze, including the bank accounts of would-be acquirers.
If the seed funds can’t exit, that’s a big issue. Even though most of our funds have substantial reserves, they can’t carry a company forever. So a perfect storm would be a 20 percent market crash that causes Series A and B investors to pull back. You could end up with a lot of zombie companies. Still, even with a higher loss ratio, I think we’ll ultimately see seed funds do well. It just takes one or two winners.
Sign up for our morning missive, StrictlyVC, featuring all the venture-related news you need to start you day.