#98 Emerging VC Outperformance: Insights & New Capital From Cendana, Sapphire

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“Emerging managers provide an enormous opportunity for outsized returns. A strong VC portfolio typically has a mix of established and emerging managers.” -Samir Kaji in “Why emerging managers have become a staple of LP portfolios”

Outperformance & Fundraise Insights from Cendana & Sapphire

The right emerging VC managers can drive real outperformance in investment portfolios and will continue to do so for decades to come. Every manager in the market today was emerging at one point, and behemoths like a16z just ~15 years ago. While we find ourselves in a slower VC fundraising environment today, capital allocators are still investing in emerging managers.

Recent headlines provide examples of notable investors that have done extensive due diligence and are continuing to invest in the asset class, providing potential tailwinds for years to come. It’s worth going deeper in this recent headlines to better understand the mindset of both the endowments/pensions and the managers investing directly in emerging VC funds:

“Michael Kim of Cendana Capital is often a first call for emerging seed-stage fund managers. Cendana has invested in many VC teams that have gone on to enjoy great success — like Forerunner Ventures, K9 Ventures, and IA Ventures. 13-year-old Cendana just closed on $470 million across several new funds that bring the firm’s total assets under management to roughly $2 billion.”

Rob Ross (CalSTRS) shared that “standardizing one group to focus on venture—because it’s so specialized from an emerging manager standpoint—made a lot of sense for us.” Much of the $1.4 billion in funds that Sapphire has taken control over has already been committed, but Sapphire says it anticipates investing $100 million per year over the next three or four years.

Top Takeaways / Insights from Cendana

  1. New funds totaling $470m: Cendana closed on $470 million across several new funds. The biggest pool, $340m, will be funneled into U.S.-based investors. Another $67m will flow to managers outside the U.S. Cendana also has $30m to invest directly in startups and $30m from the University of Texas (UTIMCO), whose positions will reflect that bigger, $340m fund.

  2. Seed funds need be <$100m for Cendana: “It’s always been a line in the sand with us, and seed-stage venture has changed in the past 10 years. When I started, most seed funds were up to $50 million in size, and seed rounds were $1.5 million; now the median seed round in our portfolio is $4 million. So we’ve adapted with the market, though I think over the next few years that seed funds will scale back in size because it’s a lot harder to return five times $150 million than $50 million.

  3. Returns for Cendana (net): first fund — so the most fully baked — our net return to our investors is 4.2x. And we’ve distributed back 2.2x of their capital as distributions. If we look at our second fund, it’s marked somewhere in the mid threes, and it’s almost approaching 100% and distributed. Venture is a long game. It does take time for companies to become substantially valuable, I’d say seven to eight years, if not longer.

  4. Secondaries: secondaries are a very important element of venture and that we’re going to see a lot more activity there. There is actually this green space relating to the addressable market versus the actual funds there. So I think you’ll actually see more secondary activity and more secondary firms being started actually over the next couple years.

  5. Founders Running Funds & Companies: at the seed stage, founders introducing other founders is really the best source of deal flow for our fund managers. Founders with side funds was something difficult for institutional LPs to get their arms around at first. But we took the risk of trying to back some of them [and have no regrets].

  6. Terms for Funds: we’re not asking for any more terms or special terms. We’ve never asked for a cut of the management company, for example, or a special reduced carried interest. We’ve never done that. And in our minds, for fund managers who offer that, it’s actually a negative signal.

Top Takeaways / Insights from Sapphire

  1. New AUM of $1.4b, ~$100m/yr: Much of the $1.4 billion in funds that Sapphire has taken control over has already been committed, but Sapphire says it anticipates investing $100 million per year over the next 3-4 years.

  2. CalSTRS process & approach to emerging managers: CalSTRS ran an independent process before selecting Sapphire, and it suggests it used Invesco’s decision to rethink its own approach to funding emerging managers. As Rob Ross told Fortune in a related interview, “Standardizing one group to focus on venture—because it’s so specialized from an emerging manager standpoint—made a lot of sense for us.”

  3. Sapphire’s new partnership with CalSTRS makes it one of the largest and most active supporters of the emerging manager system in the venture world, augmenting Sapphire’s previous investments in earlier emerging funds, including Amplify, Data Collective and Union Square Climate, the first climate fund created by USV. Indeed, the development boosts Sapphire’s assets under management to $3.6 billion.

  4. Existing business focus: the move complements Sapphire’s existing business, which is to look for promising fund managers in the U.S., Europe and Israel. Added Clarkson: “There is a lot of going out and sourcing and finding talent, not just sitting and waiting for it to come to you.”

  5. Bull vs. bear markets: we know legendary firms were founded in bull and bear markets and believe that will continue to be the case in the future as well. 

    1. Benchmark started in 1995 (bull)

    2. Union Square Ventures in 2003 (bear)

    3. Andreessen Horowitz in 2009 (bear)

    4. Ribbit in 2012 (bull)

  6. Emerging managers are a critical part of the VC ecosystem: Accel, Benchmark, Sequoia, Union Square, etc., all were first time funds once upon a time. And while being an emerging manager in no way guarantees your financial success, funds led by emerging managers made up 72% of the top returning VC firms between 2004 and 2016, according to Cambridge.

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