Kai Chen (OceanIQ Capital): Investing is the ability to participate in the success of an entrepreneur without being in the trenches

Kai Chen is the Founder and Managing Director of OceanIQ Capital, an SEC-registered global multi-family office that specializes in both, venture capital and equity investments. After graduating from UCLA with a BA in Business Economics, he spent 15 years working at Goldman Sachs Private Wealth Management and Credit Suisse, focusing on asset allocation and investment strategies, before starting his own firm. 

How did it all start? How did you decide to enter the venture investment business? 

I was really interested and fascinated by the world of finance in general and finance investing. I love reading about Warren Buffet, Charlie Munger, etc., even back in college. So I just felt that it would be nice to work in a space that I truly enjoy and get paid at the same time. I studied Business/Economics as an undergrad at UCLA and one of my first jobs was working at Goldman Sachs in the Private Wealth Management Field. My initial career was in Wealth Management and that lasted for about 15 years and then I started my own firm, OceanIQ Capital. So OceanIQ Capital is really when I started to go beyond just stocks and funds to go into venture capital. 

What does OceanIQ Capital do?

To clarify, we are not pure venture capital, we’re sort of like a hybrid. So we seek to invest a portion of our portfolio in venture capital, including directly into startups. The remaining part of the portfolio is typically invested in publically traded stocks and private investment offerings, such as real estate, funds of other venture capitals, and LPs.

Are there any industries that you are more interested in?

We’re pretty diverse because we’re a multi-family office, so we’re willing to invest in almost any industry that is cutting edge and innovative, so long as we are able to conduct robust diligence on an industry and maintain our investment discipline. It ranges from AI to Big Data to Autonomous Driving to Drug Discovery and CRISPR. A variety of stages as well, but our main strategy is to follow strong lead investors. We tend to piggyback on the lead investors. 

Is there any way that the startup teams usually find you? What are the sources of those applications? 

Startups typically find us, or we find them, because they’re referred. For example, if entrepreneurs who have their wealth managed in OceanIQ Capital start a new company, that would be one source because we know them already. Or maybe they invested in another entrepreneur and we learned about it and we felt that that’s a good opportunity. It’s not really an active solicitation process, it’s more of a referral and network-based process.  

So would you say you wait for inflow, wait for people to come to you, as opposed to scouting?

Yeah, that’s right. 

Has COVID-19 in any way affected the way OceanIQ Capital functions, the areas of interest that you have, or any other consequences? 

I’d say that it shifted our public equity investing from very index and funds driven into more direct stock selection. We took a lot more control in finding companies that we believe could thrive in this new environment. It changed our work hours and locations, we’re still mostly working from home and everybody can make their own hours as long as they get their job done and they can come into the office to work or they can work from home. So we have been quite flexible with that. Generally speaking, COVID-19 has accelerated technological change, as well as financial markets. Most of the markets are at pretty high levels so, like many others, it’s helped our investment portfolios and we’re going to try to continue to take advantage of the current market. 

Do you think those consequences are potentially something that’s going to influence OceanIQ Capital long term and is going to be beneficial to the market? 

Yeah, I think it’s definitely more of a wake-up call in terms of how something so unexpected, sort of like a black swan, could just come into our lives and our investments and just disrupt everything. So I think that will be a good reminder. But I think in terms of how we will be in the future, it will be fairly the same in that we should expect that there’s going to be unexpected black swan events into the market and not panic when it happens and try to take advantage of it. 

How do you differentiate yourself from other venture funds for limited partners or to entrepreneurs? 

We are a family office, so, unlike a venture fund that might inject a lot of expertise and control, we actually, generally, don’t exert that much influence on our portfolio companies. In general, we are not the lead investors in those companies so we tend to be a more passive investor that’s not taking a direct board seat, etc. I think companies find that welcoming as well because they have enough VCs on their boards. In addition, because we have established a solid and diverse cross border and entrepreneur client base, we would like to be able to offer up our networks to the companies that we invested in, whether they wanted to go into new markets, access our relationships in China and Asia, or if they wanted to have a lower-cost operation set up or if they wanted referrals to executives, job candidates, or customers, we can leverage our client base, which are 40-50 entrepreneurs and executives of both private and public companies, to be a resource to those companies. 

How do you select startups to support? What criteria do you have for reviewing startups? 

I think it’s always that the best startups everybody wants to invest in and they’re hard to get access to. I will say it would be extremely helpful if the entrepreneur is a successful entrepreneur who has started companies before and had a successful track record. I think it would also help us if the company has strong institutional investors, whether it’s VCs or corporates, invested in the company. We would like to follow those strong investors with strong track records. We would look for companies with a business model that we like, such as a strong moat that protects their business from competitors, recurring revenue so that their revenues are more predictable and will come in year after year. So that lends itself to Software SaaS companies, that would be a great type of company that we would like. In addition, because we’re in the financial industry, we really like FinTech (Financial Technologies) Companies including in crypto-currencies

How many startup projects would you say you review per year? 

Probably under 100 or so. 

Is that number something that has remained constant throughout the past several years? 

Very different from a venture capital fund that actively reviews startups, it could be tens of thousands of startups that they reviewed in a year, we actually only pick from the ones that came into our network because of strong VCs, someone we had already invested in, or a strong entrepreneur that we know who referred us. So it’s a fairly tight network and when we receive those referrals, it’s not a large number. So it tends to be less than 100 a year and we tend to select from those opportunities. 

What would you say was your favorite or the most unusual startup that you ever supported? 

I don’t know that any are unusual because they are all, in a way, fairly similar, but one of our favorite startups is a company that’s backed by SoftBank Corp., which is a very strong institutional backer, and the company has a very big dream. It wants to replace Visa and MasterCard, so I would say that’s unusual. Most startups, I would say, maybe have a little bit of a smaller market or competition that they’re trying to disrupt, but this one has a really big dream. 

Is there a startup that you ever rejected and later regretted? 

There’s a company that helps foreign students apply for universities in the US and Canada. When I initially saw the company, it was a very early stage and now the company is worth multiple billion, so I definitely would have hoped that I had invested in that company early on. The reason for rejecting them back then was that I thought what they were trying to do was not something that would satisfy a huge demand. Basically, they were helping students who wouldn’t be able to find the schools themselves, through their network or research, go to a website and ask the website to help them to select the school. Initially, I thought there were not a lot of students in that category, but it appears that was the wrong assessment. 

What is your due diligence procedure and how long does it take you to cover the whole track from the first meeting to contract and check signing? 

We can act pretty quickly. We have acted as quickly as just a few days in terms of from meeting the founders to ending up investing. But, if given more time, we would prefer to have at least one or two months. In terms of how we do due diligence to the company, typically we would rely on the fact that the company would have passed through the screens by other VCs. So once a company has passed through these multiple screens, as a family office whose main focus is not venture capital investing, but managing wealth across asset classes for our families, we would rely on those VCs to conduct the screens and select the best of class companies. Once those opportunities present themselves, it’s a look at valuation to see if we’re comfortable with valuations that the lead investors are paying, and then it’s about access. Are we granted access to be on the cap table along with other investors into this company? I will say a lot of what we do is not just us selecting the company. It’s equally important for the company to pick us. The company has to want our investment as well. 

What size is your current fund? What percentage is reserved for follow-up rounds? How big is a check you would usually issue to a company? 

We generally use SPVs to invest in companies, so when we invest in companies we may form an SPV and then get exciting or new LPs to invest in that SPV, which in turn invests in the company. Typically it ranges from $500k to $2 million would be our average investment. And so far, we have invested about $15 million or so into venture-backed start-ups from our portfolio. 

What should be the sum that a startup should ask for or how should they estimate that sum? 

This obviously changes a lot. If it’s a startup that’s just starting, it probably is only raising one or two million, if that much, and most from friends and family and angels. If a startup moves into Series A or Series B, that check size ranges from 5 to 10 million or even significantly above. It just depends on the stage of those startups and there’s a fairly well-observed range for it. It’s not like a startup at the Seed round could easily ask for 20 million, nor can they just raise 200k to get it started, it seems to be fairly difficult. And there’s also a market for the valuation range. A start-up with a business plan that’s just freshly started is typically worth 10 million dollars, pre-money, or even less. As they start getting traction and customers, those valuations might multiply.

Are there any qualities that you look for in founding teams? 

I would imagine, if this entrepreneur ran into difficulties, ran into a really hard time, he’s the type that’s all in, that’s willing to mortgage against his house, that’s willing to dedicate every resource he has into his company. Not someone for whom this is just a bandwagon that he’s trying to jump on to make money, without true dedication and passion. I would look for somebody with true passion and willing to bet everything he has on the company. 

Are there any red flags that you have when it comes to founding teams? Is there something that can make you stop cooperation with a company even after you’ve invested? 

I think there are probably too many red flags, it ranges from if the company has a new management team, trying to do a turn-around, that could be something to watch for. Maybe that turn-around could be successful but maybe it won’t, that would be one issue. A company that hasn’t found its product-market fit, how it’s going to develop its product, it’s still searching for that. That happens with all startups, but that could be a little bit early for us. I just feel that it’s much better to invest in companies that have already found their product-market fit. 

Investors prefer to work with teams, but have you ever invested in a one-person startup? 

No, because that would be a very early stage, that would be just a person with a business plan. We would look for later-stage companies with employees and other team members. 

Would you prefer to work with Steve Jobs or Steve Wozniak? 

Steve Jobs. I think it’s a good example of why the CEO does not need to be technical. It could be somebody that has strong leadership, strong vision but doesn’t have to be technical to start a strong technology company. 

What are the three most breakthrough startups in the last 50 years? 

I think everybody’s probably going to pick the same startups, the FAANG stocks, so Amazon, Google, Facebook, Microsoft. Those upper companies, they have a very strong moat, meaning that it’s hard for competitors to replace them. For example, with Google being the #1 search engine, very hard to set out another search engine, with Facebook being the #1 social media platform, very hard to set up another one to try to disrupt Facebook, with Microsoft being the #1 business software, very hard to start another one that would replace that. These are companies with very strong moat that have recurring cash flows, very strong cash flow generation. And they impact our lives every day: buying from Amazon, using Facebook to communicate, using Google to search. They’re the most disruptive. The question is, in the next 10 years, will there be other startups that come out that are going to disrupt them?

Are there any industries that you like but won’t invest into? 

No, I don’t think, if I liked an industry, I don’t think there’s any reason why we would not invest. 

What is your process of working with a startup once you’ve invested in a company? What kind of support do you offer to portfolio companies? 

As a family office, we have the ability to help the entrepreneurs and the company on the personal and the corporate side. On the corporate side, we might offer corporate cash management through some of our institutional fund partners who have managed corporate cash for the likes of Google and Cisco, to provide that same server to those companies and help them try to earn a little bit more yield than they otherwise would have on the cash. We also help the startups with their 401k setup and management. We have service providers that could help the company and their employees set up their 401ks and also allow these 401ks to be a lot more flexible in terms of having the ability to select your own security, having the ability to have a Roth 401k, or convert to a Roth IRA, so that’s on the service side that we can provide our portfolio companies. On the business side, our portfolio companies could reach out to us for any needs they would have if they wanted to get referred to certain customers or just to brainstorm about a decision that they have to make, such as whether or not to take an investor, we’re there as a resource to help them, but we’re not really actively involved in the company. It’s up to the company to leverage us and where they see the most value. 

In your opinion, what is the best margin from investment to exit? What is a fair stake to take from a company for investment? 

If we invested into a company when its valuation is under 20 million when the company gets to 200 million, that will be a 10X and potentially they could get acquired, that would be a great outcome. If we invested into a company when their valuation is 200 million, then they’re typically looking at IPO and at IPO, we’re looking at a 1-2 billion valuation, so that would be a 5-10X, so that would be a great outcome. So, if we look at that trajectory, if we could invest into a company when the valuation is in the seed stage, quite low and under 20 million and all the way up to IPO, we’re looking at potentially 50-100X, but if we’re only betting on companies that are at the later stage, with valuations over 100 million, then the outcome would be probably in the 5-10X range, so anything above that would be a pleasant surprise. 

Is there any point at which you would choose to exit?

We have sold our shares in a few cases, but it’s typically because the company is doing so well that there are other investors who wanted to buy those shares, most often at a premium and we felt that it would be fine to take some chips off the table or exit because we already made a good enough result, even before the IPO or merger event. So, yeah, if we could find a secondary buyer for our shares, then we would exit. 

Are there any common mistakes that startups make in terms of pitching, or operating, or how they approach funding? 

There are probably too many, so it’s very difficult to generalize. What I will say is that I generally don’t look at business plans sent in cold, so unless there’s some type of network that connects us, it’s a little bit unlikely that we would be very excited about it. It certainly happens occasionally, but generally, I would prefer a warm connection to that startup or to the founder. But in terms of business plans or presentations, there’s so much that could go wrong, so it’s more about if they can highlight the most critical elements, such as their customers, what problems they’re trying to solve, what is the feedback of those customers, how much funding they’re looking for, what they’re using for, etc.

Why do you think start-ups fail, based on your experience? 

I think most startups fail. As we look at the statistics, we all hope that the startups we invested into won’t be part of those statistics, but the reality is that the majority of them fail. For any business to fail, there’s only one reason: they overspend the money that they have. With most startups, they’re not cash flow positive, so they have to continuously raise capital in the markets to sustain their growth and if we run into a market that’s shut down, those startups could be in trouble if they run out of cash. So, I think, startups fail mainly because they run out of cash. Just having a proper plan for their cash flow and their funding well ahead of time, well ahead of when they need it would be important. 

Do you think the venture capital business is more like chess, checkers, backgammon, go, or card games? 

It’s definitely a card game, Texas Holdem. It’s more about calculating the probability of winning in this hand that you are given and if you think your probability is high, then it’s more about how much you’re willing to bet. If you bet a sizable amount plus a high probability of winning and if you continue to do that hand after hand, you’re going to have a very good result. So, it’s actually very similar to Poker. 

Venture capital is a long-term game. What keeps you going and what’s the most challenging part of being a part of it?

In terms of what motivates me is that investing is just fascinating, whether it’s investing into a publicly traded stock or an early-stage startup. It’s the ability to participate in the success of an entrepreneur without being in the trenches. We’re able to parlay capital and let the capital grow. I think this is a long game, meaning that I’m not just planning to do this for 10 years and then retire. I felt like this could be something that’s so enjoyable that I could keep doing this until I’m old and I think the best example would be Warren Buffett and Charlie Munger, they’re continuously investing into new companies, continuously learning, even in their 90s, so there’s no reason why anybody else couldn’t do the same. I’d say the hardest part is probably fundraising. I feel like we’re in this niche of raising mostly from individual families instead of institutions because we invest through SPVs and individual families are very fragmented, unlike institutions. It takes a long time to develop trust, it’s not easy to meet them and once you meet them it takes years to build a relationship. I think that’s probably the hardest part is to be able to raise the capital. 

Where do you see yourself or your company in five or so years? 

We would hope that we would be in a situation where the internal portfolio, or the partners’ capital, would grow to be a size that would allow us to participate in our funds as a larger percentage. Meaning that we’re not just taking a fee in our clients’ successes, but we’re actually betting alongside our LPs and investors. And we are already doing that, but I just hope that, based on the next few years’ success, this would be a larger portion of our capital, that we would be investing partners’ capital alongside our client families. So far we’ve invested in about 25 companies, so it would be great if, over the next five years, that list could double and the size of the funds over the next five years, could double or triple would be a really nice goal. 

What are the most important things you have learned, either from founders or fellow investors, over the course of working in this business?

A good example would be a cryptocurrency company, Harmony, its founder Steven Tse is just a great, passionate leader and I hang out with him every week to play basketball. He also formed a gathering of crypto entrepreneurs called TGI every week to brainstorm and share. I think what I learned is that a really good leader is someone who creates a culture and an environment for a group of very diverse and talented people, not necessarily even working inside the company, but outside of the company, as well, to all come together and create different splashes of collaboration and exchanging ideas from these types of team-building gatherings. I see leadership as being a lot more than just focusing on the company itself or the task at hand. 

What sources would you suggest to startup founders who are looking for funding in the venture capital industry?

For anybody who’s interested in investments, I always recommend Warren Buffett’s annual meeting. He hosts an annual meeting every year for about four hours or so and for those 4 hours, the audience would ask them any questions about investing or life or Berkshire Hathaway and he would answer them. Those recordings are all available on the internet, on CNBC since 1994 so if you listen to all the recordings from 1994 until now, it’s way over 100 hours and I think there’s just so much wisdom and investment insights packed in there. Somebody who would go through that once is like reading the Bible once, it’s really a good fundamental education on investing, a foundation on investing that one could receive for just a little bit over 100 hours. 

What advice would you give to startup founders? 

I think the question is probably too broad. Most startup founders are amazing leaders and they’ve gone through life, they took on risk. These are just amazing people. I don’t have any general advice for them, I feel like they don’t need my general advice. But, in terms of specifics, whether it’s fundraising or investment, then maybe I’d be happy to give some advice, but just generally speaking, I say I would invest in a company and people that I admire. I wish I could be them doing this, but if I can’t, maybe just at least I could invest my money into it and be part of the team. 

Is there anything that you think people should know about OceanIQ Capital that you didn’t get to mention during the interview?

I think it’s the same point, maybe going back to how we’re set up really as a multifamily office that is able to invest across all asset classes, but in particular, because we’re based in Silicon Valley, we have access to all these entrepreneurs and companies and VCs, we also make direct bets into these startups and that’s one of the most unique portions of what we do as a wealth manager. Most wealth managers would not invest in startups, but we do. 

IMPORTANT DISCLOSURES

Kai Chen is the Founder and Chief Investment Officer of OceanIQ Capital, LLC, an SEC registered investment adviser.  Any opinions or views expressed by Mr. Chen are solely those of Mr. Chen and do not necessarily reflect the opinions or views of OceanIQ Capital, LLC or any of its affiliates (collectively, “OceanIQ”), or any other related persons of OceanIQ.  You should not treat any opinion expressed by Mr. Chen as investment advice or as a recommendation to make an investment in any particular investment strategy or investment product.  Mr. Chen’s opinions and commentaries are based upon information he considers credible, but which may not constitute research by OceanIQ.  Mr. Chen does not warrant the completeness or accuracy of the information upon which his opinions or commentaries are based.