Hernan Kazah of Kaszek Ventures on investing in Latin America, learnings from building a public company, and working with founders

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 show, we're excited to have Hernan Kaza, co-founder and managing partner of Kazaq Ventures. The firm launched in 2011 has become one of the largest and most well-known Latin American firms with nine funds under management, and over time, they've made early-stage investments in companies such as Nubank, Quinto Andar, Kavak, Creditas, and Nuvam Shop. Before becoming an investor, Hernan co-founded MercadoLibre in 1999, an online auction and e-commerce platform that later went public in 2008.

0:38At a market cap today of over$60 billion, the company represents one of the greatest entrepreneurial successes in that region. During our conversation, we spoke about the growth of Latin America, making the shift from a company builder to a full-time investor, and how founders and investors should think about the capital-scarce market we are navigating today. I think you're real again a lot hearing Hernan's insights. And without further ado, let's get right into the show. This episode is being brought to you by Grasshopper Bank. Privately owned and headquartered in New York City, Grasshopper Bank is built to serve the business and innovation economy.

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2:28This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Hernan, it's so great to see you. Thanks for being on the show. It's my pleasure. Thank you for inviting me. I think you have such an interesting story. And I love talking to people that went from being an operator to being a full-time investor, which you've done. But maybe we can just start with your background of how you got into technology and ultimately what led up to starting Kaizek in 2011. Sure. So going back in time and trying to summarize more than two decades into a few minutes, I went to the Stanford GSB for an MBA right in the middle of the first tech bubble.

3:14It was 97, 98, 99. And obviously during those days and being there, you could not avoid getting involved in technology. So there I started to work in some technology projects and I met there, who's today still a very good friend, Marcos Galperin. And he was also doing the same thing. And he was planning on launching what at the time was the eBay model in Latin America. And I was working on a different project. So we would exchange ideas and do some research. And eventually, luckily, I ended up dropping my project, joined Marcos and together we graduated in May 99, went back to Buenos Aires and we started Mercado Libre then.

4:10So Mercado Libre was, it was 1999, I believe, around 99, 2000, ultimately take the company public in 2007. You stay on until 2011. Throughout those times, it was a journey that you went through and you learn a lot during those times. What I love asking is the question around when When you decided to be a VC in 2011, what were some of the experiences at MercadoLibre that really informed the type of firm you wanted to build? So yes, we started the company in 1999 during a boom, bullish market. We raised capital then, and then we went back to the market in March 2000 when the bubble burst. And it was really difficult for us to raise capital then, but luckily we ended up closing around.

5:00And with that round that we ended up closing in May 2000, we realized that that was the round that had to take us to profitability. So we raised capital in May 2000, went public in August 2007, still with some of that capital in the bank, that capital that we raised in that round in 2000. and the company took some time to become profitable. By the end of 2005, we could have made it profitable, but we decided to bet more on growth and postpone for a few quarters profitability. And then by the end of 2006, beginning of 2007, the company was profitable and we IPO'd in the Nasdaq in August 2007. The public company stayed for a few more years.

5:58And then in the year 2011, I decided to leave Mercado Libre and together with Nicolás Secasi, who was also part of the founding team of Mercado Libre. In the early days of Mercado Libre, we used to have a table where Marcos, Nicolás and I would sit. We had worked together for over a decade. And today we decided to launch CASEK. What drove us there? On the one hand, we saw really in a very personal manner the advantage that technology was bringing to the region. We saw that all the trends that we were reading about the U.S. and maybe later on Asia were also happening in Latin America. there was indeed a lack a lack at that time but that did not mean that that was not going to happen in Latin America on the contrary we thought that in Latin America the opportunity for technology was larger in the case of Mercado Libre for instance we had the e-commerce side of the business and we realized that what Mercado Libre was creating into retail in the region was more significant versus what e-commerce players were doing in the U.S.

7:16Because in Latin America, if you lived in a large city, maybe you had access to some regional retailers. But if you lived in smaller towns, those regional retailers did not exist. So e-commerce was really providing extra value there. Then Mercolio also had payments and financing business. And in Latin America, financial inclusion is a big issue. The penetration of credit cards and banking is slow. So with technology, you could really disrupt that. And this is the one we looked into for education, for healthcare, and now into climate tech and other things. we believe that the value that technology brings into a region like Latin America is more significant versus what you have in other parts of the world, in particular in more developed areas of the world, because obviously you are leapfrogging what maybe incumbents or offline players have done in those more developed markets.

8:26So that was one thing that we saw very clearly, and we had no doubts that the full technology revolution was going to happen in Latin America. And also in our days as entrepreneurs, we had investors, but those investors were more like bankers, so financial institutions that saw what was going on in technology in other parts of the world and wanted to play the tech kind of investment side of it. But those were not investors that knew how to advise entrepreneurs. They did not know how to help entrepreneurs recruit talent, think about the product strategy, the technology strategy and those kind of things.

9:14So we thought that having built one of the most significant technology companies in the region, we had an edge versus all those other investors that were working in the industry. And also that we could connect better with entrepreneurs and be more of a value-add partner rather than just a provider of capital to those companies. I want to come back to that in terms of what does it mean to add value to companies because there's so many conversations around what does it mean? How do you really add value? How do you actually transform the arc of a company alongside the entrepreneur? And I know you think a lot about that and I want to come back to that in a second.

10:01But going back to 2011, Mercado Libre, I think when it went public, it was less than a billion dollar valuation. At the time, I think it was closer to 800 million. Now, obviously much bigger. But you saw all of these markers around Latin America, both being ripe for technology disruption, but also the growth of the area. And I think back in 2011, it wasn't very clear that where VC was going to go less than a half a billion was funded into Latin America more broadly. And what was the mental model of creating a firm versus actually starting a new company and taking advantage of this technology disruption that could happen?

10:38Clearly, in the year 2011, Mercolio still had a long way to go. We IPO'd at a valuation of$800 million. During the first day of trading, we passed the billion-dollar mark. And for us, that was amazing. Then the company went all the way up to$3-4 billion. And then, as you know, the global financial crisis hit, and Mercado Libre's shares went down 80%, 90%. So we IPO'd at$18 per share. Shares went up all the way to$80. And then when the financial crisis hit, they went down to$6. And by the way, it was interesting because obviously we were all scared about what could happen with the financial world and financial markets and financial institutions.

11:39But Mercolio kept on growing every single day. We were producing cash. We had zero debt. So we saw no reason why the company had to be valued at a fraction of what it was a few months earlier. So we remained focused on executing our business plan and happy to see that more and more buyers, sellers were interacting through our platform. And eventually, clearly things paid out. So by the year 2011, probably the valuation of the company was$5 billion and there was still significant upside. But the nature of our job had changed. We were really in the trenches in the early days and dealing with real life or death problems.

12:28And then the company slowly but still became more of a corporation, still a very agile corporation and with very significant growth ahead. I was a little bit different and our daily jobs were more about managing people rather than really adding value to what we thought was the most relevant piece. So I think that it's funny because the initial thinking that Nicolás and I had was we no longer want to be managers. We want to be closer to the action. But at the same time, we realized that maybe we didn't have the kind of energy we had in the early days of Mercado Libre when we were working 25 hours per day.

13:10So we thought that given our experience, given the opportunities we saw in the region, given what we wanted to do, becoming an investor was something very natural to us as a next step. And that's how we ended up doing that. What is funny is that today, CASEC has grown significantly. So we're back with our managers hat on, but it took at least a decade to go back there. People sometimes underestimate how long it takes to show success, build an organization, which you've successfully done now over, I think it's about 12 years now, running the firm. Tell us a little bit about the early days. So 2011, you decide to start a firm.

13:56First thing you have to do is fundraise. And coming from the background you did, it wasn't like you rolled off a big firm. You were operators turned VCs. How did you build that LP network and how did you focus on that first fundraise? It was a long process and it connects well with something that you mentioned earlier, Samir. But what we did initially was we decided to raise some capital from ourselves, from our friends at Mercolibre and get started with a smaller fund. We thought$50 million would be enough for what the region was at the time, etc. But then people started hearing about our new venture and they decided to join.

14:44So some of the investors at Mercolibre wanted to invest and some other people that maybe were not investors in the company but had known us over the years also wanted to invest. So we ended up raising close to$100 million, which is funny because at the time it looked like a lot of capital and now it's just marginal. Well, not that much, but a couple of years ago it was like nothing. And we started investing in those funds. We ended up investing in 24 companies that first fund. Our focus was early stage, so we would invest in seed, series A or series B and reserve some capital for follow-on rounds.

15:32And that's what we did with the first fund. And so it was basically ourselves, highly qualified friends and family. And then at the very end of the process, a fund of funds reached out and wanted to invest also. So we allocated some capital to them and they were the first institutional investors into the fund. we always thought that we wanted to build a firm that was going to stay here for the long run, that was going to hopefully outlive the founders, etc. So we liked the opportunity of having a more formal relation with one significant investor so we could get ready for what was going to happen in the following years.

16:22But what's interesting is that our pitch was, what I told you earlier, the growth of technology in the region, why we thought more value in the gap that technology would fill in Latin America, the terrific experience we had as operators ourselves, et cetera. And people bought that and that's why they wanted to invest. But it was interesting that the most common question then was, okay, I believe they're going to find great founders. I believe that those founders will want to work with you. I believe that you can add some value to those companies. And I know that you're planning to reserve some capital for follow on.

17:04But what happens next? Who's going to provide more capital once you deploy your second, third check? And reality was that we did not know. We were very confident that investors were going to go after good opportunities. And if we had good opportunities, we would present those to them and they would agree on investing in those companies. But we couldn't name precisely where that capital was coming from and couldn't give enough indications of what was going to happen. And it's interesting to see that in some of those rounds, we had to be very creative in helping the entrepreneurs find ways to access capital.

17:51In some cases, we used our relationships and connected a past investor of Mercado Libre with this company because we thought there was kind of common ground for getting interest there. Or we started reaching out to people that then would connect us with someone that would help that company raise. At the beginning, part of the value add, and that's part probably of the second question you had there, was helping companies fundraise. And we were very active there. We were kind of an M &A investment bank boutique helping those entrepreneurs find capital. Today, that's no longer needed because Latin America technology, Latin America is in the radar screen of all the relevant global investors.

18:42But at that time, that was an effort that we had to make. And interestingly, the first fund, there was one institutional investor. And then eventually, we added a couple more in our second fund. And by now that we've raised six times nine funds, because then we added to the early stage fund also an opportunity fund. Today, most of the capital comes from institutional investors. And within institutional investors, the ones we try to favor are the foundations or the endowments, those kind of investors that, on the one hand, are really long-term focused, value-add. On the other hand, those investors make our work more interesting, right?

19:31Because we're working for their missions, and that's part of the responsibility we have today, to return more capital so they can really have more impact in whatever mission they have, which are always really amazing missions. It's amazing to see both how you've scaled as an organization, the brand, what you've done in terms of the investing, going back to that fund one, which was$100 million. Of course, a lot of happy LPs having new bank in that fund one. But kind of going back for a second, you know, making that transition from working at a company and then actually starting and building a firm.

20:10Often there's this continuous learning curve that you have to go through. Tell us about maybe the first couple of years of learning. And did you, before you started the firm, seek out any mentors to help you make that transition? So we thought erroneously that moving from one side of the table to the other one was going to be very natural. We knew how to run a company. We knew how to build a tech platform. We knew how to hack the system here or there to increase growth or improve profitability, margins, etc. So we thought it was going to be, and we knew how to deal with investors because we had done that for a decade.

20:47So we thought that it was going to be very easy to move from one side to the next. But interestingly, some of those beliefs were right and many were wrong. And I think the two most important ones that we didn't get quite well was, one, this phenomenon of the power law. We thought that because we were former entrepreneurs and knew the region like nobody, etc., that we could really find many winners and that we could help many companies become winners, etc. And at the end of the day, we have the same concentration of results that you see across the industry globally. So you invest in 20, 30 companies per fund.

21:36and then when you look at the returns of those funds, even when they do really, really well, it comes out of one, two, three companies, most of it. So that was something that we did not understand well at the beginning. And then the other part is that I think when you're an entrepreneur, you're all the time thinking about winning and you don't want to lose any battle. So if there's a problem, you just go deep into it and look for ways to solve it. And if you cannot solve it the first time, you try again, you try again, you try again until you really solve it. And when you become an investor, obviously you want to help everyone and that's part of the reputation you build as a firm.

22:23And that's why then the following generation of entrepreneurs want to be part of your portfolio. But you need to understand that if you just work in a way trying to solve problems, Maybe you're not doing your job because it's more about being a catalyst to those companies that are doing really, really well and take them to 100 to 1 ,000 versus trying to save companies that are struggling between zero and one, zero and one, zero and one. And the initial natural reaction for people that had been in the operation, had been entrepreneurs, had been really trying to solve, as I said, life or death situation is to try to solve those companies.

23:05You didn't want to see anyone going down. And that was not the right thing to do. So we ended up learning that and trying to understand how to better calibrate our value add, our support to companies. Again, always helping entrepreneurs. That's something that is part of our brand. And you need to have that brand so the circle keeps on spinning and entrepreneurs tell new entrepreneurs that you're good for them. And not only the ones that do well, but also the ones that are struggling. So you get the next generation of entrepreneurs and then you do that again and you get the following generation of good entrepreneurs, etc.

23:46But you need to be smart and try to really put all your effort or most of your effort into Compact that will produce most of the results. You're touching on something really important, which is around how you also manage your time in terms of working with entrepreneurs. You know, an average, let's say an early stage fund invests in 25 to 40 companies. And it does usually follow that power law where 10 % of the companies will drive most of the returns. will be you'll have to have a fund returner, maybe two fund returners in there. Then you have 40 to 50 % of the companies that effectively return zero to 1x.

24:22And then you have things in the middle that are doubles and maybe triples, maybe a few singles along the way. But as you're building in the early days, you don't know for sure. Over the course of two or three years, you start to get the signal which companies are moving directionally. But how do you think about the messaging for those companies that are zero to one, because you want to retain your brand as being very founder supportive. But at the same time, there's only so many hours in a day. So how do you think about your time as the portfolio matures and you know which companies are breakout versus not?

24:56Yeah, so you don't know for sure, in particular, at the beginning, you start working with companies. And our thinking is that we make an investment if at the time of that first check, we believe that that company can be a fan maker. Obviously, then reality hits and for 80 % of the companies, that ends up not being the case. But we learned that over time. And sometimes you have entrepreneurs that are doing a great job and really working day and night and basically delivering on everything they told you they were going to do, but technology doesn't catch up with the market or maybe there's something that is not there and therefore they cannot build the kind of company they try to build.

25:42So you have to understand that it's more art than science in that regard. Because sometimes it's okay, you need to support the entrepreneurs so they can maybe pivot a little bit and try to recalibrate the business plan. In some other cases, you just need to be a little more patient. That's something that we've learned. Typically, when you are innovating at big scale, it takes time to really take off. And it's not that you are pursuing the wrong idea, but it's just that maybe timing is not exactly what you thought and you need to do more. So you need to react on what you see. Remain always open, be naive in that regard and be more of the believer than the one that says, you know what, this is enough.

26:32Let's shut it down. because you don't know. And reality is obviously then by year three, four, five, maybe things become very evident. And then you start managing a little more your time allocation and your resource allocation because not only us as partners, but we also have a couple of groups within the organization, one dedicated to technology and growth that try to work across the portfolio of helping companies in things related to technology, to online marketing to product usability. And then we have another group around HR that what they do is try to help recruit talent into the companies and then also try to implement good HR practices into those companies, et cetera.

27:21So the way we allocate the time of those two teams plus our time starts to become more evident by year three, four, five of the company. Before that, it's hard. And you need to call the shots on a daily basis. And sometimes you go really too much in one direction and then you correct. It's not perfect at all. And it's funny because we all the time tell our entrepreneurs that they need to create scalable platforms and that they need to be very precise on what to do and what not to do. we don't work our talk in that regard that much. One thing that's interesting is when you started Mercado Libre in the 99-2000 timeframe, obviously at the tail end of the dot-com, but even during that journey, going up to the public offering in 2008, capital was relatively scarce, especially in the area you were, but even more broadly.

28:20And then 2011, you start the firm, coming off the global financial crisis, wasn't quite clear at that time. We'd see so much capital available for startups for growth. And as we sit here at the midpoint of 2023, of course, we're back to a capital scarce market. And I'm curious how you think about as a firm, how to help companies navigate during a time where they have to show growth, but they also have to do in a very capital, non-intensive way. And coming off a period where a lot of entrepreneurs and founders have never seen anything like that. It's a very interesting point. And I think comparing what happened in the year 2000 and what happened today, the common thing is that capital is less available today as it was less available by then versus what had happened in the prior cycle when capital was very available, maybe too available.

29:22What is different is that when we started Mercolibre, there were no internet users. So we had to be patient because there was no critical mass. Technology and businesses are mainly around economies of scale. So that means that you need volume because serving 100 customers or serving 100 ,000 customers, it doesn't imply that you need to multiply your cost by 1 ,000, but your income does multiply by 1 ,000 typically. so you really want to reach scale and in those early days scale was not possible so you had to be patient and pace yourself not only because you had little capital but also because you had to wait for the market to get there when we started Mercado Libre internet penetration was 2 % and then it was 3 % and then it was 5 % and then broadband came and then eventually mobile internet came so we had to be very patient Today, you need to be very careful about how you handle resources because you don't have that much capital available.

30:28And you need to ensure that you can demonstrate that you're building a self-sustainable business, something that not today, because in this industry, you're all the time investing for the future. but in a reasonable future, you'd be able to self-sustain the company and not that you will need another round, another round, another round because light at the end of the tunnel is miles, miles, miles away. So that piece remains the same, but the difference is that today you do have critical mass out there. So if you hit product market fit today, you can really have a profitable business if you have the right business model.

31:07In the past, even with product market fit, you had to wait because costs were high and income was low and you needed more users to eventually get online and eventually to get into broadband, etc. So that's kind of what you need to somehow calibrate better today. It's not only about waiting. It's also about setting the right pace. So if you go too slow, someone may outpace you. If you go too fast, maybe you run out of capital and cannot demonstrate that what you're building makes sense. So we always tell entrepreneurs that it's around two things. One, product market fit. So do not accelerate too much if you don't feel you have it there.