TX Zhuo’s of Fika Ventures on raising a Fund I, evolving decision making frameworks, and what founder first means to them

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 Khaji, and today we're joined by TX Show, co-founder and general partner of Fika Ventures. TX's path to venture capital began in college when he accidentally became an entrepreneur, building an online textbook marketplace. After stints at McKinsey and as a CFO as an operating company, he moved to VC by joining Innovation Endeavors, after which he co-founded Carlin Ventures, which was backed by a single-family office. From there, he co-founded Fika Ventures, where today they have a 10-person team and have raised three funds to date.

0:34During the pod, we discussed the culture needed to run a successful VC firm, how they thought about LP fundraising as a first-time fund, and how they think about valuation methodology. Let's get right into the episode now. Samir Khadji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other. Any statements or references made by Samir or his guests regarding third parties, investments, or securities are solely their views and opinions and are not intended as investment advice or an endorsement of such parties or securities by Samir, his guests, or Allocate.

1:08Allocate or its clients may maintain relationships with or investment positions in guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. TX, it's good to see you and thanks for being on the show. Of course. We've been friends for such a long time, and I've been looking forward to this. I know. It's a long time coming for sure. So one of the things I love to do with managers is think about their path to venture capital. And I think you have a really unique one. So maybe, TX, you can go through how did you get into tech and then how did you get into the world of startup investing?

1:47Well, the joke is that I never wanted to be an entrepreneur to begin with. So as the accidental entrepreneur, But halfway through college, we had an unfortunate kind of family incident where my dad was diagnosed with cancer. And my mom said that, hey, you have to earn some money and figure this out quick. So I think the path of least resistance and at that point, a friend and I have been noodling on a couple of ideas was to start a company. We were doing something super simple. We are selling college textbooks online of all things and took some time off college over the course of three and a half years.

2:22build it to about a 20 million run rate business, which we ended up selling. And through the accidental entrepreneurship journey, I got very excited about kind of building a company. The honest truth is that I tried to start a second company, couldn't come up with a great idea. So I thought that Nick's best alternative is to help people around me do the same thing. So then became very excited about venture through my time at business school. Again, and was very lucky to get hooked up with the team at Innovation Endeavors, where I worked through my summers and throughout the school year. After graduation, started a fund called Carlin Ventures based in LA, which was a$30 million early stage fund.

3:01And that was kind of the start to my venture career. So as you think about it, going from Innovation Endeavors to Carlin, to the firm that you co-founded, which is FICA Ventures, now about seven years old, roughly. Tell me what was the inspiration of starting FICA? and what was that blueprint of what you wanted to create as part of this new firm? I think Carlin was a great learning experience for me. I think when I first started as a VC, obviously there's imposter syndrome. I was thinking, hey, my own company, we only got it to 20 million in revenue. So am I really well positioned to help these entrepreneurs?

3:37And I think we took a very humble approach when we started Carlin, that saying that whenever we dealt with the founder, we all were kind of communicating as peers. It never felt like I knew more than the founder, but we're just there to help. And I think four, four and a half years to that Carlin journey, I think I learned that it was great having a family office behind me, supporting me for our first fund. But I really wanted to have some leeway in terms of shaping the vision for the fund and sort of making it a more institutional platform as we grew. So in 2016, a good friend of mine, Eva Ho, and I came together and started Fika.

4:15And our goal was, hey, we really enjoyed being entrepreneurs ourselves. And we want to support people in a similar stage of their journey, that being kind of at the seed stage, work through some of their challenges and really be there as a friend and a peer, help them. I think it's a very fun journey. We both miss it tremendously. And I think to get the same adrenaline kick, it's to help people who are going through the same stage of the entrepreneurship journey. Yeah. I feel like whenever you're starting something, whether it's a company or it's in this case, a firm, a lot of how you structure and think about the overall thesis and how you're going to operate is based on past experiences, both what you've learned as that has worked, but also things that have not worked.

5:01Can you maybe talk about some of the things that you learned that where you made mistakes that helped you think through a better way to actually create a firm and invest in entrepreneurs through Fika? We didn't have formal investors. So the other irony is that I pitched 74 angel investors to invest in my own startup and none of them said yes. So maybe I'm not qualified to be a VC at this point. But a couple of them came on as equity advisors where they were guiding us from time to time. And what I realized that there was a pretty unique distinction about the advice that you would get from these advisors.

5:37I think the ones who are former operators, I think they could contextualize and understand that, hey, we're here to support you and you're the one as the founder spending 24-7 on the company. So you understand the company best and we're here to help you solve problems. Whereas some of these advisors who didn't have similar experiences were coming to us and sort of almost forcing their own advice or decisions on us, which I felt was pretty jarring at that point in time. So when we thought about Carlin and we thought about Fika, I think we wanted to be a platform where we took a founder's first approach.

6:13But I think the principle that even today we abide by is that we try not to be the captains of the ship. We know you're steering the ship, but we're trying to be your deckhands. You're trying to be kind of an extension of your management team and help you with every other problem. So I think my own experience as an entrepreneur getting kind of advice that was good and bad and being able to kind of distinguish who the right advisors will kind of shape my understanding of what FICA should be today. So I want to go back to that founders first or founder friendly, because it means so many different things to different people.

6:44It's been diluted to a certain degree over time. You mentioned this before, innovation endeavors, and then going to Carlin, whereby you had, you know, a single family office that was supporting you. While you had raised capital as an entrepreneur, raising capital as a fund manager is very, very different from an experience standpoint. How did you attack that piece of it? Because obviously, to be founder friendly and invest in companies, you need LP Capital to back you. Maybe talk a little bit about how you approached that first fundraise. It was a very difficult fundraise, being honest with you.

7:17We, again, pitch, again, I can say this today and laugh about it. We pitched probably 700 investors and we got 105 commitments to close a$41 million fund. I think that the first few years, I felt pretty embarrassed about giving those stats, but now I feel that was like trial by fire. And we really understood the founder journey of raising capital ourselves. I think the other realization that I've had now being a VC for this long is that VCs are technically salespeople. We're selling capital or we're selling the dream to a lot of LPs. And I think back in the day, we used to tell the story, I'd say it's all steak, no sizzle.

7:54So I think we were just talking about kind of our prior accomplishments, but not being able to convey that dream to LPs on what we could do with a platform like Fika. And I think that has changed a lot. I think many thanks to a lot of institutional investors who have helped us over the years. But the first one was tough. I think the only way we got it done, and not going to lie, there are moments where we were like, oh, we did our first kind of hundred pitches and we got 4 million in capital. We're like, oh my gosh, Is this really going to be the case? But Eva and I have both been entrepreneurs before.

8:27I think we understood that, hey, the going is going to be very tough in the early days. Not that it gets easier, but that was a challenge that we were up for. So I think we just persevered. I think one thing that we did was we did, we agreed that over the course of eight months, we'll do at least eight LP calls a day. It could be with people we've chatted once or twice with, or it could be a net new prospect, but we weren't going to look at new deals. We weren't going to do anything else. And I think that steadfast focus to closing the fund, which is what I admire in a lot of our entrepreneurs, is what allowed us to get there.

8:58And some might say, oh, my gosh, 105 investors for 41 million. That's not worth your time. But I think we knew that there was a stepping stone to get us to where we were today. So, again, both of us were willing to do it. I remember we did three overnight flights to Singapore and coach. I think that was probably the most painful part of the fund one race. How much of that do you think was related to not going after the right investors or not telling the right story? I think it was a bit of both, right? I think the LP world, and today I understand how it works, is that they're looking for prior track records and credibility.

9:30I think at that point, I think we obviously had managed two funds before that were relatively new. When we raised Figa 1, our first two funds, which was Carlin 1 and Sousa 1, they're both like three-year-old funds. so there are some signals that some of these companies were doing well but really no breakouts if i have to be honest with you so at that point it was a huge bet that lps were making i think what eventually convinced them was again going back to the founder first principle was the glowing references they got from some of our founders uh in addition to the kind of grit and hustle that we showed i think i think eva and i kind of take pride that we we almost have a zero inbox policy.

10:10So when LPs were interacting with us, I think they were, I think, surprised in a positive way by how fast we'd respond with data requests. And some of them were kind enough to take a bet on us. And I think we'll always be grateful to those initial backers of ECA1. Going back to this concept, because you're right, you know, track record at the time, you had some at Carlin, you had some at Innovation, but it was still early, maybe not a ton of realizations and sometimes people look for longer track records but it's also you two coming together for the first time as partners how much of that was a question of it's not just the track record but it's also the team have you worked together what were some of the most difficult questions to answer as part of that first fundraise some of the questions were one although we knew each other as friends we've co-invested before it wasn't like we formally worked together.

11:05And because this was a 50-50 partnership, I think they were very worried that, hey, we wouldn't get along after the first three, six months. And that would be a kind of a huge challenge for LPs. And they were already taking like a first-time fund risk. So for them to get into a first-time fund and have that partnership dynamics that they were uncertain about, that was always a concern for them. And I think the other was, I think some LPs thought that even though Carlin was a single GP fund, we technically had one LP and Sousa had multiple GPs. So could Eva and I really do this on our own without the backing of other partners of or kind of a strong kind of single LP?

11:46That was another question that came up a lot. And then I think the final question that came up is that we were selling them hard on this kind of founder first approach is that's what we want to do. I think the scalability of the strategy and whether that was a true differentiator when you come against kind of the established brands like Sequoia and Dreesen was always a question that we have had to answer. Even today in our most recent fundraise, we've had to talk about these issues and questions. I don't think that will ever go away. I think the only kind of validation we can provide is, hey, go speak to any of our founders.

12:17They can probably validate that we've been fairly helpful to them. And hopefully our win rate through some of these deals kind of illustrate that that's kind of how founders actually feel. One of the things you've probably seen over time now that you've raised, I think, four funds, the three main funds that are opportunity fund, I think you did at some point, is that you're building your portfolio, you have more founders, you also have more LPs, and these are LPs that are relationships. I want to get into what founder first means for a second. But what have you learned in terms of being LP first?

12:50And how do you actually create these and foster these relationships where ultimately some of your early backers are going to be with you multiple times over? Some of the, well, it's, as you know, kind of the performance of the fun follows a rollercoaster in the early years. So there are good days, there are bad days, there are days where like, oh my gosh, like, how do I actually tell my LP that this is actually happening? But I think we've taken pride in radical transparency. So I think over communicating and taking a very conservative approach with LPs. If there's something happening with one of your companies where you maybe don't feel comfortable with the valuation, or you think that might be an impairment to revenue, I think calling some of your main LPs up before they hear about it in the news and saying like, hey, I think this might happen.

13:34I'm not too sure. And the other thing is taking a pretty conservative view. I think we've had instances where we felt like, hey, this company might not survive. We've proactively written them down to zero. And some of the LPs have called us and say, hey, we have other fund managers who haven't done it. Why have you guys done it? We say, hey, we're not 100 % sure, but we feel like we want to take a conservative approach. So I think that financial prudence and over communicating has really, really helped us earn the trust of a lot of our LPs. How tough is that? And I ask that question because I think on one hand, if you see your peers not doing it, and they're out fundraising with better numbers, you're obviously at a position where you're raising, where you've done the markdowns, maybe your numbers don't reflect as much as if you had not done those markdowns.

14:20And there, of course, are some LPs that are actually paid by how the performance is. So if you mark it down, their overall IR goes down. Therefore, they may be measured differently within their organizations. It's funny you mentioned it. I'll come back and answer your question. But I remember we did a sizable markdown at the end of 2022 and not going to mention names, but we had two of our LPs call us and say, like, why do you do this at the end of the year? this actually affects some of my bonus that's going to get paid out next year. And I didn't realize that some LPs were comp based on the IRR for that year.

14:54So I think that was very enlightening to me. But I think fundamentally, there's this intellectual honesty that we believe in. So we're not going to, for the sake of pleasing a few LPs, not make the right changes to our marks, our valuations. But it's always a tough conversation. I think when you're out in market, I think the marks are pretty important. And like you said, when you raise against peers who have higher marks, obviously it's going to hurt you. But I do think the best LPs look at marks as kind of a historical validation of what the fund has done. But I think what's a better predictor of how the fund's going to do in the future?

15:32it's other data points like i think founder references how they're perceived by co-investors how their more recent deals are performing not just from a valuation standpoint but have they hit all their numbers so i think we've been fortunate that we have a pretty sophisticated base of lps who take that extra time to understand what what's really going on in the portfolio and how fika is perceived in the market and again feel very blessed that we're in a position where We've had strong support from our LPs across all our fundraisers, but definitely agree. Still a challenge we're dealing with, but I think honesty is the best policy and that's what we're going to continue to do.

16:09Yeah. And I think in the early days, of course, the numbers don't really mean a lot in the first few years of a fund. It's really around the execution. Are you generating the right type of deal flow? Are you winning the deals that you want to get into? And a lot of that is based on reputation or brand, which at the end of the day does come from what do founders say about you? Why do they pick somebody like Afika over all the different options? So let's talk a little bit about this concept of something I hear you talk about a lot, which is founder first and taking a service provider mentality. But what does that actually mean to you and within the walls of Afika?

16:47It's honestly changed over the years. And I think we were somewhat naive when we first started Afika. I think when we first started Afika, it's like, we can do everything to help a founder. And we're doing everything. We were doing everything from contract negotiations to setting up HubSpot for them. And honestly, as we grew our portfolio now with 85 companies, that wasn't sustainable. But more importantly, we realized that we weren't really enabling these founders. We're giving them a crutch. We weren't teaching them how to do it on their own. So we realized that we had to tweak the business model where now we focus on maybe two or three things that really moved the needle for them.

17:26So I think specifically, we helped them still a lot with customer introductions. We helped them a lot with talent introductions and finding the right fallen investor who can still carry the baton after us and continue to help them in the same way. That's how we really help founders. But I think being clear what we're not going to help them with, but it's not to say that, oh, we're not going to help you and you're left to sink or swim. We're going to give you resources that can help you get there. And I think that's been pretty helpful. The other thing that I think we've done well is that we've earned trust among all our founders.

17:59And I think the way we've done that is being very open about what we're doing. And sometimes we get things wrong. We don't do things right all the time. And being willing to admit to your mistakes and let founders know that, hey, we're humble. We're willing to roll out our sleeves. We're going to work side by side with you. That trust has gone a long way where founders feel like being vulnerable with FICA doesn't mean that we're going to be sharks and kind of use that to our advantage. All it means is that we're going to problem solve together with you and we'll find a quicker path to a resolution.

18:30So I think those steps that we've taken have really allowed us to kind of win a founder's heart, for lack of a better word, and really embrace that founder first mentality. Let's talk a little bit about sort of this, what it means to get a great founder reference. You know, a lot of LPs will call the founders and say, would you take money from them again? Like, what did they do right? How would you improve what they do? And there's a variety of different opinions. But generally speaking, you know, it's around, did they actually do what they said they were going to do? And I always view net promoter score as the delta between expectations and reality.

19:05So in the early days, you were selling all these expectations and you were doing it, but obviously over time, it doesn't scale. So how do you approach the founders today in terms of what the expectation should be when they work with somebody like Afika versus another fund? One good thing is that we try to do even before we set these expectations is whenever we try to win a deal, I think something unique that we do, we offer the list of 150 founders at this point, and a prospective founder can speak to any one of them. We say we'll facilitate interest wherever you want on the list. And what we can assure you is that for better or worse, it's a pretty consistent experience and we're not trying to hide anything.

19:47But once we get into kind of that relationship with the founder, this is kind of like expectation setting exercise that we do week one of the investment to say like, hey, these things are in scope and these things are not in scope. And even for the ones that are in scope, we always try to under promise and over deliver. I think one pet peeve of mine in the venture industries, A lot of VCs will sell you very hard as they're trying to win a deal. The first three or four weeks, there's a very high engagement level. But I think post that initial kind of honeymoon phase, it quickly tapers off. And that creates a very bad experience for the entrepreneur.

20:24I think it sets the wrong expectations. I think it creates that dependency, which is then very hard to take away. So for us, we almost adopt the opposite. it. We try to not tell the entrepreneur that we can do like XYZ and then surprise them over the course of a couple of months and actually kind of deliver, say, three customers to them. The other thing that I think entrepreneurs get very disappointed by is investors who might not invest in follow-on rounds, especially when they need your support. That's something we've tried to be very objective with founders. I think it's very hard, right? When you have a top tier firm coming in for follow-on round, the natural instinct for us is like, hey, let's just do it.

21:04These are good shepherds of capital. I'm sure they will take the company to new heights. But we now document what are the right milestones for each company within 6, 12, and 18 months whenever we first make an investment. And I think our internal compass will say that, hey, if they hit these milestones or come close enough, we don't really care who the follow-on investor is. Sometimes we don't even care if there's a follow-on round. If the company needs capital, we're there for you. But if they've fallen short of those milestones, then we need to have a conversation. And having this objective framework allows founders to kind of really embrace what we're doing here at Fika.

21:40It's not like, hey, this is a flippant decision where we're just trying to not fund you because you're not our favorite child. This is following a rulebook, which we set in place and you've agreed to. So I think establishing that this is a mutually agreed kind of path for you and the company goes a long way in kind of building trust, even though you have to have those hard conversations sometimes about not participating in their rounds. Well, how did you navigate that in 2021? Because I was looking at the data and in many cases, companies are going from the seed where you participate to the next round of capital in less than 12 months.

22:15And there's not a lot demonstrably that can happen with a lot of these companies in terms of objective milestones. And not only were the following rounds happening, but they were happening at high step up in valuations, which of course make the early marks of the seed investment look good, but also presents a really interesting issue for you of if you were objective and milestone based, but there's just not enough time, what did you do during that time? The short answer is not well. I think that was a very, very tough time period for us. And I'll tell you why. I think there are two elements which made it tough, right?

22:49In order to have these tough conversations with founders, you need to have that relationship and build trust. For that to happen, at least in our humble opinion, it involves in-person time. I think you and I have known each other for 10 years, so we can pick up the phone and have those conversations. Some of these founders, we only knew them for six to nine months, and we never met them in person. So to suddenly jump on the phone and say, hey, either we want super prorata, we're not doing it for these reasons, even though we agreed to them, was a very, very difficult conversation. For some of those relationships, it took a couple of months before we could repair them.

23:23And I'm glad to say that most of them have been fixed. And then on the other side of the equation, now I say 6, 12, and 18. Before that, when the venture market was at its regular pace, we only assume a round would happen after 18 to 24 months and not after three months. So we never had those short-term goals when we were looking at a company's progress. And sometimes it's impossible to tell. For some of them that were selling to enterprises, it was unfair to expect their closer customer within the first four months. So we had to make judgment calls based on a very limited data set at that point in time.

24:00And I guess, unfortunately, one of the proxies was like, do we trust the next round's investors? So I would say that that vintage was very, very tough for us for those reasons that we We didn't have enough data points and we didn't feel that our relationships with founders was deep enough for us to have those tough conversations. Yeah. And of course, we've returned to a degree of normalcy. Maybe AI is this exception that is in the ether, which everything is a little bit different within AI. Back to this concept of founder first, right? There's these different variables that you have to juggle.