I Invested in My First Startup—And It Was Terrifying

Katie: Welcome back to The Money with Katie Show, Rich Girls and Boys. I'm your host, Katie Gatti Tassin, and this week we are talking about something that is pretty new to me. We're going to learn alongside one another in this one, because while I feel extraordinarily comfortable stretching out inside the roomy walls of a taxable brokerage accountant tossing around ETF jargon with the best of them, investing in startups, small private companies, is something that before this year I knew next to nothing about. We have two formal guests today. The first is Arman Hezarkhani, the founder of a startup that I recently invested in. I am going to ask him a bunch of burning questions about everything I did both right and wrong.

Arman Hezarkhani: Hi Katie. My name's Arman. I'm the CEO and founder of Parthean.

Katie: And the second is Steph Mui, the founder and CEO of Pin, a company that helps accredited and non-accredited investors invest with their friends and communities in startups. We are going to come back to all of those terms. Steph worked in venture capital before deciding she wanted to bring VC investing to the masses.

Steph Mui: Hi, I'm Steph, and I am the CEO and founder of Pin, which stands for Power In Numbers.

Katie: We also have an informal guest, in the sense that I was getting dinner in New York with a new friend, Erica, who just opened her own venture capital fund called Park Rangers Capital. I was peppering her with questions about venture capital and ended up deciding to just whip out my phone and record the conversation, with her explicit permission, of course, because we're not that kind of podcast, but okay, allow me to set the stage.

A couple years ago, a very close, very smart friend of mine co-founded a startup called Command Bar, and over time they've raised $24 million in funding. In 2022 during their Series A round, another term that we're going to get into later, my husband and I had the opportunity to invest alongside big venture capital firms like Thrive Capital, whose notable investments include Airtable, ClassPass, GroupMe, Glossier, OpenAI, Plaid, Skims, and Spotify. Immediately you may be like, "Sounds like they really know how to pick the winners. Why wouldn't you toss everything at a company they're investing in?" That was my initial reaction, too. But this little anecdote highlights a few things right off the bat about the elite world of venture capital. You only ever hear about the investments that pop off. Nobody is going to list the other 2,000 things they've dumped money into that failed on their website, and realistically, 90% of startups will do just that: fail.

So much of investing in startups is looking around at what other smart people are investing in and going, "Huh, well, if it's good enough for them, I might as well." This is partially why WeWork founder Adam Neumann was able to grift billions of dollars from big names, a case study that I'll come back to throughout this episode because it is the quintessential runaway freight train of groupthink.

Finally, scale matters. It is super impressive that our friend and his co-founders got big name VCs to invest in their company, but these firms make lots of bets that seem humongous to non-investment professional regular plebs, NIPRPs, like you and me, but are relatively small for the VC firms. It would be ridiculously reckless, not to mention financially impossible, for all of us to try to operate on the same scale. And so much of this world seems glittering and fancy. There's all this wealth and celebrity and it kind of feels like it goes hand in hand. I mean, just listened to what Erica told me she did earlier in the day before we met for dinner.

Erica: You know who I just met, or I didn't just meet, we smiled at each other? Karlie Kloss.

Katie: Shut the f...

Erica: No, fully.

Katie: Are you shitting me?

Erica: I'm sitting there, I'm waiting for this meeting. I'm meeting just an investor there and I'm sitting and I'm like eight minutes early or something because I didn't know where the building was, and all of a sudden I hear, like you hear people walking around you, and I hear someone and I can see this very tall person and I look...it's fully Karlie Kloss.

Katie: So yeah, it felt like every conversation that I had included some ridiculous detail like this, and it was easy to feel pretty intimidated by some of the institutions and names that were getting tossed around. But when our personal friend gave us the opportunity, I was conflicted. On one hand, I know how hard he works and how good of a developer he is. I wanted to support him, but I was scared. I didn't know anything about investing in startups, how to get paid back. What does success look like? Did people really check this box that confirms they know they're most likely going to lose their entire check before wiring thousands of dollars into a black hole? I felt like I had been tossed into the deep end of the pool. At the end of the day, my husband who went to high school with the founder compromised by investing $5,000 of his own personal savings, not money from our joint account. In this world, FOMO competed with FOLM: fear of losing money.

And let me tell you, my FOLM was greater than my FOMO, but part of the reason I felt unsure was because admittedly, I don't know about B2B SaaS companies like Command Bar. This basically just means businesses that sell software to other businesses. I comically tried to poke around their website in an attempt to get comfortable, which I imagine looked like the equivalent of a 14-year-old with no mechanical experience kicking the tires on a race car going, "Yeah, this seems about right." I think my instincts to be uneasy were probably right. Here's Steph.

Steph Mui: Something that really resonates with me as advice I've gotten in general is to really only invest in things that you understand. I think this world will be confusing in the same way that learning any new thing is confusing, and once you learn the terminology, it gets easier. Even once you nail the terminology and the financial terms behind it, investing in something you understand, say a consumer product that you use and love every day, or an industry that you've worked in that you understand inside and out versus a startup in a completely different sphere, is really, really different. Even though there are rules that you can follow and ones that our communities follow, they co-invest typically with the top-tier VCs for that level of security.

Like I mentioned before, I still recommend people really only invest in things that they trust and have a fundamental understanding of the business of, because even understanding the business, there are lots of questions that you can ask and probably things that you'll miss, but it's so, so, so much harder, especially for a new venture and something totally foreign to you. I just urge people to kind of narrow in their scope there and the questions will come a lot more natural and easy.

Katie: We'll be right back after a quick break. Because we had finally achieved a level of financial security that allowed us to invest in startups, a status called "accredited investor," it felt alluring. Everyone knows the story of Jeff Bezos's parents who gave him $300 grand to start Amazon, and, well, I would call them and ask for comment about how that went, but I think they're on one of their yachts in the Virgin Islands right now. Let's take a moment to define accredited investor, because it sounds a lot fancier than it is.

The Securities and Exchange Commission, better known as our pals at the SEC, sets criteria that attempt to more or less protect regular people from losing their shirts in big risky bets. Anyone can go buy a share of the S&P 500 ETF VOO, but the SEC attempts to build guardrails around things like venture capital and hedge funds. In order to be an accredited investor, you and your spouse collectively, if you have one, have to meet one of two requirements. You must have earned at least $200,000 or more annually for the last two years or $300,000 per year between you and a spouse, or you must have a net worth of more than $1 million, excluding the value of your primary residence.

Now, there's no grand certification ceremony or a court jester who's going to show up with a trumpet and dub you accredited; instead, it's just something you become when you meet one or more of these qualifications. I'm not really sure how these things are verified or checked. If the little FBI man in my phone is listening, I am encouraging you to embrace the honor system. If you're not accredited by these standards, but you still have a hankering to invest in an early-stage company, fear not. 12 states have made it possible for non-accredited investors to obtain equity in startups through a method called crowdfunding.

I did a little digging. It looks like there are some parameters in place. People with an annual income or net worth below a hundred thousand dollars are limited to no more than $2,000 or up to 5% of the lesser of their net worth or income. If you make a hundred thousand dollars or more, there is a 10% cap on either net worth or income.

I'll take this moment again to reiterate what I told you at the top of this episode. I am a plebeian with access to Google, right? We are learning together this week. I'm not a licensed financial professional nor an expert on VCs, just someone who eventually did take the plunge and wants to talk about the experience. Please do your own due diligence and research. On the note of due diligence, I will give you the Money with Katie take on non-accredited investing in startups. If you don't yet meet the standards of an accredited investor, I would probably urge you to focus on safer, more standard investment practices until you do. I can't give you investment advice, of course, because there's always a chance you're related to the next Jeff Bezos and you have a winning lottery ticket in the form of your quirky Uncle Dave. But let's be real: probably not.

My personal opinion is that you're better off getting to your first million the slow and boring way, and then exploring other opportunities once you've got that solid foundation to fall back on. Because as I mentioned, 90% of startups fail. Any check you write to a startup is a check that you are effectively comfortable with shredding. Why would you invest in one? Well, I didn't know anything about B2B SaaS companies. I do know a thing or two about personal finance. The field, the landscape of products, and the customers for those products. Going into 2023, one of my stretch goals for myself was to find an up and coming FinTech company that I could make my first small angel investment in. I was looking for a couple of things. First and foremost, it was a product that met a need I knew many of my readers or listeners had. I wanted it to be something that took a new or novel approach and or had an excellent user interface.

I'm thinking of the app Copilot as an example. Their software was developed on a platform called Swift, which makes it feel completely different than other finance apps, and I happily pay $70 per year for my subscription. I wanted to find something that struck that same chord. I also was looking for something with recurring revenue, a subscription model, because that tends to be preferable as it creates ongoing revenue for a business. I wanted to find a founder who did not treat me like the noob that I am. Investing in a business that met these qualifications felt valuable for two primary reasons. The first is that my tire-kicking would be a little more informed, and the second is that I have a way to share that product and influence that product's development.

I knew that I could directly help the business and potentially influence its outcomes to whatever small degree. There are other reasons, too, to take a bet on someone else, like my husband supporting a friend that he knows well. When I asked him how much research he did before feeling comfortable, my husband was like, "Well, I did tons of research. I've been hanging out with him for years." And I'll concede that while that's not exactly a compelling investment thesis, I imagine that in practice, a lot of small-scale, regular person startup investing happens for the same reason. You are investing based on trust in that individual. But if you're looking for something a little more solid, per Forbes Advisor, these are some of the questions you might consider asking yourself if you are thinking about making an investment.

What do you know about a startup? Is it a field, industry, or product that you are familiar with? Ideally, you want all three of them to be familiar to you. Is the team passionate about the idea? Alex Lieberman, the co-founder of Morning Brew, told me, most startups fail, so I don't think about it like I'm investing in the company. I pick the people that I want to invest in, and I basically invest in those that I'm most confident in.

Does the startup have domain expertise? The startups should know the ins and outs of the space that they're operating in. How big is the market, so the total addressable demographic of people, of customers that they have to work with? And why this, and why now? Has this idea been tried before? If it hasn't, why not? And if it has, why did it fail previously? That's a little bit about the why.

Let's talk about the how of investing in startups and the rounds. Because startups raise money in stages; most companies complete a number of fundraising rounds before getting to the initial public offering, IPO stage, assuming they ever get there, which is when the public can finally invest via a public stock exchange. Now, public companies have to jump through a fair number of hoops to report their financials on a quarterly and annual basis, which can allow investors to learn more about a company's growth prospects and financial position. Or you could be like me and just invest in index funds. But startups, they don't have to do that. No reporting, just vibes.

Anyhow, these rounds allow investors to invest in a growing company in exchange for equity or future equity, which is basically ownership in the company. In case it's not obvious, if the company ends up worth nothing, your ownership is also worth...checks notes...nothing. You can see why this is risky. The initial investment, also known as seed funding, is followed by rounds known as Series A, Series B, Series C, and so forth. During each round, the company gets a new valuation, which helps determine what your equity as an investor is worth. Valuations are determined by lots of nebulous factors including market size, company potential, current revenue, management. To get some clarity on how all of this is calculated, I talked to Steph.

I want to get into the technical stuff with you a little bit because when I was going through this process for the first time, two terms that I kept hearing getting tossed around are pre- and post-money valuations, and I feel super comfortable and well-versed in public market jargon, but I was like, post-money valuation...what in the hell? The startup that I invested in had a post-money valuation of $12 million, and when I learned this, I was like, "Oh, sure, yes, of course." And in my head I'm like, I can't make heads or tails of that. I don't know what that means. Steph, what does that mean? What is a pre-money valuation? What's a post-money valuation? What's the difference? Why should we care?

Steph Mui: Don't worry. It still trips up many people, including founders who literally do this for a living. It's definitely not just you. So pre-money versus post-money valuation is actually a lot simpler than I think people make it out to be. The calculation really is pre-money valuation plus the amount of money that you're bringing in for a certain round equals post-money valuation. For example, if you're raising $2 million, from your example, the post-money valuation on that company was $12 million. Say they raised a $2 million round, that means their pre-money valuation was at $10 million. Why it's actually important is to understand your ownership stake. I think the biggest mistake that people make is that they use the pre-money valuation as the denominator when they're calculating their ownership instead of the post-money.

Katie: Oh, I see.

Steph Mui: People overestimate how much they own of a company, and so founders especially, or early stage investors, make this mistake all the time. The key is when you're evaluating how much you own, say in this example, you invested $1 million, you understand your stake by dividing one divided by 12, aka the post-money valuation, not one divided by 10.

Katie: I see. Okay, that is really fascinating. That makes a lot of sense. Thank you. That was the clearest explanation that I've heard so far. It is the value of the company, and we're using value in a very theoretical sense here. The value of the company plus the money they've raised, that's like the total assets. Cool, that makes sense.

Now in boom times, these valuations are based on a unicorn fart and a prayer, but we are not in such a boom time right now. We'll get right back to it after a quick break. So how did I find the startup that I ended up investing in? Like I noted, I wasn't seriously looking. I had a general idea for the type of business I'd probably want to invest in if the opportunity presented itself, but I wasn't really seeking them out. Then a few months ago, Alex Lieberman Slacked me and he mentioned that a founder he knew, Arman, was developing a personal finance app, and he was hoping to solicit a few second opinions about some of the things they were developing from someone who knows the space and products well.

I agreed to meet with him. We set up this call, and initially I figured I was just going to answer a few questions about the non-negotiables of a finance app. But by the end of our 30-minute conversation, I was asking Arman if I could invest in what he was building, which was one of the first commercial uses of AI in a finance app. I didn't even ask to see a business plan; I just saw a product, I used it. I asked them questions about the monetization strategy, and as they say, I've seen what I need to see. This might sound or feel a little haphazard; I suppose it was. But from being on the periphery of the space over the years, the business plan has always seemed to me to be a bit of a theoretical MBA exercise in the startup world. It's based on a lot of estimates and guesses and I think might be less important than the product itself.

Still, I was in over my head, primarily because I was not actually sure about the mechanics of how I would make money on this investment, and I wanted to know why she felt so strongly about "regular people" investing in startups when it seemed so obviously high-risk and convoluted to me. Steph, I am in uncharted waters here and I'm trying to make sense of the private investing world. One of the only deep dives that I've ever read about how these things work was actually about WeWork. I know the early investors in WeWork ended up making a boatload of money, but not because WeWork ended up being crazy profitable, but because later valuations were so sky-high. How does that work?

Steph Mui: Yeah. Oh man. I think that's a great story to illustrate the nuances around venture investing, and to compensate for the risk of investing in companies at super early stages, you usually get in at a discount to a future valuation, meaning, say you expect a company to ultimately hopefully be worth a billion dollars, you would invest say today at the infancy of a company at a valuation of say, $10 million. The kind of risk reward is that you're getting in early. You get a much larger percentage of the company for your investment than you otherwise would. The hope is that there's a small percentage that the company will take off and be a billion dollars one day, in which case it'll 10X or more your investment.

Katie: Okay. At that point then, the piece that I find so confusing is these liquidity events, because I assume those earlier investors made money before WeWork went public. No? Or did they have to wait until the company went public? Is that the only way that they can make money?

Steph Mui: Yeah, I would say that's also very nuanced. Especially in the last few years, it's becoming more and more common for founders and early employees sometimes to, to your point, have early liquidity events. Part of that also is because in the last 10 years, companies have waited a lot longer to go public than they historically have been. To compensate for that, they'll sometimes do liquidity events for founders and early stage employees. They'll essentially sell their stake early before an IPO to other investors who want to get into the round. That's spot on, where I'm sure a lot of people actually did take advantage of that. Even though WeWork today obviously has fluctuated a lot in the public markets, it's a very real possibility that at the peak of WeWork's valuation in the private markets, a lot of people at the earlier stages made a lot of money.

Katie: By selling the shares that they already had to new investors at those higher valuations. How should we think about these various rounds? I assume, like you said, the Series A investment is considered riskier than say a Series C, where I would assume the company has already proven itself to some extent or has more of a track record.

Steph Mui: I would say in an ideal world, that is exactly how it should be. Seed, Series A and beyond, to your point, Series B as it continues on usually means that the company is more mature, they're taking on typically larger rounds, they're giving up more and more percentage of their company to new investors, but it's not always the case, which is kind of tricky. For example, it's very real that a investor that's not very educated in the space comes in and gives a huge offer to a company for a Series C round at a sky-high valuation, but the company fundamentals might not support it. This is obviously an extreme example, but I think Theranos is kind of an example that most people know. That company raised a ton of money, I don't even know what series they got up to because they raised so much money, but that did not at all reflect the fundamentals of the business and the true value it ultimately ended up being.

Katie: Elizabeth Holmes, America's girl boss.

Steph Mui: Sadly.

Katie: Your mission is to bring startup investing to regular people, groups of people. How do you think about the risk that a non-accredited investor would be taking on in order to do something like that? I imagine there is a bit of a balance between you want to bring that "to the masses;" you don't want it to be gate-kept, but at the same time it's risky for a reason. Why is this something that you want to introduce to a wider audience, given how risky it can be?

Steph Mui: 100%. I am the first person to tell people that when you make an angel investment, you should absolutely expect to lose all of your money, which is in some ways not a great way to set up a pitch for your company and why people should invest. But despite that, the reason why I care so much about our mission is on a macro level, if you look at where wealth creation has been driven over the last 15 years, more and more of that has been driven by private markets, aka startup investing, VC, private equity, versus public investing, aka the stocks that everyone has access to, and you don't need to be an accredited investor to access. I fundamentally, just looking at that alone, think it's really unfair that this asset class that has historically outperformed what is available to everyone isn't available to everyone.

Even though venture investing is really risky, I still think it's a worthwhile asset class to learn about, especially in a responsible way. For one example of how Pin operates in a way that I think helps people get into this asset class is we take an index approach. Venture investing, one of the biggest qualities of the industry is that it works on a power law, meaning you expect 90% of companies to fail, but the 10% are the ones that so outperform the rest that they almost make up for the investments that fail 90% of the time. When you see venture investors make those investments, that's very much how they think about their portfolio. They make 10 risky investments and they expect kind of the big winners to really make up for all the other ones that has historically not made it.

Pin actually works very similarly, where instead of just investing in one company or two companies, you invest one check into a group that you care about in either a mission that really aligns with you in an industry that you care a lot about or understand, with people, either ex-coworkers, friends, founders, whoever that you really trust, and you invest in usually 12, 15, to 20 or more companies with that one check, giving a more diversified approach.

Katie: Wow, I didn't realize that that was how it worked. It's an interesting balance, I think, between when I think about angel investing or private market investing within my own portfolio, it does strike me as, okay, this is a very concentrated bet. It's admittedly a small sum, but if it were to 20X or 100X, that is going to be far and away the best investment I've ever made. Well, and as you've noted, it's most likely to go to zero, but there is that concentrated bet on that one racehorse, so to speak, as opposed to the public market investments. It's interesting to marry those two things where it does feel like diversification in the private markets too. Are your customers, when they're investing in these companies, I assume they are not necessarily picking the 12 to 20, or are they?

Steph Mui: Not every individual is necessarily picking every investment they make. It's interesting, actually, that's a huge benefit to a lot of folks, right? They're like, "I want exposure to this asset class and venture, but I am not qualified as someone who can do diligence on all these companies." Either I don't have the time, which is very reasonable, or I just don't have experience doing diligence in these companies. We find that people actually like the safety and comfort and fun of investing alongside a community. Usually there are leaders with experience in the space who kind of help with the first line of defense, but secondly, actually, I'd say 95% of our groups co-invest alongside the top tier venture investors. So there's a level of security that what you're investing in is a legitimate company. There have been legal resources and lots of money from these large firms that have diligenced the opportunity, even though venture investing is still risky, even with those parameters. It's a safety net, if you will, especially for newer investors.

Katie: Well, sure, I wouldn't even know where to start. I would hve no idea how to do due diligence on a business. That's just so outside the realm of my life experience. So that's really fascinating. What timeline should somebody be if they invested in...like you said, you are warning people, "Hey, most likely this is going to go to zero. This is probably a check that you're effectively shredding." On the off chance you're not shredding it, what types of timelines are you suggesting people think about when they're investing in an early stage company for, if you were to get a return, it's probably going to be this long from now?

Steph Mui: Yeah, I would say five years at the minimum, closer to 7 to 10 years. Two things that I found super interesting. One is the huge upside case to your point of obviously you should expect your money to be completely lost, but the kind of major upside case that people look for, I remember we were just looking into Uber's early cap table, for example, and Uber's a consumer product that was out in the wild. A lot of people knew about it and had unaccredited people or people in general had been able to invest. People at the seed stage or at the earliest stage of the company who invested $5,000, they ended up making $25 million. And that's obviously...

Katie: Oh my god.

Steph Mui: How wild is that? That's the most extreme crazy, crazy success example. I know. I saw those numbers. I was like, "Oh my god, I was born at the wrong time."

Katie: What's also so crazy about that though is that, is Uber even profitable?

Steph Mui: That's a whole 'nother discussion to your point. Yeah.

Katie: It's insane to me that you can turn five grand into $25 million on a company that technically might not even be turning a profit or not until recently, relatively speaking.

Steph Mui: Totally. No, that's a very, very fair point. It's wild. That's what makes this world kind of irrational sometimes.

Katie: I know. Well, doing this for me very much felt like, okay, the vast majority of my investing is super boring, straitlaced, responsible. I don't even invest on individual stocks. I am index ETF mommy. This felt like literally standing at half court and throwing a basketball backwards and being like, hope it works! This is my one check that I'm going to throw out there. I knew that, worst case scenario, I've still got a good podcast episode out of it, so there's some upside inherent. Thank you so much for being here. I really appreciate it.

Steph Mui: Thanks so much for having me. It's been a blast.

Katie: Back to my experience with Arman, after I pressed him and he started to understand that I wasn't kidding about wanting to get involved, he told me about a few of the other investors: Brian Kelly, better known as The Points Guy, famed Twitter shitposter Litquidity, and my boy Alex Lieberman. This groupthink, as I referenced earlier, for better or worse, confirmed my gut instinct that there might be something here. Now, when it came to deciding how much to invest, I wanted to balance my belief that there really could be something valuable here with my realistic understanding of how unlikely it is for a startup to succeed.

I wanted to keep my husband's and my total investment in startups or around 1% of our net worth for risk mitigation purposes. I invested the same amount in Parthean that Thomas did in Command Bar: $5,000. We both keep these investments recorded in our Wealth Planner, but in some ways we've more or less written off the money as though it's not really there. We have no way to access it anymore. It is gone, and we won't access it in the future unless there's a liquidity event at either company, which we both know is quite rare. In this way, the exit strategy is basically "hope for the best."

I wanted him to join me to weigh in from two perspectives. One as the founder and entrepreneur raising capital, in the event that there are other entrepreneurs in our audience who are going through this process, and as someone to whom I have entrusted my capital, here's my conversation with Arman. Arman, before we dive into the juicy stuff, give us the elevator pitch for your product, Parthean. It's one of the first commercial applications of AI in a finance app that I am aware of, but you wrote in an investor update a couple months ago, "Hey, I understand just putting AI into something, that's not enough to make it valuable." It feels like these days it feels like everyone is injecting AI wherever they can, this hot new thing. I want to hear from you, how is this different? How did you decide that AI made sense in your product?

Arman Hezarkhani: Yeah, when you're building something for people, I think it's important to recognize the people. I think a lot of people who work in tech and startups are more excited about the technology than their customers. I am both. My background's in software engineering and marketing. I think it's really, really interesting as a technology. The difference and the thing that we constantly remind ourselves is, how is this technology going to make the product better for customers? Historically, Parthean was actually, I started as a financial education company because I believe that financial illiteracy is the biggest problem that is leading to the wealth gap and just difficulty and in Ramit Sethi's words, keeping people from their rich lives.

Soon after, after I brought a product to market and everything, I realized that people don't really want to learn about money actually, unless you're a finance nerd. You actually probably like learning about money because you think it's fun, but most people don't. I think what AI allows us to do is it allows us to get people closer to just doing the right thing and just learning the minimum amount that's necessary to go out and do the right thing and make the product feel more warm-blooded, akin to what it would feel like if you were speaking to a financial expert.

Katie: I see. That education is just a means to an end for most people. You don't want them to have to spend too much time listening to information that, hey, if there's an easier way to just help you apply this right away, that's a net positive. How was the valuation determined and how does that generally work? How it worked for you, and I think just if there is a broader application to be shared, that our audience would appreciate that too.

Arman Hezarkhani: Absolutely. When you think about valuing a public company like Google or Tesla or whatever, it's much more mathematical because there are equations and we can debate on the merit of each of these equations and we can debate on what's more important, whether it's EBITDA or profit or revenue or growth, but there are things to be debated. It's scientific and people see it as a science. For early stage companies, it's more difficult to do that because there is less data about the company itself. Oftentimes, there's no profit or no revenue or sometimes no product. Most of the time for a pre-seed round, there's no product. What you're really valuing on is the future potential.

If you think about how you can make money when you invest in a startup or when you start a startup, you can sell or you can IPO, and there are those events that you can make money in, and the valuation is determined based on what investors think those numbers might be, how quickly you might get there, and whether or not you will even get there. A lot of it seems more like an art than a science, but the science is there. It's just that the art is you're just betting on whether or not this person or this team or this product will be the one to hit that number that you see in the future as successful.

Katie: It makes sense that there's such an emphasis in those early stage situations on founders, because you really, that's the only known variable that you have to bet for or against. How did that work for you guys?

Arman Hezarkhani: I think a big part of it is the founder, but it's less about like, oh, I'm great. I'm this really interesting, amazing person. It's more about, okay, what is this person and what is this team trying to do? Where are the biggest risks and are these people the best equipped to mitigate and solve for those risks? For us, for example, in the consumer finance space, the biggest issue is first of all, giving the right information, building a product that is actually sound financially, growing quickly, and building technology. We have technological chops on our team, and I'm a software engineer myself. One of the people on my team, her name's actually also Katie, and she was a financial advisor for many years. We have that in our core. It was a specific part of my strategy to bring creators onto the team and influencers onto the team so that we can solve for that distribution and make sure that we can really spread the word about what we're building. So the valuation went up based on those factors because our team and our investors were well-equipped to solve the problem.

Katie: Okay, I see. Now onto the harder-hitting questions. Now that I've invested money into your company, what did I do wrong? It didn't take me long in our first conversation to be like, "Yep, I've seen enough. I want in." What questions should I have asked that I did not ask you?

Arman Hezarkhani: This is an interesting one because I actually think, and I'm not saying this to just blow smoke up your ass or anything like that. I think you're just in the space. We were almost finishing each other's sentences and you didn't need to ask about, "Oh, who are the competitors?" Because you know the whole market and you didn't need to ask about how do you get in the hands of consumers because you talk to over 200,000 consumers every day, and some of our other investors, and believe in the fact that we can get there. The things that people usually ask about I think are in your blood. Then there's also the technology piece. That part I think you just kind of trusted me on about digging into the tech. How does the AI work, how are we going to make the AI work? I explained those things and you got it, but I think there are some investors that are not technical that really dig into the AI. I think you asked the right amount of questions, so I think you killed it.

Katie: I did not tell him to say that. Well, I was talking to my producer after the fact, and I told her that I did decide to invest, that it was the first time I had ever done something like that. She's like, "Well, did you see a business plan?" And I was like, "No." I was like, "I just asked to see the product. I didn't ask to see any plans." To me, that seems like something you do when you get your MBA, but then never again.Is that real? Do you have a business plan PDF ready to be showing investors or we have startups evolved past that?

Arman Hezarkhani: Yeah, I think the venture ecosystem specifically has evolved past that. Most early stage venture investors, like venture capital firms, will not ask for a business plan. I've never been asked for a business plan. In fact, I probably could figure it out, but I would not know why I would do something like that. However, I have all the information at hand, and so the conversation that we had during our first meeting in another world, I could have just conveyed all that information to you in a business plan, but instead I just explained it. That's one part.

Then there's also financials and projections that some investors ask for, but they even say, "I know all of these are going to change, I just want to hear how you think about it." To whatever extent a business plan is useful, I think it's more useful to understand the founder's thinking. If you're a founder, if you're starting your own company, it's very useful to go through some of those exercises in order to clarify, okay, how will I grow this company? Do the unit economics make sense? When will I make money? Those things I think are useful.

Katie: Can you shed a little bit more light on how you are thinking about those things and how you think about growth, whether or not you have made those types of projections or feel confident in them, but how are you thinking about that? Obviously companies have to make money, right?

Arman Hezarkhani: Absolutely. Right now we are on the precipice of a moment where for the first time everybody can have access to a financial expert. That financial expert might be AI, it might be human augmented by AI, but since money was invented, only the richest people in the world could have a financial expert that they could outsource their problems to. And the rest of us have been completely on our own. For the first time, we are at this moment where AI, FinTech and the market in general, like consumer readiness is at a place where we can build a product that provides that service to the 99%, to all of us. If you can build a product where for the first time anyone can affordably access a financial expert, I believe we can then figure out growth. Right? Because that is the most difficult problem.

We often measure this in startup land by a term called product-market fit. And so what we're really fighting for every day is product-market fit, measured by usage, retention, things like that, and just how many dollars are we saving and making our customers? Once we solve that, we have all of these wonderful people that are ready to help us really grow and blow up and get in the hands of people and start helping more and more people. But first and foremost, we need to make a product that is day in, day out, helping people get closer to their goals.

Katie: Yeah. Let's shift gears. I would love to talk with you more about the mechanism that we used for my investment. I had never heard of it before. You introduced it to me. It's called a safe. What is a safe, how popular are they, and where did it come from?

Arman Hezarkhani: Yeah, so basically historically when you start a company, you have shares and when you want an investor, you sell some shares to that investor. That's actually way harder said than done. Typically, the documents used to buy and sell those shares are like 40, 50, 60 pages. There's a lot of negotiation. There's like a thousand different terms that you can negotiate on. And so that process is very expensive and it takes a lot of time. In addition, it's really hard to set those valuations, like we said, right? And so all of these problems together led to what's called a convertible note first, and then the safe was born out of the convertible note from an organization called Y Combinator. It's basically an accelerator where startups can apply and they get help on raising their first round of funding and getting their first customers and things like that.

They are the ones who wrote this document called the safe. What a safe does is it makes it very, very easy to get to the investment. So when you meet your first investor, you say, "Okay, I'm raising this on a safe." And there are only three terms that you can negotiate on. The first is the amount, so how much are you going to invest? You can negotiate on that. The second is the valuation, and you can determine whether you want it to be a post-money valuation or a pre-money valuation. Then the third is if you want, you can set additional terms. There are other things that you can tack onto this. You can discount the price so that you're sure to get a better deal on the next round of fundraising. You can get pro rata rights. You can tack things onto it, like little Lego pieces, you can plug it into the safe, but really you're negotiating, how much money am I going to invest and at what valuation?

It's a six-page document. You can read it and you can understand most of it, and it makes it so much easier to get to a deal because you're only negotiating two things and you're understanding it really easily. That's the document that we signed, and it also makes it very clear when you'll get your money back.

Katie: It sounds like the safe's intention was to standardize this process and streamline it for people. So let's say the company succeeds—how would I make money back on this investment in the future? And more generally, what has to happen for an investor in a private company such as your own to make money?

Arman Hezarkhani: The safe outlines four different events where your safe will convert to shares. The first is if you go out of business. If the company goes out of business, here are your shares; they're worthless. The second is if you raise another round that is not a safe, it's actually like an equity purchase. The third is if you sell the company. If I go and I sell the company to some other bigger company, we make a ton of money, then you would get money in that event. Then the last is if we IPO. And so the safe outlines those events. Of course in the first two, you're not really making money. If we go out of business, you're not making any money, of course, and if we fundraise another round, you'll just get shares, but you become liquid, so you'll actually get cash if we sell the company or if we IPO.

Katie: Got it. Okay. You've kind of then addressed theoretically raising another round, but it sounds like that's one where we need to dig a little bit deeper because you mentioned that at that point you would get shares, yes?

Arman Hezarkhani: Yes.

Katie: What does that mean in practice? Explain to me like I'm in fifth grade what that would mean.

Arman Hezarkhani: Basically when you invest in a safe, you don't own shares in the company. You own a document that gives you the right to have shares in any of those four events that I outlined. In those four events, then your safe transfers to shares based on the rules that we set in the safe. Once you have shares, and if we're continuing to run the business and everything, you technically could sell shares in the secondary market, but it's very, very difficult to do so. That's why investing in private equity or private businesses is not as popular and more highly regulated than investing in a public company. Technically, you could do that after you've received those shares, but the real benefit is that then you know the price, how many shares you have, and it's said and done, you have those shares in your pocket as opposed to the safe, which gives you the right to shares in the future.

Katie: Okay. To recap, the safe is basically purchasing the right to own shares in the future should one of those events happen. If one of those events happens, you'll have options for what you can do with those shares. In my research about safes, I heard about a founder who raised money using one, but then he never raised again. He kind of just continued to run the company, and up until this point, nothing had happened. The early investors never saw any return. Would you consider that a real risk? Is there more to the story there? Or could somebody theoretically raise a bunch of money with a safe and then basically just continuously run the company without having any of those four events happen and the investors are kind of out of luck?

Arman Hezarkhani: Yeah, absolutely. Starting a venture-backed startup is a very specific type of business, and actually I'm running one right now. I wouldn't recommend it for every type of business. In fact, there's a very few number of businesses and types of businesses where this actually makes sense. There are a lot of founders who they start the venture backed startup because raising millions of dollars seems really exciting, and growing really quickly seems really exciting. Then they raise some money, let's say on this case in a safe, and then they find after a year or two that actually the venture-backed startup thing is not what they signed up for and they don't enjoy it. They just want to grow it at their own pace and they want to run it and they want to have weekends and things like that. That is a thing that people want. That is definitely a real risk. I think that goes into, though, investing in the founder. I think when we met, you could see in my eyes that I'm kind of nuts, and I think a part of mitigating that risk is investing in people who are missing a couple screws.

Katie: Oh my goodness. Well, are you comfortable talking about how much you've raised or your burn rate, which means for the audience that might not know, that means just how much you're spending in the business. We talked about how the post money valuation is $12 million, so how much of that is capital that you've raised?

Arman Hezarkhani: Basically we have raised $2.8 million in the history of the company. Since you have come on board, we've raised another an additional million, and that's the luck of Katie. Our burn rate is very low comparatively to other startups. The reason for that is I think when you're raising money, the expectation is that you'll raise another round in 12 to 18 months. You typically want to budget such that you have 18 to 24 months of runway. Let's say you raise $2 million, you want to burn $1 million per year, so that can last you two years, right? You start with a seed or a pre-seed, then a seed, then a Series A, and each one of those rounds should typically be between 12 and 18 months. However, the past two years have been nuts, and you've seen people go from pre-seed to Series B in a year and people were getting money thrown at them, and the markets were incredibly liquid and you could raise money really easily and you could grow because the economy was really hot so people were spending and it was like this crazy, crazy time.

Now things are turning in the private market at least where it's really difficult to raise money. We're actually in a space where it's easier to raise money, but I don't want to be...oftentimes founders get really excited. Someone gives you a million dollars and you're like, "Holy crap, I want to spend this and I want to have this big team." But there are a lot of those ego metrics, like big team, big amounts of money that you're bringing in all these things. At the end of the day, if we were spending more money than we are right now, it wouldn't accelerate us towards our goal of finding product-market fit. We would just have too many cooks in the kitchen. Right now we are very aggressive in iterating and building and putting things out in front of people and getting feedback, but we're being conservative with our spend so that the company can last.

Katie: Do you mean in the FinTech industry it's easier, or are you referring to something different when you say that it's not as maybe gnarly in the world that you're raising in?

Arman Hezarkhani: It's AI. Right now AI is very exciting. If you say the word "AI," a venture capitalist will run after you with a million dollars in hand.

Katie: Well, it makes sense. It feels like the new frontier. Someone's going to be a winner. Each niche will probably have its own set of winners. People are trying to put their eggs in a lot of different baskets, I assume.

Arman Hezarkhani: Absolutely. You just did the valuation thing in your mind. You just did the valuation calculation. You said, somebody is going to win this market, and if you do any comparable, how big are the biggest financial institutions worth? Hundreds of billions. So this company has the potential to be a hundred billion dollars. I really believe in this founder for X, Y, and Z reasons, so I'm going to invest in this company. You just did the thought process in front of everyone.

Katie: Incredible. Well, there you go. Brainiac over here. If you had invested in the seed round of Uber, like $5,000, it would be worth, I think, $25 million today. And I was like, okay, Arman, that's the number to beat. Come on, buddy. I'm counting on you. You're my golden ticket. Thank you so much for joining us today. That was really illuminating, I think.

Arman Hezarkhani: Thanks for having me on.

Katie: It's a little bit like buying an informed lottery ticket. As far as my ongoing communication with Arman and the company itself, I get investor updates via email that explain how things are going, connections he's hoping to make, challenges they're running into, and I just weigh in wherever I feel I can help. We've covered a little bit about how people can invest in startups with money, but there are other ways to get involved with startups too. So I asked Erica at dinner to explain to me like I'm five how someone with a lot of expertise, but not a lot of capital, could make someone valuable enough to a founder that they would give them equity in exchange for their help or their connections.

Erica: Well, there's a lot of ways that people can be involved with startups. I think that's where it has to start. It has to start with someone that has a certain level of expertise. It could be you're an amazing product designer. It could be you're someone like you who has a strong personal brand and your own experience. It could be you're an incredible software engineer, literally, and that's it. You want to either make money, meet cool people, there's a lot of reasons why you do it, but you want to work with startups. I would say advising is one way, which we'll get into. Just consulting is another. Angel investing is another. Then there's kind of this fourth way that not everyone talks about, which is actually investing in a fund that invests in those kinds of companies that you're excited about, which is another really cool way to get involved and be a preferred partner.

Katie: She told me about how advisory relationships can start for a number of reasons, but that typically you can trade your time for equity. Compare this to consulting, which is trading your time for money. Now, her advice was to think of that equity like monopoly money.

Erica: There are so few companies that ever see an exit. You should think of it as it doesn't actually exist. And if you ever get a payday eventually, lovely. But the odds that are coming together are less than 10%, less than 5%.

Katie: She walked me through an explanation for how you determine how much equity you should be getting based on your advisory contributions. How do you value the contributions that you're giving that are non-monetary? But I will warn you, the math is mathing pretty hard in this section, so just bear with me.

Erica: One of the best ways to do it is to get really clear on what your hourly rate is. I think this is a valuable, if you're going to be consulting or you're going to be advising, and then figuring out how many hours per week, per month, per quarter, per year you're going to be spending, and committing to that. One of the examples I can give now is just, let's say your hourly rate is a thousand dollars an hour. You feel very strongly you can either get that consulting or you have an extremely strong personal brand and that's what your ad rates are. Whatever. A thousand dollars an hour, you'll do one call a quarter. Again, I'm being kind of dramatic here, usually it's much less than this, much more time and less hourly, but a thousand dollars an hour, one hour a quarter, so it's $4,000 a year. You're going to want to basically...and we say sometimes, usually you do commit for several years.

Katie: Essentially, the formula is this. You take your hourly rate times the number of hours per year that you want to devote and the number of years you intend to be involved. She said that they often use 10. I was talking to someone else who told me five. Then you need to figure out what percentage of their current valuation that amount represents. Pretend you're working with them for $20,000 over the span of five years, and that the value of the company is $5 million. You'd take $20,000 divided by $5 million, then multiplied by a hundred to learn that you own 0.4% of that company. That would be the equity that you would ask for in exchange for your time.

Of course, if the company continues to raise more and more and more money, your shares become diluted. This basically means that your denominator that you're using, or the amount of total money in the pot, is getting larger, so your shares are just worthless. I am currently in the process of exploring an advisory position with a different FinTech startup, so I'll report back about whether or not that process is meaningfully different than this one once I've got some experience under my belt, because at the end of the day, I don't invest in individual stocks. I figured this was my fun money investment stake and a good learning opportunity, a great way to meet founders, and if nothing else, hopefully it made for an entertaining podcast episode.

That's all for this week, and I'll see you next week, same time, same place, on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound sign from Nick Torres. Devin Emery is our chief content officer, and additional fact checking comes from Kate Brandt.