NCI: What’s Broken in Fintech & VC?

Ram Ahluwalia & Rohit Mittal

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Episode Description

In this episode of the Non-Consensus Investing, we have host Ram Ahluwalia, CIO at Lumida Wealth, joined by Rohit Mittal, founder at Stilt, a Y Combinator alum and fintech founder, who talk about a range of topics, including the challenges of immigrant financing, the cultural nuances of entrepreneurship, and the overarching impact of immigration on the economy. Additionally, an angel investor shares his approach, prioritizing investments in individuals and uncovering opportunities in early-stage startups and 'zombie' companies with turnaround potential. Key themes include the importance of understanding valuation, the 'power law' of investments, and the crucial role of networking and strategic thinking in fostering success in the dynamic startup ecosystem.

Episode Transcript

[00:00:00] Welcome to Non Consensus Investing. I'm Ram Ahluwalia, your host and CIO at Lumida Wealth, where we specialize in the craft of alternative investments. At Lumida, we help guide clients through the intricacies of managing substantial wealth so they don't have to shoulder the burden alone. Through this podcast, we draw back the curtain to reveal the strategies employed by the best in the business for their high net worth clients so that you too can invest beyond the ordinary.

Ram: All right, and we're live. I'm pleased to be joined by my friend, Rohit Mittal, who is An exited founder, went through the Y Combinator program, built and sold a fintech lender financing immigrants, which is an interesting topic we want to unpack today. I think immigration is influencing the economy in multiple ways.

And Rohit's also a global citizen. He was born in India, lived in Berlin, lived in London, lived in SF. And then New York. And so he has very unique cultural perspectives at [00:01:00] large and also perspectives on the United States and entrepreneurship and why things come together in the United States. Prior to founding his startup, he has extensive experience in credit risk analytics.

And data science, as well. And he's got a master's in operations research at my alma mater, Columbia. So welcome Rohit, good to see you. How are you? 

Rohit: I'm doing well. Thanks for having me. Yeah, I actually, I lived in Germany in Dusseldorf. I wish I lived in Berlin. Oh, it was Dusseldorf? 

Ram: Okay.

Thank you for the correction there. 

Rohit: Yeah. And it wasn't as cosmopolitan as Berlin, but it was one of, it's one of the world's best cities to live in, like in terms of, quality, safety, all of those things. So it was pretty good. 

Ram: Okay. We're going to talk about a few topics today.

One is the truth about venture investing because You've looked behind the veil, and you've met the Wizards of Oz, 

Rohit: and 

Ram: you can undress that for the [00:02:00] audience, and I believe the conversations you have to share, I share, and others including VC share, we'll talk about trends as well, Cedar Funds, we'll also share some perspective on the 2021 mania, 

Rohit: Where 

Ram: we are then, where we are now and some of the nonsense that happened, but let's start off with venture investing.

So what is, what's the truth about venture investing?

Rohit: I think a lot of people like me, especially folks who have been outside the bay, we only see what's put in front of us and somehow I, I believed that many ideas are venture. Scale businesses or venture businesses, and they can raise venture capital and, generate big exits.

I've found that there, I found that there are very few ideas that actually fall into that bucket. And I've my, my pendulum has swung on the other side in the sense that, very few ideas actually fit. The box of a business that can actually become venture scale within three to [00:03:00] five years or five to seven years of being funded by these VCs.

For most of these businesses, you cannot compress. 

Ram: And do you mean from an ex ante or an ex post perspective? Meaning ex ante, What you're saying is that these are businesses that going into it, we know that the TAM or the ability to scale isn't there, or do you mean that after the fact, which of course, most startups fail, we know they can't capture that opportunity.

Rohit: I think ex ante, especially in the last few years, people just wanted to believe that many of these businesses can scale. And starting 2023 and 2024, they are seeing that expose that many of these businesses couldn't, it wasn't, we just changed the definition of what can become a venture scale business.

And now that definition is going back to what it was previously, like pure software or majority software, very high gross margins, and then where you can spend money to actually scale the company. 

Ram: So that's self deception then, right? So there was a belief that these were [00:04:00] scalable venture backable businesses.

And, and one of the factors was valuation, right? In 2021, what were the valuations you saw up there? And you're also an angel investor too. So you see this in a couple of different ways. 

Rohit: Yeah. So our business was, thankfully never valued that highly because we were a lending business and most of our revenue was from, interest revenue.

And VCs at that time had decided that, lending businesses are not 500x ARR businesses. So we never got the highest of the valuations, but a lot of other businesses in unproven categories, got very high valuations. Now, when I, as I'm angel investing in some of these companies, I'm seeing, I invest because of the founders, because I'm the, just that early stage.

And because I know the people, I don't even know what the business is. to do or how eventually they're going to make money, it's just very broad. At the time I'm making that investment, and then some of these companies I see, like I invested in let's say day zero. I invested in the company, and day 15 [00:05:00] they are valued at 50 million.

So I said, they have 

Ram: to know you. Invested at what valuation? 

Rohit: I invested in around maybe 10 million, something like that. And that was when 

Ram: you seed or seed first money in? 

Rohit: First, second check in, third check in, like right out of YC or during YC or something like that. So mainly I, like my network is Y Combinator because we went through, YC in winter 16.

And I'm, as I'm helping some of the YC founders, I decided to just invest in some of these companies. And. They're like, yeah, no, we are starting a friends and family round. And if you would like to invest, we'll, whatever amount you want to invest, we'll, we are happy to take it. And valuation for friends and family is 10 million or 15 million.

So we, yeah, so I invested in that. And then one week or two weeks later, they, I think 5x'd in their seed round. A 

Ram: VT showed up and say, Hey, look, I'm going to give you 50 million valuation. Yeah. A few weeks later. And then what happened after that? 

Rohit: They're just, they just raised a lot of money and they're continuing to build a business.

But I think, the business [00:06:00] has somewhat caught up to these valuations, but I still think like there's a lot, still a lot left to be desired given where the businesses are, and where the valuations are. They're still like, 20, 30, 40X ARR valuations. 

Ram: I don't know that I've heard many entrepreneurs say, and I'm glad we didn't get an excessive valuation like you said.

Yeah. Because the VCs had wisened up around the valuations of fintech lending. Most entrepreneurs are saying, hey, let me max out on the valuation. 

Rohit: Yeah. 

Ram: Because they're accomplishment oriented and they measure that. Mark of success, 

Rohit: as 

Ram: opposed to growing profits, because they read the headlines around them.

And if they're not keeping up with the Joneses, their peer group in SF, then they feel like their idea, Lax validation. 

Rohit: I think it is, I was in, in that category also, but because I think it's just my natural inclination that I've always been like outcome [00:07:00] oriented then. And I always thought if I raise that, 50 X ARR.

Like, how am I going to get an exit in the company that's valuable to my investors and to ourselves also? Going 

Ram: Why is that? Why does the math of raising at a 50x ARR, which is a high valuation, hurt the outcome when you might look at that as a marker? That you're on the path. 

Rohit: If my, so valuations always are always ahead of value created by the business and at least that's what I believe in, especially in the early stages of the valuations are too far ahead of the value and the value never catches up.

The fall down is. Super, demotivating for the founders, for the investors, for the team and, broadly for the ecosystem. If some, someone, something's valued, like I saw a company today, the news came out in information security [00:08:00] started valued at 8 billion being sold at 150 million. And I just can't.

Yeah, I can't imagine like how demotivating it is for the employees who bought into the vision of a company and they're taking so much risk. I think it is also not fair to the employees who are taking a very high risk joining. The 

Ram: opportunities are worthless. And what happens? Maybe explain for our audience, what happens when you raise at that high valuation and you sell for less money that you took in?

Who gets paid 

Rohit: out first? Sure. So we actually had the, the longest stack on top of us as we sold the company. So the first, all the debt investors get paid. So if the company took any type of, loan or corporate debt or, asset backed debt or whatever, They get paid first. Then you have to make sure that all the employees at least payroll and things like those like vendor bills are paid.

Then preferred investors get paid. So whenever someone raises [00:09:00] money, all the investors get preferred stock. All the founders and the employees have common stock and options. 

Ram: And they're last in line 

Rohit: They are last in line. So employees are even after the founders in many cases. So if between debt and bills and preferred investors, all, if all the money goes there, you don't make anything.

Ram: The employees don't have restricted stock. They have options, which have a strike price. And another way to simplify is like last money in gets paid out first. Because of, VC is called LIQPREF or it's liquidation of preference. It's a structure in the, you called it the stack, the capital stack, that protects new money.