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Scott Orn

Scott Orn, CFA

David Pezeshki talks about 409A valuations and how Initio makes the process easier

Posted on: 04/23/2023

David Pezeshki

David Pezeshki

Co-Founder - Initio


David Pezeshki of Initio - Podcast Summary

David Pezeshki talks about 409A valuations and how Initio makes the process easier by offering customized valuations with optimized, defensible outcomes.

David Pezeshki of Initio - Podcast Transcript

Scott: Welcome to Founders and Friends Podcast. Before we get to our guest, special shout out to Kruze Consulting.  We do all your startup accounting, startup taxes, and tons of consulting. We’re whatever comes up like financial models, budget to actuals, maybe some state registration, sales tax, VC due diligence support. Whatever comes up for your company, we’re there for you. 750 clients strong now $10 billion in capital raises by our clients, I can’t believe it. $2 billion this year. It’s been a crazy awesome year. So, check us out at kruzeconsulting.com and now onto our guest.
Singer: (singing). It’s Kruze Consulting, Founders and Friends, with your host, Scotty Orn.
Scott: Welcome to Founders and Friends podcast with Scott Orn at Kruze Consulting. And today my very special guest is David Pezeshki of Initio. Welcome, David.
David: Thanks for having me.
Scott: My pleasure. By the way, we should note I’m a personal investor in Initio. Love what they’re doing. That’s why I wanted to have Dave on. So, I’m a personal investor. But Dave, maybe you can start off just by retracing your career, and tell everyone how you had the idea for Initio as well.
David: Sure. Not a problem. So, my career started out pretty standard. I worked in San Francisco Bay Area at a Big Four accounting firm. And when I was there, it laid the foundation for me regarding accounting, compliance, tax, all the things that matter for every company, and especially startups, because you have smaller finance teams, et cetera. While I was there, I got the real push to go into something different, and I knew the Bay Area was the center of the universe for venture capital. I was lucky enough to find a pretty decent size VC in Palo Alto, and go work there as a controller for about… I stayed there about 15 years.
Scott: Wow. I didn’t know that.
David: Yeah. It was a firm out of Palo Alto. They had, at that time, $1.2 billion under management. They were doing early stage split between tech and life science. But the thing I learned there, in addition to just being around startups, being around founders and early companies, and I saw the way they would tinker with things, and pretty much there was no box. They were always pushing the envelope on everything they did. Companies were always trying new things. Failure was an option, which really was shocking to me because it wasn’t something I was used to seeing, but in the Bay Area it was okay. If you try big things, you can fail. And so, I spent 5 years there, as I mentioned. And while I was there, I started doing temp CFO for some of the portfolio companies. And doing that, in 2007 I ran into the whole 409A valuation issue that had come up. I think it was passed in 2006-ish, and there were a few providers at that time, very few providers, and I used one of the standard providers that was recommended to me. And after working with them a couple times, I realized they didn’t really have a great understanding of what the value drivers were from my specific companies I was working with at this venture firm. And so I was just sitting in Palo Alto thinking, I can do this way better. And so, I just said, I’m going to start a valuation firm. And we did that in 2007. It was called Redwood Valuation Partners.
Scott: Good for You.
David: It grew and became one of the leading consulting valuation shops in Silicon Valley, and I sold it in 2020. All those years of experience of working there really showed me where consulting was lacking in that specific space, and where automation… There’s a lot of redundancy in some of the things we did, and where that could be helpful. I actually saw there were other firms that got started probably about 10 years ago that promised automation and more of a machine learning style, and none of those things panned out. So, after I sold Redwood in 2020, 2021, I decided, since no-one else is going to do it and automate it, that’s how I started Initio.
Scott: Yeah. That’s really amazing. It’s such a powerful story too, because you grew up… Because I remember when 409A’s became mandated, because I was working in a venture capital fund too, and everyone’s freaking out because they’re really expensive, and it was this new step you had to take, and all this stuff. And so you’re one of the pioneers that really… You brought the price down somewhat, but you also made it very efficient and value added, as you said, which is really, really cool. And now you get to… It’s almost like your second life, right? Everything that you learned in that first journey is going into Initio.
David: Yeah. I think that’s true. That’s a fair point. We did bring the price down at that time. The prices at that time were 10 to 12K.
Scott: Yeah. It was crazy.
David: And we shot the market [inaudible 00:04:47] three to 4K for pretty basic stuff. But that price point is still too high I think for a lot of early stage companies that are trying to save every dollar to extend their runway to get to the next inflection point. And so, we were limited on what we could do at Redwood, because it is consulting, it takes a lot of time, you have to pay [inaudible 00:05:08] have experience. So that’s why it led to Initio. I figured we could cut the price again if we could build software that could effectively calibrate the valuations, and I could jump to what we’re doing in Initio. But that’s a crux of Initio, is can we do it better, faster, cheaper, and more transparent than what’s available right now?
Scott: Yeah. Better, faster, cheaper. The Silicon Valley way, which is… That is the… [inaudible 00:05:34]
David: If we don’t do it, somebody [inaudible 00:05:34] someone’s going to do it. It has to always be that way.
Scott: That’s a very good point. So maybe talk through the Initio value prop and how it works and how… Because there’s probably people who are listening to this who are like, interesting, I need a 409A, this is something I should be trying.
David: Happy to do that, and I think we’ll take one step back. Our goal, while we’re doing our first product is a better 409A is what we call it, our goal is actually to really be the real time provider, providing private market data in real time to founders, employees, and investors. We all know because of last year, you could see that the private market takes a while to readjust. The first three months of last year, the public market hit the wall, dropped like 50%. Nasdaq, all the major tech players. And the private market just froze, because founders and employees hadn’t absorbed that data yet. And the reason they hadn’t absorbed that is because there’s an opaqueness to that market. It doesn’t flush out as quickly as the public market. And we thought, you know what? If there’s a way to aggregate all this private data and then give it to our clients in a way that’s real time and actionable, that would be light years ahead of what’s out there today that you can get. And so that’s te crux of Initio. Now, in order to get the data to build that out, you’ve got to offer startups, VCs, and other private market participants something of value. And our first push into that is this better 409A. And I’ll go through why we think it’s better than anything out there. It is 100% software. It runs its own calibrated set of scenarios, effectively. So, you give it your cap table, your articles, you tell it what vertical you’re in, it’s about a eight to ten minute onboarding process. You upload your cap table, upload your articles, the system runs on its own, produces a sandbox that you can make final tweaks on your final 409A price within reasonable bounds, and it tells you how many scenarios it ran that are considered defensible.
Scott: Yeah. That’s amazing.
David: You could look and say, the price is between X and Y, and there’s really no other… In that framework, which is an option pricing framework that we’re using, that most valuation appraisers use for early-stage companies, there is no pricing another appraiser could come up to that’s already not shown into our graph. The only difference is you’re seeing everything at once, so you know how much risk you’re taking effectively when you’re picking a final price. And when you’re done picking the price that makes sense for you and the board and is defensible, your press print, your report’s generated, and it’s off to you so you can give it to your board and have it approved. Again, onboarding’s like 15 minutes, doing the tweaking of price takes four or five minutes, and then it’s done. So, we’re takinga process that takes hours at least, to call a consulting firm, to talk through what your company does, et cetera, et cetera, to go collect… A lot of these firms collect a lot of data you don’t actually need for a 409A, but they’re charging four, five, 6K, so they want to make you feel like you’re getting something of value. Most of that is just busy work. And again, understanding startups, because I grew up in VC and startup land, you don’t have any time for busy work. You just need to get it done, and you need to have it done right, and you don’t want to… The other issue is, if they do the black box approach with even some of the automated providers, if they give you a price that your board just rejects, you have to call someone and hunt them down and spend an hour or two trying to negotiate another price. This skips all that. It’s like, you know what, let’s just get to the meat of the meal and get it done, so you can go on and do other things that are more important for your company.
Scott: That makes so much sense. And you said the word defensible, because for those that don’t know, you can talk about this for a second, but the valuation accreditation has… Those bodies have mandates on defensibility, it needs to be in certain approaches, and then ultimately the auditors or the IRS needs to be able to accept that valuation. And so, can you talk about how you make sure that Initio’s valuation is within those defensibility?
David: Yeah. So, you bring up a great point. Getting a 409A is only half the equation. If your company exits and has a successful exit, either financial auditors and/or IRS could end up looking at those reports to make sure you’re not giving below fair market value options. So, we’re using very standard methodologies. It happens that we’re mixing the standard methodology with the Monte Carlo effectively, and running hundreds of thousands of runs. Now, what that gives us is visibility into what the possible ranges could be and what the defensible inputs are. And I’ll give yu an example. If a client presses, I want the absolute lowest defensible price, our system will pick the most defensible inputs to give that output that they want. Because there’s [inaudible 00:10:31] one way to get to the same price. And so we’re pretty confident that we know what audit firms, Big Four, some of the other larger accounting firms, will accept with regard to volatility, term, NTM options, everything else that goes into these valuations. And then the beauty of our system is, it will allow the auditors to see everything if they want. So, they’ll have a 35,000 foot level, and they can do their own sensitivity analysis to see, if you change this to this, what happens to the price? And is that material for my audit? Again, we’re all about trying to make things easy, keep our clients… Keep their lives easy and make sure they can get through audit quite quickly. On the IRS, not a lot of these have been audited. It’s rare, you’d have to have a very large outcome for it to be audited, but we believe what we’re doing is within the bounds of the regs of 409A, and we have the experience necessary. I personally have been involved with 6,000 valuations with my previous time at Redwood. So, I definitely meet the criteria, CFA, CPA, so usual accreditation. Not trying to brag, just saying I think we could… [inaudible 00:11:30]
Scott: No, I get it. I get it.
David: And just so whoever watches this podcast knows, we did the valuation for WhatsApp, Fitbit, Robinhood Markets. We’ve been involved with some of the largest exits in Silicon Valley. So, we know how to not step outside the bound. So, I’ll leave it at that.
Scott: And you’re right about the audit. The auditor wants to be able to look at what went into this, because the nightmare scenario is, your company becomes… Three years later, four years later, you’re late stage, you’re getting ready for an IPO, and you’re doing the stock option accounting and making sure everything’s okay, and they look back and they say, the 409A, that was too rich or too cheap or whatever, and we’ve got to restate. And that takes a lot of work and a lot, lot of money. And so, the fact that you can give the play by play and show how you got those numbers, instead of just relying on one number, like this was the number, that’s why I love the Monte Carlo aspect of this, because you’re showing a lot of different… You’re testing in a lot of different ways.
David: Yeah. So, one of the things that was interesting that I didn’t realize, I kind of knew this in the back of my head, but I didn’t realize that these… We used to call it multi-scenario OPM model. So, it’s an early failure mode and a late success mode, effectively, two option pricing models together. And when you look at the output of this, it’s not a single mode, which is like one, you would think a normal distribution. It’s got multiple modes. And so, you could be looking as a valuation professional, you pick your volatilities and the different inputs, and then you go up or down a little bit to see if there’s sensitivity. You could be at what you think is a local minimum, but actually the curve goes down even further on the other side of that mode, and you could be missing that because you didn’t see all the data. No other firm runs thousands and thousands of transactions, because they don’t have time. And so, if you’r only doing a single point or a couple scenarios, you’re really relying on that expert picking everything perfectly. And if they don’t, they may put you in a spot where they picked, most of the time, a price that’s too high, that you could have had a lower that’s still defensible. Sometimes if they have no experience, they could pick a price that’s nonsense. Let’s say it’s either way too low or way too high. But I trust my valuation [inaudible 00:13:46] at least know enough to make sure they’re picking at least in the range.
Scott: Hey, it’s Scott Orn of Kruze Consulting, taking a quick pit stop to give some of the groups at Kruze a big shout-out. First up is our tax team, amazing. They can do your federal and state income tax returns, R&D tax credits, sales tax help. Anything you need for state registrations, they do it all.They do it all and we’re so grateful for all their awesome work. Also, our finance team is doing amazing work now. They build financial models, budget actuals and help your company navigate the VC due diligence process. I guess our tax team does that too on the tax side, but the finance team is doing great work. And then, I think everyone knows our accounting team is pretty awesome, but want to give them a shout-out to. Thanks, and back to the guest. Thanks, and back to the guest. Yeah. And he reason why people don’t want a valuation that’s too high is, that means the stock options have a high exercise price, and the employees are paying a lot of money to exercise their options eventually. Most boards want to have a defensible price, but they want it to be tilted towards the lower end if possible, to create more incentive for their employees. So that’s actually really, really important. The other thing which I love about the product, you were talking about this, was it’s like a self-onboarding. It’s quick. You can kind of control the process. Because you’re right, a lot of times you do a 409A, you got to set up a call, you got to send over the document, you don’t get to do it yourself. And so many of us are in the self-serve mode nowadays that it’s really nice that you built it that way.
David: Yeah. We want to make it easy. If we think of large companies that do it pretty well, we think of TurboTax, QuickBooks. So, things that help people that are non-experts be able to do a lot of stuff that you would’ve needed an expert to do. Like TurboTax helps people, I’m not saying it’s a good idea, but it can help people that aren’t tax experts do some tax work. Not saying whether you should do it or not, but we want to give non-experts the ability to do valuations confidently and see all the data they need to see to make a decision. The other thingI’d mention is, we actually provide a phone number to get to a live person as well. So, if you get stuck, we don’t want to be a company where… Again, we’re client focused. So, my job is to make sure you have a good experience. So, if you can get all the way through, which I believe 95% of clients can get all the way through the process quickly, no issue, but if there’s something that’s confusing or a client has a question, we offer support, because we want to make sure you have a good experience. We don’t want you to feel like you’re lost in the woods. Nobody feels good then. And we’re happy to continue to provide that. And they get a phone number they can call and reach a live person that can help them get through the process if they need that.
Scott: Yeah. That’s really nice, because there are a lot of questions around this stuff too. When you do the upload and you run the analysis, and then you get the report or you pick your price, is that the end of the process, or is there a waiting period of a couple days? How does it work, soup to nuts, to get that report in front of the board?
David: So right now we’re doing five to seven business days from the moment you submit your data to the moment you can print your first report.
Scott: That’s fast, by the way, for people who are listening to this. Normally it’s 10 to 15 business days.
David: Yeah. [inaudible 00:16:51] it could be even faster later on, but right now what we’re doing is, we’re having it reviewed by an expert. Every report’s being reviewed by an expert to make sure… We believe the calibration engine is working perfectly, but we want to make sure everything’s quality assured. So, we take our time, make sure everything’s working as expected. If there are any corner case issues with clients, we catch them, make sure we do what’s right by them. And so, by the time you get the email saying, “Your sandbox is ready for your review,” pretty much an expert has already made sure that it’s all calibrated for you. You go in [inaudible 00:17:24] final tweaks, press print, and you’re done.
Scott: Yeah. That’s really good. That’s really great. And I’m sure the board who this is being presented to appreciates that too, because the person can… If we have any questions or anything like that, I can follow up.
David: Yep.
Scott: Yeah. It’s really amazing what you built. I’m really happy for you too, because you’ve taken just all those lessons and you could have probably, I don’t know your financial situation, but probably could have lived a pretty chill life, but you still have the desire to fix things and make things better.
David: I just wanted someone to build an automated valuation product that’s actually calibrated. That’s all I wanted.
Scott: Yeah. It’s awesome, though. And also, your passion comes across so much, because I’ve talked to you a bunch of times, and this is your baby. It’s really cool.
David: Yeah. One other thing I want to mention is, as we go forward in time with Initio, our next product will be an ASC 820, which you may be familiar with, which is mark to market, which helps VCs mark their portfolios to market. And this will be the first product in mark to market that will be free to upload all your data, and it gives you a dashboard for the VC to see green, yellow, red. Green is, you don’t need a valuation, it should pass audit no problem. Yellow is, we can get to your holding value, you may need to print a report for your auditor. You can wait till they ask for it, because it’s instantaneous when they ask for it. And then red is, your holding value is not defensible with our framework. You may want to bring in an expert, like a consultant, to help you derive another modeling technique to help support the valuation. This should be ut by year end 2023, and it’ll be the first of its class, free product for all VCs to use, and they only pay when they print the report. Now, why is this important to your clients? Because once a VC uploads all your data for your company, we can offer a discounted evaluation to those companies because we already have all the data. So, we have the data to help run a 409A, so we could do it concurrently, if they want to year end 409A, we can make sure that happens for those clients as well.
Scott: That’s really cool.
David: And those would need very little information from the company, because we have most of [inaudible 00:19:25] VC.
Scott: I was going to say also, I used to work in a VC fund, and I was unfortunately head of compliance, and so I would see a lot of that valuation argument with the auditors, and it’s not fun, the venture capitals hate that. It’s a lot of work and the audit… So, the fact that you’re building that is really amazing.
David: We want to help fund admins and other… It’s really geared toward fund admins and other… So again, another thing about our company that I want to make very clear to everyone listening to this is, we believe our product is here to augment the professionals around startups. So, the accountants, the tax people, everyone that’s around there, the lawyers, everyone. We’re here to augment that. We’re not here to replace anybody. We just want to go in there and make everyone’s life easier for valuation, whatever that may be, whether it’s mark to market, whether it’s 409A, whether we’re giving the clients that sign up for our platform real time data to make decisions on their business. We just want to make that process easy for everyone involved. And if we do that, in my opinion, in venture, best product always wins.
Scott: Yeah. Also, there’s a lot of busy work that all of us have to do in their jobs, and the less busy work, the more value add you can offer. I got to be respectful of your time, so we should wrap up, but maybe you could tell everyone how to find Initio, how to reach out if they want to work with you.
David: Sure. So, anyone can email me at dave@initio.software. Conversely, you can go to initio.software, which is our website, and there’s a contact us button, and you can even start a 409A just on the website directly, self-serve, and ping us later if you need any help or anything. So that’s pretty much the easiest way to get to me. I’m on LinkedIn as well. My LinkedIn handle is on my email, but it’s on the website as well, so probably the best place to go is the website.
Scott: I love it. I love it. Congrats on what you built. It’s amazing.
David: Appreciate it.
Scott: And the venture capital audit tool sounds awesome too.
David: Yeah. We’re looking forward… And we’re able to use the same engine to run that as well, so we appreciate it.
Scott: That’s amazing. All right, man. Thank you so much. Really appreciate it. Really happy for you.
David: Thanks for your time. Have a great weekend. Bye-bye.
Scott: Bye-bye.
Singer: (singing) It’s Kruze Consulting, Founders and Friends, with your host, Scotty Orn.

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