Arjan Schutte is the founder and managing partner of Core Innovation Capital. Core invests in financial services companies that empower everyday Americans. Core is making seed and pre-seed investments out of its one hundred twenty five million dollars third fund. They have a great portfolio of companies like Ripple, Synapse, Opportun, NerdWallet and more. Arjan, welcome to the podcast.

Great to be with you. Great. I heard you say that you are your mission is something like to democratize prosperity. I really like that, me too. How's that working for us?

Well, if it wasn't obvious that we needed it before covid, it certainly is obvious today. And how's it going? Well, mixed honestly, you know, worse, we're a small fund, and it's a big, gnarly, complicated problem that that needs more investments and is getting more investments but can't only be investments. There needs to be a policy side to it as well, which on the side of my desk, I'm trying to figure out how to do a separate story.

But there there are so many ways in which the private sector can figure out this set of public sector problems. And it's just fun to see the emergence of mission driven fintechs of so many shapes and flavors out there chipping away at this. Yeah.

What are the what are the big levers are where you focused? So we really started looking at the unknown under banked where we perceived there to be a boatload of people, shockingly so I had no idea how many people were on an underbanked and then be a complete absence of technology, like it's kind of an old school world of like, you know, place based check cashers and such that serve that industry at significant scale. Consumers are spending like a hundred billion dollars on stuff that you and I get entirely for free.

Where where does that come from?

Yeah, it's fees. So I want a cash this check, oh, that will cost you one to 10 percent of the of the of the face value of that check for me to assume that you didn't Photoshop it and give you cash in return or its fees on payday loans or on title leases or, you know, a whole litany or on Western Union checks, Radware, or even just paying your bills like a shocking number of people walk into a physical location, 7-Eleven to pay their bills.

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Right. Like we do this for free. I get I get miles for paying my bills. Like I'm actually making money, paying my bills. They walk into the 7-Eleven, I actually don't really know the experience they're having, not had to do it myself. And 7-Eleven charging fees to pay their bills. Yeah.

So you're walking with with with your with your Comcast, you know, paper receipts and you say, I want to pay this. And they say, great, you know, do you want to do. How long do you want to take to, you know, typically like if you if you want to wait a week, it's free or cheap. And if you need expedited today and that's typically, you know, how long you've waited because you've got kids and you're in you're hanging onto your cash, you know, as long as possible to wait for what you needed for.

And then when you come at the 11th hour and you want to declare today, it'll it'll cost you up to 20 bucks per bill just to have it expedited in real time so that the power doesn't go out.

So are you looking at, you know, solutions to eliminating those fees? How do you approach that? Yeah, so. By shifting from a cash based economy to a digital economy, you can eliminate a lot of this stuff. And so that starts at the payroll, right? Because how people end up with cash in their hand is because they get a paycheck and then they take that to a check casher and then they sort that out.

Right. They put some in their pocket use up to pay your bills. You pay your rent in a sense of home, wherever your home is. And, you know, and that's kind of how you conduct your whole financial life there. And and it's very fee extractives. If you can get direct deposit, which which is a very positive trend that has grown in the last 20 years, where a direct deposit started with something like eight percent of the population, and now it's something like 93 percent of the population.

Very positive trend. And so then you can do a lot of these things digitally or more or less digitally, and you can chip away at all the middlemen basically who are who have got their hand in the middle of the transaction.

Hmm, play this out for me a couple of years? Sadly, it'll look pretty similar for a couple of years yet because our infrastructure lags dramatically. So, for example, we're like the only modern economy that doesn't have a real time Federal Reserve system. So ACH, the automatic clearing house, which is like, you know, the way our techs used to run.

And now everything digitally runs from our bank accounts is not real time. And so consequently, all of these lags are still there. Those need to be eliminated. And check has been or cash has been eroding pretty consistently for decades. But what people don't realize is that the amount of cash in circulation is so high that even if it continues to erode at the rate that it has for the last 20 or 30 years, it will be a prevalent form of payment for another two hundred years.

I had no idea. Nor I know and of course, you know, that won't be a straight line and it'll be an accelerating line in the punctuated line, but not. But the point is, you know, the bigger point is like where we're going to have cash in our lives for much longer than most people presume. Hmm.

So but OK, so back to the infrastructure not being at a point where in this country, you know, our infrastructure needs get upgraded, I guess.

Will you invest in sort of the more infrastructure things and and why not why can't we just copy other countries.

Yeah, great idea and, you know, the the benefits of being in a competitive free market economy are that we're great innovators and the disadvantages are that there are no autocrats who will mandate a single standard.

And so the way banks are regulated is extremely complicated. And there's not one prudential regulator, there's four. And so there's banks of every shape and flavor, and so then it's just like an endless quagmire of political constituencies and bureaucracies that other modern economies can, you know, can just have a have a government mandate to say we're doing this. Now, that is less the case here. And what was the other part of the question? Well, I'm just interested on that.

So we have four regulatory regulators, is what you said. Do you think the regulator. Do you think there's regulation that is potentially feasible that could really move the needle here by any of any of our current regulators?

So the Federal Reserve Bank has had a real time payments task force for the last 10 years, have been on and off of it repeatedly, and nothing really has happened. We're still having the same conversations. I mean, I got this I moved here from Holland and I moved here in the in the 80s. That's a long time ago now. And in the 80s, I didn't even know what a check was. A paper check. We still have paper checks, paper checks to our gardener, for heaven's sake.

I'm sorry. It's not funny. Yeah. OK.

And so, OK, so with your core your core innovation hat on here, you're looking at these things and are you sort of looking at where you think the future will go with your realistic core innovation hat on and trying to back the entrepreneurs who are innovating on, you know, on these, you know, whether it's real time payments or elimination of middlemen, I guess.

Yeah, we kind of have a technical, technological view of this Martin Luther King quote, I love, which is the mark, the arc of moral justice is long, but it ends. Oh, I forgot the end of it, but it ends positive somehow.

And basically, the way the way I see things technically is very similar. I feel like technology and and private markets, you know, in long form are are a are a are a march towards liberty and a march towards emancipation. And we're placing bets against both the world that we wish the world that I want for my kids. And we're placing simultaneously we're placing bets on where we think the puck is going.

What are some great examples? Well, Ripple's, a great example, along the infrastructure side, we have tens of millions of people move from poor countries to rich countries and send back every year tens of billions of dollars. And at a cost of somewhere between 10 and 20 percent, which is crazy when you think about it, the poorest people are paying such tolls and they're working so hard and leaving. They're like all these crazy. And we and we certainly see this in spades in L.A., like there are so many immigrants, something like half of Western Union's domestic revenue is made in Los Angeles County, which is huge.

So. Ripple is basically just modernizing cross-currency settlement technology, right, like if you want to move money from here to there today, the probably Swift will be part of the story, whether you use it directly or whether Western Union or a third party uses it. And swift technology was literally written when the Apple two E came out, and we're still using that today. And it's moving 50 trillion dollars per year today. And it has a six hundred basis point error rate because someone fat fingers a number because it's intended to number and someone has to physically type that in when you're sending someone 300 bucks or 300 million bucks across the ocean.

Yeah. So keep going. So Ripple is building a modern tech stock that makes up real time and virtually free and secure and addresses a whole litany of issues that have kind of just gone by the wayside. Happen to you as a cryptocurrency, which is kind of a sideshow where the point is just as a modern tech stock for making cross-currency settlement as easy as sending an email is across borders.

How did you decide that this was actually going to be, you know, a startup disrupting this multi-decade old industry? How did you decide that this would actually work and be worth betting on? Well, as you know, right at its dumbest, we basically look at Team and Tim and so this was an incredible team. Chris Larsen is a serial visionary who founded eLoan and he called it. Right. He founded Prosper and called that right and has always been and in the scheme of things, not that many people who are right repeatedly.

And so there was a formidable founder who is a force of nature, and that's an important part. And then there's a TAM know, that's like a trillion dollar tin, like the world spends two trillion dollars on fees for getting money from A to B..

But otherwise, honestly, when we invest it in, like, you know, mid 13, we had no clue that any bank would ever buy them, let alone be moving billions of dollars across borders with them today.

And we were willing to take a big bet very early, and I'm glad that we've done it, although there's plenty of examples where we did it. You know, I rue the day.

Yeah.

And so. Right. So this is your third fund. You've been doing this for a while.

Also, just can you tell me the story of how how you came to be doing this?

Sure. Know very much by accident. So out of college, I fell into a startup. I hacked my way into college grading system, and that got me a job at a startup down the hill in Portland, Oregon. And so I was developing educational software and had a real B in my bonnet around, you know, making education better by by developing software for the Media Lab in MIT, which your firm has a connection to, and a couple other education startups.

And then someone gave me a book in 2002 about Muhammad Yunus and Grameen Bank and micro lending, which is all completely new to me. And I read that cover to cover over a weekend. And I was like, holy moly, that is awesome. I love everything that that it's about, and I was just blown away how this is basically a Bangladeshi man who was a US trained economist and who learned about free markets. And he went back and he devised a system of lending which is economically empowering, which is incredibly efficient.

These are loans to the poorest people on the planet of Earth, and they have one to two percent default rates, which is insane. Jamie Diamond would kill for the thrill of a default rate from a prime customer. So anyway, I was just like, wow, this whole thing is so very cool. And so I was looking to start something like that in the US. I realized for a variety of reasons that microfinance isn't going to work in the US.

And someone introduced me to a bunch of hippie bankers in the south side of Chicago who had started a financial institution called ShoreBank in the 60s when all the banks were getting a lot of shit for redlining and they were not making loans or black people lived. And these were a bunch of renegades who moved their bank into like the South Side black ghetto of Chicago and created a cottage industry around community economic development. And now there are hundreds of Shore banks around the United States.

And the other aha was, you know, they were 50 years into their journey and that whole cottage industry was serving one half of one percent of the population. And so I was like, well, this is great, but it doesn't scale right, like half a century later, it's just barely scratching the surface. They're incredible.

Place based organizations are hyper local. Mm hmm.

And so how do you solve the problem at a national level? And so a woman called Jennifer Tushar and I started a think tank spun off from ShoreBank called the Center for Financial Services Innovation CFSI, now called the Financial Health Network, and started asking the question of how can technology basically. Creates economic empowerment, and I started making small investments off the side of my desk and one thing led to another as like this will be my next startup, so.

So many questions there. Can we can can I rewind and ask why microlending doesn't work in the US? Yeah, totally. What makes microlending work is shame and shame is a is a. Is a deep cultural phenomenon, and the reason that the default rates are so low is because there is relatively little migration in poor communities in developing countries. You're kind of grow up in the same tribe, in the same place, and so every week you pay, you make your payment against your loan and you get together with a handful of other people.

And if someone doesn't have payment, then the other ones in the group have to pay for the person who couldn't pay. And the shame is the red like it is just unconscionable to not make a payment, there's just no fucking way that you'll do it. And hence, it's so people scramble and just make it work because they're because they're they don't want to live in shame with their neighbors. And for a variety of reasons, good, bad or indifferent and not all bad, you know, we don't quite have that cultural construct here and and poor communities are much more migratory here.

So you came from a think tank and now Core, you're here in L.A. Kat, who I know a little bit. She's in the Bay Area and you're you're investing in the US.

Across the US.

Yep. Fantastic. So let's go back to kind of what you're investing in.

We talked some about infrastructure and fees. You know, it seems like fees don't matter if I'm not making any money. I mean, not don't matter. But like how do you think about helping people have jobs, keep jobs, have jobs that pay more money, that sort of aspect?

Yeah, that's a great question. Something I've been I've been much more mindful of lately, 10 years in. And we collect both our financial performance and we measure the externalities of our work. So what is our social impact? And our portfolio companies have in the aggregate created about forty five billion dollars of savings for twenty five million Americans. 80 percent of them are low moderate income. And that's starting to really add up. And I'm really excited about that.

If our investors didn't care about a return and thankfully all of them do, and thankfully all of them are happy we would have an incredible social return on investment. Right.

If they were all foundations and they gave this to a charity, it's something like we've created six hundred dollars for every one dollar that has been invested in the core in terms of of measurable value to an end consumer, which is should be a wake up call to philanthropy, which can hardly deliver this kind of our why.

But all that you know, all that said, I'm cognizant of the fact that. Cheaper and better financial services are positive, but only mildly so. And what people, as you say, need much more than the cheaper alternative to a payday loan or a cheaper way to find an auto insurance or whatnot is they need more income, they need more steady income, and they need better protection from shocks because it shocks that send people down these rat holes that they can never come back out of.

So better, smarter insurance. And then on the income side, you know, we've we've looked for quite some time in small business finance, which is a big driver for income. We spend a lot of time looking in and around housing because for so many people, home ownership still is. There is the the main way to create some form of wealth. It's basically forced savings regime across all of the positive and negative stories is net positive for most people.

And you're measuring your social impact. I just didn't don't want to let that that that comment go away.

I don't know a lot of VCx who measure their social impacts.

Yeah. I don't either. More should I said read like we're badgering our portfolio companies to measure everything, not just their financials. Read to read like we're talking about OKRs and KPIs all day long and what are the right ones and what are our dashboards and all the stuff.

So we measure what we care about, right you know, like we have a bee in our bonnet about leaving the campsite a little bit better and I feel like, you know, being in this asset class, so many people do.

We're like, we're all doing this because we want the world to be a little bit better.

How how how do we know we're doing? Well against that. We're like we know how well we're doing or not financially. And for almost all of us, that's basically it. You know, we've measured it for a decade now and we found lots of opportunities to do a better job and to and to avoid this kind of business model, to seek out this kind of business model.

Do you have any specific it sounds specific recommendations.

Yeah, we basically measure three things skill, quality and alignment. And scale is like, are we reaching enough people because the reach five people, not interesting, we want to reach like the lion's share of the US population. That's the way you can make a dent. And then within within the scale is like reaching the right people. We're like super wealthy people. They're fine, the super wealthy. 

And then quality is like, you know, are are we advancing better quality products that are cheaper, that help in other ways? Read like by using this, your credit score can go up really good performance can actually be net positive in other ways or you're better protected in case of a shock or, you know, et cetera, et cetera. 

And then alignment is kind of the adventure veteran. I'd like if we're right, we're not compromising returns. In favor of social benefits, if we're right, then therefore investing in companies that create more value to consumers, they'll be more valuable companies. And so we're just mathematically measuring the correlation between the financial performance of our companies and the social performance of our companies. Mm hmm.

Mm hmm. One of the things you said was it'll lead to improved credit scores or things.

Can you tell me some about where that's headed and how does data factor into the future?

Yeah, and so many exciting ways. Great answer. Thanks.

Like we've we've had credit scores for a long time and credit scores have have basically taken very few inputs. Our performance on other credit instruments, those are the traditional trade lines. And we're increasing nontraditional trade lines all the time. And it's a it's a fairly laggy process. I invested in two thousand seven in a company called RentBureau that we sold for not that much to Experian that collected rental bureau rental payment data so that you could report it and build a credit score.

Only now, how many years later, 15 years later, this. The FICO nine score contemplates rental data. And but that's an accelerating curve of adoption in terms of non-traditional data, and then people use a credit score for more and more things, are the permissible use for credit scores is expanding, not contracting. And that's just the official credit score in the official credit bureaus.

There's a whole litany of of unofficial credit scores and another interesting trend of data that I'm super excited about is. You know, today it's FAANG, the big tech companies have largely monetized our data exhaust.

Mm hmm. And I'm excited for that to shift. Mm hmm. And for us to be able to monetize more of our own data exhaust.

Mm hmm. To come back to an earlier question of like, you know, how do you make up for people's income? I'd like since the 70s, the how we're paid for our time has flattened well, our productivity has gone up.

So that's that's why people are basically, you know, dusted for inflation as poor, rich as they were, you know, 40 years ago, more or less. You know, we need to find more and different ways by which to bolster our net income. You wrote a great title. It was something like ten, nine, nine problems, but two eight one. That's pretty good because there's got to be a lot of different ways of bolstering, as you say, our income.

More people are making more of their income on form ten ninety nine versus form W-2. So as a contractor versus an employee and just as a secular matter, just for purely financially, that is to the consumers. Disinterest. Because our whole social safety net for four, however good or bad it is, I am a European, so it's bad here.

Is is conceived through four two. Mm hmm. Right.

Are pre tax benefits are accessed for one in retirement health insurance. All the stuff is through a W-2 relationship, not a personal relationship. So that is a policy question, and I think.

The sad reality is like what made America's middle class the richest middle class in the history of the planet. Was the labor union, hmm? And it was Labor who we love to hate today who fought tooth and nail, and it did ugly things in ugly ways and just pushed and pushed and pushed and pushed obscenely.

You know, in ways that is very distasteful to to us modern people, but got like a working class, a great income, and with labor mostly dead and in many cases I feel like. Rightfully so, random in so many so much meritocracy has been upside down but what will take its place, right, because.

Yeah, so we'll see. Meanwhile, we're writing checks against things that can just create financial efficiencies no matter where things go, but it is a real question. Yeah.

So I want to save time to ask you a couple of other questions. But in terms of where you're writing checks, I think we kind of covered your your point of view of the world.

Anything else about Core to know? 

I can't compete against the next guy or gal on finding a full stack developer. But where we can really help is like, you know, your chief risk officer, your chief capital markets person or, you know, that kind of thing. That's easy for us. And then navigating all those all those relationships, how do you find a bank? How do you find an insurance carrier? How do you deal with the state regulators versus the OCC versus the FDIC versus the Fed?

All that stuff? We love that stuff.

It shows, that's great. OK, first first random question. If you if you could start a company, what would you start?

What would it be solving?

I think I'd want to start a company that employed a lot of people and paid them a great living wage and built an ESOP in a world where ESOPs don't really exist right in the startup world, everyone's in ESOP. And that's kind of part of the ethos here. That's not true in most of the economy. And with no pensions, the lion's share of people are just making their money on their hourly toil. And so so I'd like maybe like start a light industrial company and like, you know, make auto parts or plane parts or drone parts or something like that and and build a great ESOP so that people could really build, like, you know, intergenerational wealth as part of a normal working class gig.

Mm hmm. So having equity in the company that they are building, I like that.

Um, would you say, like, do you feel like you did a big career change in your life? Like, I was done with DA Wallach who was on tour with Lady Gaga before becoming a biotech investor. I of the.

Oh, he's amazing. And but he was such a big career change. Like, do you feel like you did that?

Yeah, totally, yes, very much so. I feel like I'm an accidental v.c. I've I've always just followed my nose and my career. I have I've never made the, you know, the move to the like, learn a skill or look and use it later.

I've just always followed my nose right and realize that the best things that have come to me have been a function of serendipity and not volition.

I think this has been a great discussion. I don't think I have a lot of other questions. I know I told you I was going to ask you about about how you evaluate founders, because I heard you say something great, which is actually negotiating the terms, yet a lot comes out.

Yeah. I always tell the team I wish we could negotiate the terms before we negotiate a term sheet. Right. Because everyone's courting each other right before that point. We want to be the VC of choice. They want to be the entrepreneur of choice. And so it's all best foot forward and everyone's courting each other and it's all good and it's typically way too fast.

And you have no idea who the counterparty is, which, by the way, I think is a is a problematic phenomenon where we're engaging in ten year relationships, literally ten years plus for successful outcomes and forcing on both sides, you know, forcing this into a you know, into a seven, 14 day decision process. Neither party knows who they're dealing with--unless you do for better. For worse. We did an analysis for L.P meeting the other day or the other month.

To see how long we've known founders before we get a check on average at 17 months. Hmm, that isn't to say that you need to run the 17 month series a process to get our dollars. Don't. I'm not saying that.

But on the term sheet, you know, instead of you're not courting each other anymore, you're suddenly negotiating and there is such a diversity of how we negotiate. And there is so much useful signal for making an investment decision in how a founder negotiates, right, someone can be a product visionary but not be able to strike a deal if their life depends on it. And you kind of have to do all kinds of deals in order to make a company work.

Hmm.

And so, yeah, we found ourselves occasionally in situations where like, oh, my gosh, like we're really doing this for like we're. Yeah.

Well, I'm not going to ask you any more about negotiating term sheets, although I could instead just say thank you so much for coming on the podcast.

And, you know, I hope you I hope you can bring back the American dream.

Really. Well, it's going to take a bunch of us, so thanks. I really enjoyed it. I so appreciate your your happy curiosity and enthusiasm for for your subjects.

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