How a VC determined Katerra was a bad investment

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p 1 a vc explains the one factor in decision making that could avoid a fatal mistake

Disrupting the development trade makes a lot of sense on paper. The trade is huge. The Related Normal Contractors of America estimates that $1.3 trillion is spent on building within the U.S. alone each single 12 months. But it’s a extremely fragmented trade. It doesn’t use software program or expertise intelligently, labor prices are excessive, it has very intensive working wants, and it comes with vital regulatory, media, and political threat. Plus, getting it proper in a single metropolis doesn’t robotically imply it’ll in one other.

That every one sounds tough, but it surely’s truly what enterprise capitalists are searching for—alternatives to do issues higher and make a lot extra money within the course of. However as VCs and analysts had been busy extolling the virtues of modular construction and non-union labor, they had been additionally taking a lot on religion. 

Why? As a result of irrespective of how good we traders are (or assume we’re), there are limits to our expertise and experience. There’s all the time extra we don’t know than what we do know. And once we like an investment, we’re normally prepared to imagine that the issues we don’t actually perceive have to be okay so long as somebody smarter than we’re already checked it out.

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That assumption could also be crucial but it surely can be deadly. Katerra, as soon as the brightest gentle of the development tech sector, is a excellent instance. The tech startup expertise aimed to “join Constructing Data Modeling (BIM) instruments and computational design on to its ERP international provide chain infrastructure for ease of fabric ordering, manufacturing, monitoring, and supply.” So when Katerra debuted as the largest and most bold building tech startup on the block in 2015, it was with a lot of hope, a lot of promise, however a lot of uncertainty and challenges too. 

Tusk Enterprise Companions didn’t launch its first enterprise fund till late 2016, so Katerra was already too highly-priced for us to spend money on, but it surely appeared like a excellent shopper for our political consulting agency, Tusk Strategies. In fact, it’s a lot cheaper to construct one thing when you may manufacture modular buildings in a manufacturing facility after which have non-union labor stack the bins on web site. However that additionally means the underlying ideas of building tech develop into as a lot of an existential menace to the Constructing Trades (which embody everybody from electricians and carpenters to painters and plumbers) as constitution faculties are to the lecturers’ unions. That’s not useful in most political circles. 

To make issues worse, land use and zoning selections are all the time intensely native and intensely political. Even with utilizing union labor, getting consensus and approval on a main challenge can nonetheless take years. With out it, it’s worthwhile to be ready for a struggle in nearly each Metropolis Council of each main metropolis throughout the nation. 

So when my companion Matt Yale and I talked to the crew at Katerra dealing with authorities, media and politics, we had been initially very excited. This was a huge, disruptive concept that required a lot of political know-how, which is true in our agency’s wheelhouse. However then we met them. 

Some members of the federal government relations and advertising groups at Katerra got here from the Gates Basis. Invoice and Melinda Gates do great philanthropic work however I’ve noticed that their basis might be simply as bureaucratic as any authorities company on the market. They’re regularly sluggish, overly process-oriented, and sometimes afraid of threat. It could be a wonderful approach to offer malaria nets in Africa, but it surely’s not the way you wage conflict within the trenches of native U.S. politics. 

As soon as we talked to the Katerra crew, we realized they had been considering a lengthy RFP course of to determine who may assist them navigate the politics of every metropolis. They had been contemplating giant administration consulting companies that knew nothing about politics. They didn’t appear notably involved about participating with organized labor to win permits and zoning approvals. They didn’t appear notably involved about something. The issue wasn’t simply that the Katerra crew clearly didn’t know something about municipal coverage and politics. It was that they didn’t even know that they didn’t know.

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To us, that was a evident crimson flag. Possibly simply the federal government relations crew was overly bureaucratic and the remainder of the corporate was agile and nimble. But when hiring individuals from a nonprofit ivory tower basis to deal with extremely politicized zoning battles made sense to the CEO and the administration crew, you’d should surprise about their judgment extra broadly. 

Since we had been nonetheless comparatively new to enterprise investing, I assumed that the distinguished funds backing Katerra knew greater than we did. We didn’t have interaction with them, however I nonetheless figured that these funds would make cash. 

That evaluation might have been too beneficiant. Just a few weeks in the past, Katerra filed for Chapter 11 bankruptcy. On reflection, I wasn’t stunned that that they had a spotty monitor file on delivering tasks, that they suffered continual leadership shakeups, and even that they (voluntarily) reported “potential improper income recognition practices” to the SEC in Could of final 12 months which is below investigation. I wasn’t stunned that they burned through $2.78 billion between 2019 and 2020 and missed all of their monetary targets. The postmortems from trade analysts equivalent to Pitchbook and CB Insights weren’t notably stunning both.

Early administration didn’t seem to know how the development trade works, identical to their political crew didn’t appear to know how unions work or zoning works. They had been making an attempt to use concepts that made sense on whiteboards and in Google docs to the actual world of city building, zoning, labor, and politics. They usually didn’t appear to acknowledge simply how tough that may be.  

On reflection, the corporate’s destiny ought to have been clear from day one. The politics crew might not all the time be a good proxy for the remainder of the corporate, however on this case, it was. In case your interplay with a tech startup is in an space you recognize properly—say finance or operations or hiring—and it looks like they simply don’t know what they don’t know, that’s most likely a main indicator of what could also be improper throughout the complete firm. 

That’s precisely what Softbank and all of Katerra’s traders bought improper. They both didn’t see the crimson flags or they simply ignored them and stored pouring in money, to the tune of $1.6 billion total. They wished the thought to work, they wished to assume that logic and cause would prevail over cash and politics. They wished to take the concept sounded nice in a pitch deck and fund it no matter whether or not that concept mirrored the truth surrounding it. That’s the way you make bad investments. You low cost what you do know and make too many assumptions about what you don’t.

You possibly can all the time speak your self out of any deal, so a good enterprise capitalist can’t be afraid to leap in and take dangers. That’s inherent within the nature of the enterprise. However when these crimson flags pop up—particularly in your space of experience—and when it’s clear the corporate doesn’t perceive the problem at hand, it’s worthwhile to see it as greater than a threat that will get famous someplace in an investment memo. You should see it as a proxy for the administration crew, their imaginative and prescient, and their skill to execute. What you need to see and what’s truly there aren’t all the time one and the identical. In different phrases, take your individual experience severely. It’s price greater than you might understand. 


Bradley Tusk is a enterprise capitalist, author, philanthropist, and political strategist. Tusk was not an investor in Katerra nor was he ever retained by Katerra as a strategist.


EDITOR’S NOTE: At press time, Katerra’s crew had not responded to a request for remark. We’ll replace this submit once we hear again.