Shadow Ventures CEO KP Reddy On What Proptech Venture Capital Gets Wrong

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Having earned a bachelor’s in civil engineering from the Georgia Institute of Technology, where he later ran the university’s incubator, Reddy wrote a textbook on building information management, BIM for Building Owners and Developers, which along with a serially successful entrepreneurial career, put him on his path to becoming a tech VC.

Founded in 2018, Atlanta-based Shadow Ventures numbers some two dozen startups in its portfolio, including well-known companies such as Aren, Icon and Stake.

While on the road in Dubai last week, Reddy spoke with PropTech Insider about his VC investing philosophy, why many leveraged partners are agnostic as to what they invest in, and why artificial intelligence should not be overlooked in real estate.

This interview has been edited for length and clarity.

PropTech Insider: What made you create Shadow Ventures, and why was it the right time to do it?

KP Reddy: I’ve been a serial entrepreneur. I was a civil engineer and then started tech startups, taking a couple of them public. Then, quite honestly, I was kind of semi-retired. 

And then the industry started coming to me asking me for consulting help. “Oh, we’re thinking about investing in this startup.” And I was like, “You’re a structural engineer. You have no idea what you’re doing. But what are you doing?” So I started doing some consulting, and it wasn’t that interesting to me. A lot of these clients of mine said, “Hey, we want to invest in these startups. Clearly, we have no idea what we’re doing. Once you start a fund, we’ll back you.” 

That’s really where it came from. I took about a year to do due diligence and meet with the last company I sold out in Silicon Valley. I spent about three years out there with my VC friends to really understand the business. A lot of people just think they can just decide to be a VC, and then they do it and they really have no idea what they’re doing. I really wanted to understand if it was a fit for me in terms of what I wanted to do. After that we launched, and our first fund was backed by strategic investors — friends and people like that. I’ve been in this space for 30 years, building stuff.

There was a time when I was at Georgia Tech running their incubator. I told people I don’t ever want to see another proptech, construction tech, or any of those deals in that space ever again. Because all they had been was heartburn. During the dotcom era, they were heartburn, my own startups were successful but could have been bigger, that kind of thing. I was kind of sour on the entire industry. I had to understand what the signals were as to why now was kind of a thing. 

For me, the “why” was one thing: We had a generational shift. You now have executives who started their first day of work with a computer. I think in our market that culture is such a driver of behavior. My first startup that I launched in 1997 was targeting general contractors to have them do construction management on the internet. They literally told me the internet was a joke, a toy, and would never amount to anything.

What made you persist?

I was fortunate that I pivoted into telecom and did well there, but I had a lot of scar tissue. 

Then, we started tracking labor shortages. Clearly, there’s a labor problem in our industry generally. Nobody wants to swing a hammer. Nobody wants to manage the property. People don’t want those jobs. They want to be social media influencers. That was another factor. 

The third factor was just some of the environmental impact stuff in terms of decarbonization. I try not to use the term “ESG” because that’s a whole other topic. Really big construction waste is amazing. All you have to do to understand construction waste is go to a job site and look at how much garbage is in the dumpster. On a brand-new project, 20 percent of a building ends up in a dumpster. Seeing those trends brought me to the conclusion that it was a perfect storm, even if the industry had a cultural negativity toward change in tech adoption. They didn’t really have a choice.

Let’s step back. What were you doing before entering the proptech VC world?

I’m a second-generation civil engineer. My mom’s a computer programmer, my dad was a civil engineer. They bought me a PC when I was 13 and I started writing code. Then my dad told me to build him software so he could do his job better.

So now as a founder and CEO of a proptech VC firm, what is your investment philosophy?

We tend to look at companies where there’s much more technical risks and market risk. If you look at revenue as being the sword and defensibility being the shield, the business startups always take longer and more cash than you need. We try to target companies that, if they can solve the big technical problems, the market is there. 

We invest in seed and pre-seed stage. So, if a founder starts coming to talk to me about revenue, I’m generally very disinterested. My interest is: What big problem are you trying to solve? How did you solve this problem? Why do you think you are uniquely qualified in the entire universe to solve it? 

If you look at the first check I wrote, it was for a company called Icon, when they were a three-person company. Guys in their backyard screwing around with concrete and robots trying to do a 3D-printed house. That’s when I invested, because I knew, if they could figure it all out, they’d be a $10 billion or $100 billion company.

What’s it valued at today?

Somewhere on the order of $10 billion.

What kind of proptech startups are you most attracted to right now? What do you think is really hot?

So, one, I’m not a big fan of the term “proptech.” And my friends know that; everybody knows this about me. I think those labels don’t really differentiate. There’s not necessarily unique challenges other than just slow to adopt, per se. 

But I think the biggest challenge with proptech today is that too many real estate people got into the VC space. That’s a problem. When the wolf’s guarding the hens, or whatever the saying is, they’re not going to get excited about any model that puts them out of business. Also, psychologically, VCs make bets on companies that mostly go to zero in three years. Real estate investors don’t understand that. It’s just not in their DNA. So what happens is you end up with companies that get funded that are very mediocre. They can’t be big home runs, because your investor base is not going to take those types of risks. As much as people think real estate is high risk, if you have the assets, it’s actually not that high risk. At the end of the day, you have an asset value. So I think that that has been problematic for the market.

Then, finding technical talent who want to come into our space is such a challenge. You know, do you want to build a tenant optimization platform using AI? Or do you want to go work at SpaceX? It’s just unsexy and hard to get technical people excited about. So, when you have investors that are very risk averse and you can’t attract talent that is going to go build stuff, that creates a problem.

It’s like before there was Facebook there was MySpace. Before MySpace there was AOL forums. Before that there were these things called bulletin board services, which is what I used to run when I was a kid. Sometimes the first model doesn’t scale. So I think there’s a slew of proptech companies out there that did a good job on a problem, but the solution set wasn’t scalable enough, interesting enough, wasn’t on point enough. 

I think you’ll start to see 2.0’s out there. A lot of MySpace is out there. I think you will see the re-emergence of the Facebooks of the world.

What do you mean by that?

It means — and I hate using this one because I never thought that they were a tech company — but WeWork (WE). The reality is there’s still huge demand for a third space, whether you call that third space coworking or now social clubs. Whether your office is at Soho House or at WeWork or any of them, there’s still a demand post-pandemic. Actually, so much more of a demand. We all went and worked out of our houses, and then we realized this is kind of terrible. So, now, we’re all trying to find a third space and go to Starbucks, and that sucks too. I don’t think anyone disagrees that there is a demand for a third space now more than ever. 

So why wasn’t WeWork successful? They over-capitalized, over-grew, with lots of mistakes made. It doesn’t mean that you couldn’t start a much leaner capitalized, right business model WeWork today, which people are doing by the way. There are businesses and they’re getting venture backed. WeWork was never a venture bankable real estate play. There’s one third space in Atlanta, and I think they’ve announced they’re going to do 100 locations around the country. They call it a social club. That’s just coworking. They have a cool little brand and design, and will brag about their coffee, all that good stuff. But they have the right model: B-type real estate properties, making them very community-based actually.

Let’s talk about your capitalization and what LPs are looking for today. When you go to raise funds, what do you tell them? What do they want to hear?

They want to hear returns.

But are they more interested in one type of startup over another?

To be honest, I don’t think they care. I think anyone who tells you they don’t care about returns is lying. You know who cares about returns the most? Me. That’s how I get paid. You don’t come out of retirement for management fees. So, I think it’s very important that returns matter. 

I will say this: I think the last 10 years, some of the stuff with the private equity guys coming down and buying out on the secondary market, and some of the stuff that’s happened has really moved the pendulum back to the norm. Venture capital is more of an artisan business. If someone gave me $10 billion to start a venture fund, I would probably waste $9 billion of it. There’s so much pressure to deploy that kind of capital. And you’re just not going to have enough great ideas to deploy that kind of capital. So, in many ways, venture capital got too big.

I think with interest rates where they are, it’s competitive now. We’re not in a zero rate environment. Investors were like, “I need something better than zero. What can I do better than zero?” So, they did a lot of things. Now, if you look at a lot of endowments, their target is 4 percent. If they get 4 percent returns on their $10 billion, they’re kind of happy. Well, they can get that at the bank. Why take the risk? So, the risk-adjusted hurdle rate is 5 percent, and you have to be good at your job as a VC. If you don’t have immediate returns, which very few of us do in this sector, you have to at least demonstrate that you care, that you’re tracking it, and that you’re working with your portfolio to get the right outcome. 

I’m not here to hang out for three years and see a portfolio company go sideways and grow 2 percent a year. I don’t have time for that. You should burn through all that cash in the next 12 months and I’ll see what happens. VC, after all, is rarely about survival. You have to align with investors on investment philosophy and help them understand, if they don’t already understand, how you’re going to deliver returns.

Which of your investments would demonstrate that you’re a good VC?

Well, you can only give people directional guidance until a liquidity event happens. Most liquidity events I’ve had have been OK. We do this comparative analysis where some of our portfolio got marked up. A third party has validated that my investment is worth more than I paid. While I’ve had markups, if there’s not liquidity, it doesn’t matter. And then what if the guy that invested after you was a dumbass? They just overpaid, right? 

So you have to level set, go back and look at your portfolio and say, “OK, well, yeah, great. These guys paid 10 times what I paid. Fantastic.” But does it still hold water? Will someone still pay that much today, or more? You have to be super realistic about that.

Are general VCs continuing to enter the real estate tech market?

As a VC, there’s no recourse really when someone stops your capital call. You can’t really do much about it. The existing dry powder that we think is out there may not actually be out there. That’s one thing that I think people don’t like to talk about. If we work with one of your LPs, are they going to send me money? Probably not. That’s one dynamic when it comes to raising new funds. I think so many of the strategics are on pause.

What does that mean for founders? Back to basics. You bootstrap. You’re not taking chips off the table. You’re not paying yourself $250,000. When I was a founder, I never made over 30 grand a year. That’s just how that is. I run an incubator, and we don’t give any of the companies money. We just give them free advice. They’re realizing it’s more important to recruit a technical co-founder that’s willing to come give 12 months and not get paid than maybe getting a VC.

In many ways, I think we’re back to basics and maybe overcorrected a little bit, but I think it’s fine. That’s part of the reason why I’ve doubled down on my incubator activity. It’s very exhausting, it’s very time consuming, but my thesis is that capital will really start to flow again in a few years. If I can coach these companies, bootstrapping them and helping them understand how to build a good company, I’ll have a great cohort to invest in over the next two years.

I enjoyed our conversation. Did I miss anything?

You didn’t say AI even once.

I think I may be over-AI’d these days, but what do you think of the subject?

Besides the fact I just had a book released three weeks ago on AI [Creating the Intangible Enterprise: The Critical Skills Required to Thrive in an AI-Driven World], part of the reason I wrote the book was to make people feel better. I think there’s so much, “AI is going to take everyone’s jobs.” People get really focused on, “Oh, PR firms and writers like you are going to go away.” There’s such a focus on that, but it’s kind of a big head fake. I think the creatives will be fine — as long as they’re good. That’s how life is if you’re good. You prosper.

The two sectors that people Aren’t aggressively talking about is software development. We’ve done a massive disservice to our children by telling them to go get computer science degrees, because within two years you will not need to know how to write software, AI will do it for you. However, you will need to have domain expertise. Entrepreneurs can say, “I don’t know how to write code, but I can punch it into AI and it can write code.” 

Now you might have an era of not only bootstrapped startups that never need money, but also the ability of corporations to say that instead of buying a startup company’s product, we can build it ourselves. I saw a demo of a company that logged into a very well-known customer relationship management company, ran their AI, and cloned it. 

So, we know real estate people can be cheap. If you’re paying XYZ property management system, and you can clone it, then you own all of it. It’s all your data. Why am I going to pay XYZ real estate software company unless they have something that is just so compelling above and beyond? But, if it’s a job order or lease report, that’s all basic stuff. The tech companies that are just taking spreadsheets and turning them into software and workflow are probably at risk.

The second leg of that is if founders don’t need money, what are the VCs going to do? The VCs that actually create value, actually provide expertise, are probably fine. We think we’re OK but I’m still here talking about it. We’re not infallible. Not every company wants a VC, so I do think that AI is going to spur a massive wave of entrepreneurship.

Philip Russo can be reached at prusso@commercialobserver.com.