Welcome back to Inside the Mind of an NYC VC, a new series at AlleyWatch in which we speak with New York City-based Venture Capitalists. In the hot seat this time is Issam Freiha, Cofounder and Partner at Alrai Capital. Alrai’s first fund is a $10M fund focused on transportation technology. The firm is currently raising its second fund that will have a broader mandate to include investments in deep tech, consumer tech, and digitally-enabled marketplaces. Issam stopped by to talk about the genesis of the two-year old firm, its investment thesis, autonomous vehicles, the role of government, and much, much more.
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Bart Clareman, AlleyWatch: Tell us about your journey into the venture business and how you came to found Alrai Capital?
Issam Freiha, Alrai Capital: I’ve been passionate about investing for most my life. In college, I studied finance and data science. I joined the board of the largest finance community on campus and worked for the student run investment fund.
Those were pretty formative years, and they opened a lot of doors for me. I worked at four or five financial institutions; for most of them I was conducting in-depth research on different asset classes, geographies, and sectors.
I had a knack for diving really deep into the weeds when analyzing markets or products that interested in me. I covered Rocket Internet for several months throughout one of my internships. I met with some of their founders and by interacting and learning from them, it was clear to me that technology was an industry dominated by young, ambitious, like-minded folks, which was exactly where I wanted to be
Midway through college, one of my good friends from Dubai and another friend of mine from Columbia had started raising small SPVs from friends and family to invest in startups in New York. I joined them and helped scaled their portfolio.
We ended up dabbling in a few frontier tech markets through our academic networks, which led to the transportation tech thesis of Fund 1.
I think our DNA is very similar to the entrepreneurs we invest in. We started out working in dorms and libraries and slowly scaled from that. We understand the struggles of starting and formalizing a company, and of raising money. It took us a long time to raise our SPVs and first fund; we pitched to around 300 potential investors and closed about 10. It goes to show the persistence and the determination we have, and without that I don’t think we’d have been able to get to where we are today, and the same is often true for our founders.
One of the main challenges I’d say is having the experience to build conviction around an investment. Luckily, I was surrounded by great mentors and other experienced investors who helped me get up to speed on their processes. What I’ve found is, when you have the experience to build conviction around an investment, everything else grows from that. When you have deep conviction, you become a real cheerleader for the company, and truthfully, that’s probably the most important thing you can do as a VC – be there for your founders, push them forward, help them sustain the test of time.
You talked about the importance of conviction. How do you and Alrai get conviction around your investments?
We invest in a lot of deep tech markets such as the autonomous vehicle space, in which it’s usually very tough to underwrite future growth. That’s why your large growth funds don’t generally dabble into these spaces. However, if you’ve gotten to know the founders for an extended period of time, and really did your homework on the product and its addressable markets you start getting a lot more comfort in writing the company a check.
One of our largest investments is in a company called Quanergy Systems, which builds solid state LiDARs. Given we are a few years away from commercialization of cheap solid-state LiDARs and their deployment in AVs, for us to get comfortable around the investment, we had to spend a lot of time understanding how defensible the actual product was visa-vis what its competitors were developing. We saw that the market for LiDARs was on the cusp of hyper growth and that Quanergy was best positioned to capture a large portion of it.
Alrai is a stage agnostic fund. How do you think about the tradeoff between the breadth you get by casting a wide net and the benefits of specialization with a narrower focus?
First of all, most of our LP base consists of international corporate executives and high net worth family offices that have a large portion of their portfolios concentrated in real estate, oil and gas, aviation – that is, industries that are not technology. To be able to start allocating certain portions of their portfolios to technology means you have to ultra-diversify across asset classes and technology sectors with different risk profiles.
Our long-term goal is to build a technology-focused asset management firm for our LPs that is diversified across different asset classes. For example, I think we are well positioned to build a fund of funds that invests across other top-tier VCs and technology-focused growth funds.
Going back into our focus areas, we felt that the best way to start was to have a very niche focus. It gave us an edge as emerging managers. The reason for that is, the incumbent VCs don’t usually have large portfolios in deep tech or autonomous vehicles. You have a few funds, like Lux Capital, that have been doing it for a while. However, most of your top tier guys have only just started exploring these areas.
So it’s a very fresh space, and it’s a space that we we’re passionate about and that we knew was going to heat up very quickly. We did a ton of research and had a clear thesis that resonated with our investors. You had about 30 OEMs with billion-dollar plus R&D budgets, and larger portions of those research budgets were going to start shifting towards autonomous vehicle technology, and that created a huge opportunity for startups in the space.
Do you have a specific investment thesis that you’re investing off of?
For the first fund, our exact thesis was to build a synergistic portfolio where we would be able to invest across the value chain for autonomous vehicles, pair hardware providers with software providers and make them work together on solving complex technical problems instead of going for a full stack solution.
Once a few auto manufacturers and suppliers in our corporate network saw the viability of a few products we were investing in, opportunities arose to start cross-selling across our portfolio. That’s worked really well for us.
If we’re incubating a new company or investing in a new type of technology, we can show our go-to guys in the industry what we’re trying to build, connect them to the relevant founders, and then they can participate as strategic investors or as partners in the actual development of the technology.
Even before you dove so deep into autonomous vehicles on the research side, what drew your interest in the space?
It all started through one of the first investments we made in a company called Civil Maps, which is a 3D mapping company out of UC Berkeley.
Before that investment we’d invested in a few different sectors, but the second we heard the pitch and saw what they were trying to build, it was like they relayed the future to us. We walked out with our jaws dropped, turned to each other and said, “this is going to be the future, this is incredible.” It’s very rare that that such a feeling comes across in a pitch meeting, but that was the moment we figured out we wanted to really dive deep into the space.
At that point we started doing a ton of research. We also met with a few auto executives and really understood how desperate they were for new technology and talent focused on the autonomous vehicle space.
We got a certain amount validation for our auto thesis after the Cruise acquisition. When Cruise was bought by GM for $1B, Sebastian Thrun claimed that the going rate for self-driving car engineers was about $10M a head. In our minds that meant a lot. We didn’t take it entirely literally – that’s not how we value our companies – but that was a big push for us, and that’s what gave us a lot more comfort in launching a fund in the space. That was the early validation.
Where do you see autonomous vehicles going, and on what timeline?
In terms of timeline, if you break it down in terms of the levels of automations, we’re somewhere around Level 2. What that means is, the vehicle’s sensor and software systems can take longitudinal and lateral control of the car in a specific use case, like driving on a highway. It is essentially a combination of certain advanced driving assistance systems, like adaptive cruise control and lane change assistance – that’s where we’re at right now.
I think the timeline to get to a Level 4 vehicle, which means that a driver can completely have his hands and eyes off the road but can only do so in certain geo-fenced areas, is somewhere around 2021-2022 based on the penetration of advanced, low-cost sensing capabilities of solid-state LiDARs and 3D radars and their implementation in the new OEM models.
Between Level 4 and now, a lot of people say there might be this middle ground Level 3, where drivers can have their hands and eyes off the road, but would still need to be attentive so they can intervene in certain conditions – like if it’s rainy or too foggy.
We don’t particularly believe in that level. It’s too ambiguous. The marketing around that will be too opaque. To give comfort to the consumer to start mass adopting self-driving cars you really need a clear cut marketing message. It needs to be, “Given you’re located in this specific area, no human driver will ever have to intervene.”
How do you perceive consumer readiness for autonomous vehicles, and what can the industry do to convert the skeptics out there?
Well, no matter what innovation you have in technology you’re always going to have a group of Luddites. However, the reality is tens of thousands of people die in the United States every year from car crashes, and then you have another 1-2M who get injured – those are pretty significant statistics. At some point, the government will step in and straight-up ban manual driving of cars, except for very specialized zones or reasons. When the technology eventually gets there, I don’t think it will be an option for consumers.
At this point, there’s definitely a lot of friction amongst consumers. That was really highlighted after Tesla’s car crash. Accidents like that are going to create a lot of fear and discomfort.
However, I think it’s the responsibility of OEMs to go out with a clear marketing message and tell us about the actual capabilities of these cars, and explain what something like “auto pilot” means such as when a person needs to be attentive and when not.
Regardless though, I do very firmly believe that over time this question will be decided by the government and that they’ll outright ban the manual driving of cars.
What timetable do you have in mind for when manual driving would be banned?
I would say whenever we get to Level 5 automation. At that point you really have to have strong regulation by the government and the Department of Transportation.
It’s a question of when the technology is going to be ready. Given our 2021/2022 timeline, once you have certain geo-fenced zones you would need some sort of local and federal regulation to start banning manual driving of cars.
That’s not to say there will be no interaction between self-driving cars and human-driven cars. That’s going to be the case if you want mass adoption. But once you can commercialize self-driving cars at a low price the government has to step in.
You’ve talked about the role government will play in all this. I don’t doubt that the technology will keep marching forward, but it’s asking a lot of government to be ready for autonomous vehicles in four or five years. What does government need to do in order to accommodate the rise of self-driving cars?
I guess part of me believes that in order for this to happen expediently Mark Zuckerberg might need to become President of the United States – so hopefully he’s on track to do that.
Kidding aside, we always underestimate the timeline that federal and state level regulation starts kicking in and starts regulating an industry and passing laws that will make self-driving cars a reality. The biggest thing for governments to understand is that human driving is a real problem that’s causing problems in society. It’s not only an injury and death issue, but also, it’s an economic issue where we’ll start saving trillions of dollars a year by making transportation more efficient. For example, you can start cutting out useless real estate and make cities more operationally efficient through both cost and time savings.
Governments are receptive to that. They have started implementing laws and I think the timeline is “we’re getting there.” What it will take above all else to really move the needle is for government to understand that the technology is coming much sooner than they expect. As they understand that further they’ll be more receptive. To that end, I think it’s more in the hands of technologists to get the actual products ready so governments can start seeing how close these changes are. Once they see that, they will have no choice but to start implementing more regulation.
I have a 15-month old, will she learn to drive a car in the way we think of it today?
Even today, most gen Z kids are no longer interested in getting their first car. It’s more so about getting my first iPhone, my first Uber account – that’s what the younger generations are interested in.
I definitely think it’s more a societal and cultural phenomena that’s going to disinterest her from getting a driver’s license. She’ll likely be more interested in interfacing with the new technologies and products out there.
What do you look for in a company or founding team?
It all starts with the team.
We look for a combination of charisma, grit, and vision. When you combine these three traits in a founder, it’s easy to tell if the founder is going to be capable of raising money, attracting a talent base, and maintaining the interest of their engineers and investors over time.
Being an innovator in a deep tech market is very tough. Number one is, you have to set expectations straight for your employees and investors. You have to push out product fast, but you also have to be hyper-obsessed with perfection and quality because people’s lives are at stake so nothing can go wrong. Delivering that standard requires grit and uncompromising quality. At the same time you need charisma to retain your employees through a tough product development cycle, and to retain your investors’ interest when you’re showing progress on product but maybe less so on the revenue side or business side. That’s an extremely hard balance to strike.
After that, in this space in particular, you need domain expertise and intelligence. All of our autonomous vehicle startup founders have extensive research and academic backgrounds. A lot of them have developed their own products in the past as well, though it doesn’t always have to be that their past experience was in the same industry.
One of the best examples of that is in Civil Maps. The founder of Civil Maps used to work on digital fingerprinting at Samba TV . After realizing that fingerprinting was a very strong pattern recognition tool, he started to develop the same underlying technology to package, categorize, and access the 3D map data collected by an AV’s sensor suite.
The third thing we look for is adaptability. It’s insanely important in frontier tech markets. If you’re developing a certain technology for transportation or cars, typically, if it’s an enabling technology, it’ll have applications in other industries that can be commercialized even sooner. As a founder, if you can quickly adapt your team, hire new guys and shift your team or product strategy towards a new sector to make the most out of a particular opportunity, that’s a very valuable trait and something we tend to look for.
What would your portfolio founders say about you as an investor?
We’ve invested in over 20 companies now. Tracking back to the first fund, what our founders would say is that we’re very resourceful investors. We have a pretty large network that we’ve built over time. More than anything, we’re very network-driven investors.
As an example of that, prior to launching the first fund, we worked with a group of eight engineers and investors who had a lot of domain expertise in the industries we were investing in. They really helped some of our founders by opening up their distribution networks, relaying their operational expertise, and helping them attract and hire talent. When we invest in a company and we think one of those people can add more value than we can to the team, we place them on company’s board rather than take it ourselves. Our founders appreciate that humility.
To scale that strategy, our long-term strategy is to expand our expert network from eight into a team of 40 across specific sectors . We incentivize them by giving them significant economics on the deals we’ve worked on with them. Given we are young managers, we can be long-term greedy.
It was two years for the firm in September. What are the greatest learnings thus far, and how is Alrai different today than when it started?
I think from an investor’s perspective, a big learning has been that price and valuation matter more than we expect. When the price is right it gives us a lot more room to justify the investment given the risks.
When an investment lifespan is so long, you want to make sure you’ve entered at a stage where it makes the investment worth it after all the dilution. That’s especially important in deep tech when the rounds get larger and the dilution gets more significant as you go forward. That’s been one of the big learnings.
Another learning would be that your brand as an investor also matters a ton. Most VCs who have great brands but are not great advisors still get great access to deals and invest in the best entrepreneurs, while VCs with poor brands who could really add a lot of value don’t have that same access. It’s really understated how important it is to have a strong brand. It’s important of course for the startups you end up investing in as well. They value a VC’s brand in large part because it can help attract talent and other investors.
Third, it’s my belief more today than when I started that being a cheerleader matters most as a VC. More than anything, your founders care for you to be unconditionally supportive. It’s tremendously important to be there when they need you most
It’s hard to stand the test of time in these relationships. It’s hard for entrepreneurs to have the grit to build a great, sustainable business, and for investors it can be hard to be supportive through the ups and downs of a company. I think the greatest VCs are there at all times and are very supportive.
What trends are you watching closely as 2017 winds to a close?
I’m extremely fascinated by the construction space. Interesting fact about me, I built up a public company portfolio in college, and one of my best performing investments was in a crane rental business. I learned a lot about the construction business, it was one of my intense deep dives into an industry.
On the technology side, there is a ton of opportunities in the space, either in better collaboration software, 3D mapping and design software, autonomous construction machines, 3D printing – it’s a huge white space. One of our latest investments is in a company called EquipmentShare, a peer to peer digital marketplace for construction equipment. They are solving a huge problem for contractors by increasing the utilization of high quality construction equipment that typically is heavily underutilized due to the limitations of offline distribution networks.
Favorite book and why?
I don’t usually have a favorite book. Something I picked up at Columbia is I read multiple books at a time so I tend to lose track of what my favorite book is.
The books I’m reading today are Grit by Angela Duckworth, that’s a great book about the psychology of perseverance. The second one is called The Master Algorithm, that’s a book on the theory of machine learning and different fields of thought and the algorithms that make them possible. It’s a super fascinating book and a great primer for anyone who wants to understand the industry.
The third book I just finished that was a great and easy read was Chaos Monkeys by Antonio Martinez. That’s a super funny book. It gives great insights on the culture of Silicon Valley and its tech culture. The founder started a YC company, sold it to Twitter and went to Facebook. It’s hilarious and an easy read.
Most underhyped part of the ecosystem?
I’m going to go back to construction – it’s really underhyped. In terms of market size, the equipment rental market in the US alone is a $65B market, so it’s right up there with transportation and real estate. You have Uber for transportation, Airbnb for housing, and there’s going to be a giant in this space. Hopefully one of our portfolio companies can turn into that.
You’ve talked about mentors who have had an impact on your career. Is there an investor or firm that you admire in particular, and why?
It’s hard to narrow down but I would say there are three firms we really look up to at Alrai in particular. The first one is Lux Capital, the founders have a a very similar story to us, they started the fund out of college. They’ve been specializing in deep tech. I look up to them and admire their scientific research and investing style.
Other funds that have gone through similar paths to us are Romulus Capital in Boston and Thrive in New York. We look up to those guys as well, although we strive to build our own brand over time and hopefully the next generation of investors can start looking up to us.
I singled out the ones that have similar profiles to us, but where I actually learned a ton is from the more experienced VCs. The most experienced ones are still in a way the trendsetters. Fred Wilson, Bill Gurley, John Doerr have all been a major influence.
What’s your one unique take on how the world will be different in 20-30 years time?
It may sound pretty outlandish, but I think in 20-30 years you’re going to have independent autonomous cars and robots, autonomous taxis or construction cranes, that will have their own cryptocurrency wallets, that can receive payments for the services they provide, and send payments to maintain themselves.
In that sense, these machines will effectively become part of society. They’ll be machines that we interact with on a daily basis that will have their own way of life.