Startups Deliver Massive Innovation, but they also come with Massive Risks

The PropTech market has exploded.  According to the Center for Real Estate Technology & Innovation, investments in PropTech hit $32B in 2021. There has been cooling in this market over the past few months, but capital is still being deployed at a dizzying pace.  With so much money flooding into the industry, there are many flashy startups driving really innovative solutions to the market.  As I attend innovation conferences and learn about new companies, I am amazed at the speed that new technology is being developed.  As a fan of new technology and as a member of the PropTech community, all of this new innovation is really exciting.  At the same time, early stage startups present a real risk which is too important to ignore.  Most of the conversations around the risks that accompany startups are tied to the VCs that are placing bets, but the other parties with significant exposure are the early adopters.

After an announcement that came out earlier in the year, and after seeing similar events play out time and time again, I felt like it was an appropriate time to highlight some of these issues. As anyone that reads my blog knows, I try to be as objective as possible in my writing.  I never want my day job to influence recommendations or opinions that I have, and I always disclose any employment or consulting relationships that I have during relevant articles.  

I am a managing director at Kastle Systems.  We are a 50 year old provider of access control, video surveillance, visitor management, and other smart building/apartment technology solutions across the US and Australia. We currently secure approximately 3,000 Class A/B Multi-Tenant and Multifamily properties, and 50,000 tenant suites. Over the years, new competitors have hit the market with sleek marketing collateral, beautiful packaging, and bigger than life promises.  One thing that I learned is that delivering access control and visitor management in Multi-Tenant Commercial and Multifamily buildings is incredibly complex.  A typical commercial building has dozens of tenants, hundreds (potentially thousands) of employees, and an untold number of visitors.  In most cases, a building has one access control solution controlling the perimeter, amenity spaces, turnstiles, and elevators, and each tenant has their own independent solution.  Additionally, buildings have to accommodate an unpredictable number of their tenants' daily visitors that often show up unannounced and without pre-registration.  Having everything operate harmoniously is much easier said than done.  It is also not just about convenience; it is also about  life/safety.  Imagine being locked out of your office or home, or even worse, being locked inside.  That’s not to say that innovative new startups cannot solve these issues, but you need to be careful where you place your bets.

The Risks Are Real

In 2016, a company was founded by the name of Proxy.  Their pitch was incredibly enticing.  They promised to deliver seamless digital credentials (using your cell phone to open doors).  They weren't the first to promise this, but what made their pitch so special was that they didn’t require building owners to rip and replace their existing hardware.  Replacing hardware can be costly and disruptive to the building’s operation.  Whether a client was using Lenel, AMAG, C*Cure, or a mix of many disparate systems,….  it didn’t matter.  They applied a software layer on top of the existing hardware that tied everything together and promised to deliver a seamless mobile access experience across all buildings in a portfolio.  Although buildings needed to use Proxy’s card readers, those devices are relatively inexpensive and can be swapped out in minutes.

The pitch worked, and many of the largest real estate owners and occupiers in the US started deploying Proxy throughout their portfolio.  They were successful in selling to buildings as well as enterprise tenants  But as we all know, startups are risky.  On January of this year, Proxy sent an email out to all of their customers announcing that they were going to be divesting themselves from the access control overlay business. New orders would no longer be fulfilled, and the existing readers would cease to work by the end of 2022.

So what does this mean?  Very simple:  Proxy is shutting down their Access Control Reader business, and anyone that deployed their technology needs to find another solution.  If this was a one-time event, then it wouldn’t be much of a story.  But, things like this happen all of the time with companies.  Whether new funding doesn’t come in, or there are supply chain issues, or product flaws, or unforeseen competitive dynamics, there are a host of reasons (both within and outside of a company’s control) that can turn a business on its head overnight. When a startup doesn’t have a large existing customer base, or they lack a diversified product offering, a single issue can put them out of business.

Early Adopters

I am a huge proponent of startups, but I know that only a small percentage of them will succeed.  I believe that entrepreneurs keep established companies on their toes, and I honor their courageousness.  My concern is not for the VCs that have a staff of Ivy League educated analysts that do proper due diligence to understand risk, it's for the end-users that trust a flashy pitch without the full context of the health of the underlying company.  That just ends up hurting everybody.

And this brings me back to Kastle.  One of the frustrations that I have is oftentimes a company with a rich 50 year history is perceived as old school, when in fact the solutions that they roll out provide an experience that always works.  The size and scale of an established company often allows them to be less dependent on rushing products to market before they are ready, or betting their future on unproven technology.  I love an underdog story, and I love to see new startups put pressure on established players.  But as PropTech becomes more complicated, and customers are demanding that all solutions be fully integrated with every other solution in the building, one weak link can take everything down.

There is a huge difference between Leading Edge and Bleeding Edge.  There is nothing wrong with trying out a new technology, but there are caveats that cannot be ignored.  If you are looking to deploy a solution that is integrated with other systems (meaning its failure will cause other systems to fail), or when it involves life/safety or it requires a significant amount of capital, I prefer to err on the side of caution.  

Mitigating Risk Through Proper Due Diligence

As I write this article, I realize the conflicting message that it sends.  In one breath I am saying that startups are necessary, and in the other breath I am advising to be weary of startups.  And that is the paradox that we face.  Very established companies typically are not nimble and often take a conservative approach to new technology.  It is not uncommon for them to become complacent and rely on their existing customer base to provide what they believe will be a never-ending flow of revenue.  However, they offer stability.   Startups on the other hand tend to roll out insanely innovative solutions, but they bank their entire future on technology that has been unproven in the market.  As with all gambles, appetite for risk needs to be considered.  My recommendation to customers is to understand how a failure of the solution that you are evaluating will affect the operation of your asset.  If there is only upside, then taking a risk may be justified.  If the failure of the solution would take down other systems, or significantly hurt the tenant/resident experience, then it may be better to stick with the established companies that have a track record of success and a strong financial footing.

The industry needs a combination of established players and new startups to ensure that the bar continues to get raised.  Before you make a final decision on which technology to purchase, I recommend the following due diligence:  

• Demand that you see the solution in action at an existing customer’s space.  Too often, decisions are made after seeing a product demo on a test site, but these types of demos are in a controlled environment which allows vendors to bypass unpredictable variables that occur in the real-world.  You need to verify that the solution actually works at a property that is similar to yours.

• Always conduct customer reference checks on your own.  Don’t solely rely on the references that are posted on a company’s website, or in their marketing collateral, or on the shortlist of customer contacts that are provided to you.  Obviously, these are curated with the company’s goals in mind, and will not necessarily provide you with a true representation of their customer base's actual experience.

• Ask for a detailed overview of the vendor’s development roadmap along with a list of enhancements that have been made over the past year or so.  Technology will continue to evolve at a rapid pace and the only way to ensure that your decisions today will address your needs in the future, is to confirm that the company is continuously innovating and staying ahead of the curve.  

• Make sure that you receive written commitments that all future software enhancements will be backwards compatible with the solution you are buying, so that you have assurance that your hardware doesn’t need to be replaced every time a new feature is rolled out.

The purpose of technology in the real estate space is to increase efficiencies, improve NOI, and deliver tenant/resident delight.  The wrong decision can easily create the opposite effect by producing operational nightmares, increasing your costs, and frustrating your tenants, residents, visitors, and building staff.  It is never possible to remove all risks, but the only way to mitigate risk is through proper due diligence.