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 Scott Birnbaum, Founder at Red Sea Ventures, who stopped by to talk about societal organizing principles from the days of feudalism to our modern age of techno capitalism, the importance of community in building a consumer brand, and Plato’s “Allegory of the Cave” and how we’re all just now realizing that all we’ve ever known was a lie.
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Scott Birnbaum, Red Sea Ventures
Bart Clareman, AlleyWatch: Tell us about your journey into the Venture business and how you came to found Red Sea Ventures?
Scott Birnbaum, Red Sea Ventures: I started a software company my senior year of college, which was 1999. We were building really early cloud solutions for information sharing and collaboration across networks – sort of like a SharePoint extranet before Sharepoint existed. We were building that for Intel and law enforcement agencies.
The former deputy director of the NSA was on our board. The founding CTO of OpenWave, which was the company that built the mobile browser for the original mobile phones, was our CTO. We had a pretty amazing team and we were selling some really interesting software.
I ran that business with my cofounder for almost 7 years. After we sold the business I made good on a promise I’d made more to myself than to my grandmother to go to law school.
I graduated and thought I would go start another company, but there was a certain pull to seeing what the law firm experience would be like, so I went and did M&A and project finance for 2.5 years. I learned lessons about myself and about working that were very different from those learned when I was running my own company.
One was my endurance and honed my attention to detail, which is valuable when you’re an entrepreneur, though when you’re an entrepreneur it’s more about hustle than real detail. The third big thing was I learned about really large, complex transactions, which ended up being super valuable to being a VC and dealing with the corp dev practices of large acquirers.
Ultimately I left the law firm to work on strategy at CBS. While I was there, I met with a lot of entrepreneurs looking to partner with CBS Local. I was doing most of the adtech deals, most of the content syndication deals; I was product managing a few new mobile products that we launched while I was there. It was a really interesting “utility player” experience.
I found myself offering advice to many of those companies on whether they were right for CBS or not. I was also angel investing and participated in a few exciting deals. That experience confirmed my passion for working with and enabling founders in the pursuit of their mission.
So after a year and a half at CBS I decided to launch my own venture firm focused on New York and Seed stage investing. It didn’t even occur to me that I should maybe try to join another fund given that at the time there were few funds in NY focused on that strategy.
What inspired you to start your own company as a senior in college?
That was the fourth entrepreneurial project I had undertaken. I come from a family of entrepreneurs, my dad was a serial entrepreneur in the fashion space. The dinner table conversations growing up were very often about business building, and I remember overhearing conversations with friends of his who were also founders who were working through concepts and ideas. I caught the bug from that; I loved thinking about opportunities and things that didn’t exist but could exist.
While was in college, I was geeking out on tech, reading everything I could get my hands on about all the companies being launched in the late 90s. The ethos of technology, the types of people it attracts, the conversations taking place in the industry about the future, the promise of what the internet could deliver in this new industrial revolution – it felt massive to me, and it felt like such an exciting thing to be a part of.
My cofounder and I spent a lot of time thinking of the internet as the enabling technology for the creation of a distributed infrastructure that could be applied to almost anything. We settled on its application to information sharing for government and healthcare. As it turned out, it was way too early for the healthcare market, but government was spending a lot of time thinking about those concepts and how they could be applied to organizations that needed information but never wanted to give up control of their information.
You mentioned at CBS you had done some angel investing – what compelled you to “turn pro” so to speak and start a VC firm?
As I mentioned earlier, there weren’t many funds focused on seed investing in NY and the realities of starting a company had changed dramatically from the decade prior when I launched my company. What cost us $5 million back then to set up cost approximately 5 times less in 2013 and that meant that the barrier to creation had dropped dramatically and that great new entrepreneurs would be able to pursue their dreams. It also meant that many of those entrepreneurs would be 1st timers. As a founder who started at 21 years old I appreciated the value of capital, guidance and support that venture funds often reserved for later stage companies. I thought that I could be a part of the enablement and acceleration of founders and their companies and could build a human platform that could contribute to their success. Also, there was nothing else that I actually wanted to do, that I felt passionate enough about.
The entrepreneurial obsession that I had growing up made me constantly think of new business opportunities but as an entrepreneur you pick one product and dedicate your life to it for a decade or more. As I got older I realized I preferred to be a small part of delivering a lot of those products to the world rather than being a big part of delivering only one of those things to the world.
Bring us to the present and your work at Red Sea – what is your investment thesis?
The thesis is informed by a specific worldview. For the last thousand years there’s been a fairly consistent social contract that’s governed societal organization.
That’s been, for the most part, a hub and spoke model beginning with the feudal system with the lord providing land for the villagers to farm and produce and then give that back to the lord. Then you had the city-state and then the nation-state and then a similar neo-feudalism with corporations controlling such large portions of the economy, building massive ecosystems around themselves.
I think that system is breaking down – mostly because of technology. When you think about those evolutions, they’ve all been generally motivated by a change in technology. From manorialism /early agrarian capitalism, there was a point at which technology maxed out on productivity limiting growth. That led to consolidation, feudal lords invading other lands, trying to accumulate more lands because they needed to continue to increase capacity.
Then, going into the city-state and nation-state, that led into mercantilism, which was not as much about producing as it was about trade. That led to real capitalism and the city-state, ushering in the industrial revolution, thanks to innovations in transportation technology, like the steam engine and manufacturing.
Now, the internet has flattened everything. It’s given the edges of the network access to production capacity, to information, to the fundamental resources that were previously only the province of large organizations. Because of this flattening the capacity to produce and push of power out to the network edges, there is a major shift happening in how our society is organized and is going to be organized.
We see traces of that societal reorganization already, don’t we?
Absolutely. I think that early manifestations of that are the gig economy, the Uber-ization of the world, the shift to the freelance economy.
I was remiss not to say – all of this has also been precipitated to some degree by the Great Recession of ’08. Large companies were previously organized under a social contract promising to deliver employment and income security, training, identity, pensions, and also an implicit promise to continue to hire and absorb new incoming groups of workers. But that isn’t happening anymore and Automation and AI will only accelerate that disintegration.
I think we’re at the beginning of this revolution, and it means we’re shifting from this last phase of industrial capitalism to techno capitalism or information capitalism. In this new phase information is the resource and the internet can push that information to the edges of the network, which allows everyone to compete and act and build in their own siloes rather than having to be a part of these larger fiefdoms.
You invest in a number of different verticals – some that are very obviously related (e.g., consumer internet and consumer brands) and others that are less so, (e.g., consumer brands and SaaS). Connect the dots for us – how do all these pieces fit together?
If you take that worldview, the investment thesis is predicated on what this new world order is going to look like.
That means the empowerment of individuals as (1) consumers and (2) workers. The SaaS plays that we make are businesses that are empowering small business and the individual worker to build their own businesses with a sophistication only previously reserved for large corporations.
Prior to this era, as a lawyer or accountant or researcher or fashion designer you needed to be part of a large organization because of the resources they accumulated that allowed you to do what you wanted to do.
Now, the internet and SaaS tools built on top of it allow you to push those resources out to the edge and allow you as an individual to operate with a level of efficiency that was previously reserved only for large corporations. Individuals, now you have the capacity to operate at that level of efficiency, and have control over their lives and destiny, which is a really, really powerful thing to be doing.
I was a lawyer so I can speak to that specific experience. The average law student graduates with $100K in debt. That means that you are forced to prioritize your options (if you are lucky enough to have any) by going to a big law firm that will pay you a big salary.
In exchange for that you’re working those 48 hour shifts I was talking about, have no control over your life, and if you’re about to go on vacation or attend your kid’s game you might get a call from a senior partner that says “sorry, we’re moving to a close so come into the office asap.”
Very few people want to work on those types of deals in the first place, but many want those jobs because of the debt burden they face. Today though, the fact is the law firms aren’t hiring as many lawyers as they used. If you can empower those law school grads to operate as a solo practitioner, where they can work their own hours, decide how many clients and which clients they want to take on, have the resources they had at a big firm – research tools, billing tools, accounting tools, admin support, all the things you need that are not the core competencies of an attorney but are really essential to an attorney delivering on their expertise area – that becomes really powerful.
So it’s a generational shift then?
I think millennials in particular are not optimizing for the business cards, fancy cars, offices and the great line on the resume. They’re optimizing for a life experience that aligns with their values and allows them to live the kind of life that they want to live.
I think of it as Plato’s “The Allegory of the Cave.” It tells the story of people who are born in a cave, chained against a wall, and they see a game of shadows projected against the wall, and they think those shadows are people, their only reality. And then one day they’re unshackled and as they go out of the cave towards the light they realize everything they thought was reality was a lie. We’re in that moment in history. Where this emerging generation of workers are realizing that the game of shadows they saw their parents play into is not really the life they want to live and that there is something else out there. And that light at the end of the tunnel and that unshackling is the internet, which gave them access to information and a view into how other people are living their lives.
What do you look for in an entrepreneur?
One is, really high intellectual capacity. Capacity and desire for constant learning, a high degree of self-awareness, and humility.
I look for vision, specifically product vision, I want to know that this is a team that has a thing they need to get out to the world and has a very strong perspective on what it is that they’re building – and that perspective aligns with who they are as people.
I look for founder-market fit. I tend to shy away from founders that are building a business just because of an economic opportunity. The building of a startup is just too difficult if you’re motivated purely by money, it has to be something that’s driven by a burning need to create a specific thing. And I look for people who are really mission-driven, and are driven by a desire to have some positive impact on society.
We try to get a sense of the founder’s personal background and capacity to overcome adversity.
What mistakes do you see entrepreneurs make when they pitch you?
The biggest mistake I see is when they are in pitch mode, and not in conversation mode. The most exciting conversations I’ve always had with entrepreneurs were really a debate around the decisions they were making, how they saw the world evolving and how they saw their product and their business fitting into that.
When I’m investing, I invest in the team and the people. I like to get a clear sense of who they are and how motivated and passionate they are for the business that they’re building, which is very difficult to do when they’re running on script.
And I recognize that it’s very difficult to go off script as an entrepreneur when you’ve been pitching hundreds of times. You just do it so many times that it becomes this sort of rote process. It’s not a knock on entrepreneurs; it’s a result of the process of fundraising. In turn, I view it as my job to find ways in the conversation to pull them out of that mode.
Turning the tables around – what would your CEOs say about you and the benefit of having Red Sea Ventures as an investor and possibly on its board?
The first thing they’d say is that as a firm we punch way above our weight and work very hard for our companies. We spend a lot of time and effort in a few concentrated areas of support like business development, strategy, PR, and assisting them with follow-on financings. I said earlier this venture game is about hustle and we like to match the hustle of our founders.
I think they’d say that I’m one of the most supportive investors that they have. And supportive doesn’t mean I just tell them what they want to hear or pat them on the back – although I do a lot of that because I think it’s important. It’s so difficult to build a business so it’s important to remind them when they’re doing a great job and that the intensity of their effort is appreciated. You can see and feel it when someone’s going through a tough time and they just need to draw the energy from someone else to keep powering.
It helps that I’ve invested in 38 companies and over the course of my career having either started or being involved in probably 70 or 80 companies, I have the benefit of having seen things play out in a variety of ways but still being young enough to relate to this new generation of founders.
Sometimes I get to the point where I feel very strongly that the founder is not doing something the right way, they’re not thinking about the problem the right way because they haven’t pattern matched it. But I always temper that with the realization that the founder has more data points about their specific business than I will ever have. They’re on the ground talking to their employees, listening to customers, they’re seeing how product is developing, and they will never be able to relay all those points to me in the conversations that I have with them. So my position is always to give them insights into the data points and the history of the patterns I’ve seen across different examples, but at the end of the day recognize the decision is one that can only be made by them.
I think that sets up a different dynamic than a lot of investors have with their founders.
As someone who started a consumer brand I’m forever curious about consumer investors – what do you look for in a consumer play, and how do you gain comfort about investing in what is ultimately a hit-driven industry?
Just want to reiterate that while we’ve invested in many consumer brands, we are not a consumer only fund. Some of most exciting companies in our portfolio are these SaaS companies building for the worker economy I mentioned earlier like WayUp and Casetext.
Having said that, in our consumer companies, we look for a few things. One is, values alignment: the values of the company should align with the worldview and the values that I’m talking about. Two: I like to see that there is an early community being built around the product or company.
Consumers are increasingly voting with their wallets, they’re deciding to buy products that are an expression of their own identity saying, “this brand represents the value set I’ve selected for my life.” Because of that emotional, values-based attachment to the brand, to the founders and what they represent, customers are more likely to overlook certain missteps in the product, because it’s about more than just the product.
Side question: as an investor in Ample Hills Creamery, do you get a lifetime supply of ice cream?
I don’t! I gladly pay for it. I do get a discount though.
More seriously: help me understand investments in companies like sweetgreen or Ample Hills Creamery. What do you believe – and what do you have to believe – in order to get venture-level returns?
You have to believe that there’s a movement behind the brand. You have to believe there’s incredible capacity for execution from the management team. Because of the capital-intensive nature of building these retail businesses, you have to believe that this is a category that is underserved, either in product or experience or ideally in both. And you have to believe you’re at the beginning of a consumer behavioral shift that’s supportive of that particular incarnation of the business. You also need to believe that there is tech DNA built into the company that allows it to scale in a way that other consumer brands won’t be able to.
With sweetgreen, say, there was a generation of people coming of age that prioritized health and wellness, who, in terms of eating habits, were moving towards lighter meals and more vegetable-based meals, and a real growing concern for locally grown high-quality product that was sustainably farmed. They also wanted to feel connected to a part of the economy that doesn’t exist in our daily lives – for the most part, if you live in the city you don’t know farmers and you may have never been to a farm. But there was this longing for this return to how things were; there’s this renewed nostalgia for when things were simpler. And I think sweetgreen has tapped into that emotion. You also had to believe that they were going to solve the supply chain problem. Finally you had to believe that people would eat salads more often than burritos… I was willing to make that bet.
It’s sometimes said that it can take 5-7 years before an investor in this asset class knows whether they’re any good. You’re coming up on 6 years now – how do you assess your own performance, and how have you changed as an investor in those 6 years?
Great question! While I started writing my first angel checks 6 years ago, I’ve only been investing with real velocity for the past 3 years. Having said that, I think we’re doing a pretty good job. I’ve definitely learned some lessons specifically on how to assess people early on when there are really no data points. There are a lot of tactical things I’ve learned about structures of deals that work or are a ticking time bomb inside of the company – things like cap table issues, investor rights.
While I think my perspective toward entrepreneurs has remained the same, I think I’ve fine-tuned the way that I interact with entrepreneurs especially during harder or more contentious, debated times.
The big difference is that, as an angel or even early on as a fund, it was more about finding great entrepreneurs, great concepts, great markets, and making a bet and being helpful to them as a smaller investor in a round wherever I could. Now we’re making real investment of time and energy and helping the founders grow through and into the Series A. That means taking board seats or board observer seats, and having much more frequent check-ins with the entrepreneurs when things are going well or not. We also invest a lot more effort on business development, strategy, PR and being trying to be responsive to entrepreneurs based on the challenges they’re facing.
It’s still (sort of) the New Year period – what trends are you watching closely in 2017?
There are six sectors we really invest in: Future of Work, Future of Living, Food, New Media, Consumerization of Health, and NextGen e-commerce.
If you think of the rapid changes happening in the world today each of those areas is going to undergo structural revolutions. For instance, WRI says there will be 9 billion people living in cities by 2045 whereas there are only 7 billion people on the planet today. Forrester says 6% of US jobs will be lost to AI and Automation by 2021 and the UN says that 70% of jobs in the developing world are at risk by 2050. So Future of Living and Work is a real thing that we spend a lot of time on.
From a tech layer perspective, we’re looking at the application of early AI rather than AI development.
There are still some exciting direct to consumer ecommerce categories.
I think we’re going to see a renewal of the media business that will be very interesting in this post-election world exploring new monetization and production models.
You’re on the Board of Seeds of Peace, which was built on top of the former Camp Powhatan in Maine. I’m a Camp Powhatan alum with a grudging respect for Seeds of Peace (because how could you not). Why is Seeds of Peace important to you and how did you come to be involved?
Seeds of Peace is unlike anything else you will ever experience, truly. It’s important to me because I think the world is torn apart by entrenched opinions that are increasingly diverging. And when two people, whether Israeli or Palestinian, Republican or Democrat, or whatever they are, continuously hear the same feedback loop of their own self-reinforcing opinions, I think that creates a very dangerous world.
Seeds of Peace has perfected the art of creating dialogue and using dialogue as a means to develop leaders. There aren’t many ways you can get involved in conflict transformation that give so much hope but when you sit with these kids and graduates you see what the world could be. One of the mantras as Seeds of Peace is “we refuse to know what is when we know what can be” and the experience at Seeds of Peace is the beginning of knowing what “can be”. It allows me to be involved in attacking to be what I consider to be one of the major existential threats to our civilization – broadly, the risk of people not speaking to each other.
