The Generalist vs. Specialist investor takes on Constru-Tech in 2024

June 21, 2024

We bring together two distinct perspectives on the burgeoning construction tech market. Our very own Patric Hellermann from Foundamental and Enrico Mellis from generalist investment firm Lakestar discuss different investor logics for Constru-Tech in 2024 and going forward.

Enrico Mellis, VC investor at Lakestar
Enrico Mellis, Lakestar

The construction industry is a behemoth and value driver to the global economy. In every country on earth, construction contributes between 8-15% to the local GDP. Globally, it is valued at $10-12 trillion contribution to the earth’s GDP. And it stands at the precipice of a technological revolution. Despite its size and importance, accounting for roughly 10% of the world's GDP, it has historically only received 0.15% of global venture capital. This dichotomy presents a unique landscape for entrepreneurship and investment.

In this in-depth conversation, we bring together two distinct perspectives on the burgeoning construction tech market. Our very own Patric Hellermann from Foundamental and Enrico Mellis from generalist investment firm Lakestar - who invested category-creators such as Spotify, OpenDoor and Revolut - discuss different investor logics for Constru-Tech in 2024 and going forward.

Together, they unpack the complexities, challenges, and immense opportunities that define construction tech in 2024. From analyzing promising startups to discussing investment strategies and future trends, their extensive conversation offers a comprehensive look at the industry breaking out to a generational transformation.

Let's start with the big picture. How would you describe the construction technology market today?

Patric: "The construction technology market is massive, but it's often underestimated. We're looking at a $10-12 trillion industry globally, which accounts for roughly 10% of the world's GDP. But here's the kicker - it's still one of the least under-invested sectors out there, with historically only receiving 0.15% of the global VC. But it's catching up quickly in the eyes of big capital allocators, as in the last two years, construction and AEC caught up exponentially to 0.5% of global VC recently. A 3x proportionality increase in two years. So we're seeing a perfect storm of opportunity: a huge market, low digital penetration, and increasing pressure to improve productivity. The potential for tech to make a significant impact is enormous."

Enrico: "Absolutely. What's fascinating is the dichotomy we're seeing. On one hand, you have this colossal, traditional industry that's been slow to change. On the other, you have a new wave of startups leveraging cutting-edge tech like AI, IoT, and robotics to solve age-old problems. It's creating this interesting tension between the old and the new, and that's where the opportunities lie for investors who can navigate this landscape."

With such a large market, why hasn't every investor piled into this space in the past?

Patric: "It's a great question, and the answer lies in the nuances and quirks of the industry. Some have. For example, there are a number of specialists in the US, but Foundamental is not just the category-leader, but also the only one being truly global. It’s because construction isn't just one market - it's a conglomeration of numerous sub-sectors, each with its own nuances. You've got residential, commercial, industrial, and infrastructure construction, and within each of these, you have design, planning, execution, and maintenance phases. Each segment has its own stakeholders, regulations, and pain points. It's not something you can understand with a surface-level analysis."

Enrico: "I'd add that the long project cycles in construction make it challenging for generalist investors. In software or consumer tech, you can often see results and iterate quickly. In construction, projects can take years, and the sales cycles for new technologies can be painfully long. It requires patience and a different set of metrics to evaluate success. That's why many generalist investors shy away - it doesn't fit neatly into the typical venture capital playbook."

What makes construction tech such a nuanced but potentially lucrative investment area?

Patric: "The complexity is a double-edged sword. On one side, it creates high barriers to entry. You can't just waltz in with a shiny new app and expect to disrupt the industry overnight. You need deep domain expertise and often years of relationship-building. But on the flip side, if you can crack the code and create a solution that truly adds value, you have the potential for massive, defensible businesses."

Enrico: "Exactly. And let's talk about the lucrative part. The sheer inefficiency in the construction industry means that even small improvements can translate to millions in savings. Take labor productivity, for instance. It's barely improved in decades, while manufacturing has seen massive gains. If a construction tech company can move the needle on productivity even a little bit, we're talking about potentially billions in value creation. That's the kind of outsized return potential that gets investors excited."

Let's talk about some specific companies. Recently, Permit Flow and Ediphi announced big rounds. Can you tell us about Permit Flow and what makes it interesting?

Patric: "Permit Flow is attacking a problem that might seem mundane but is actually a massive pain point - the permitting process. In the U.S., the complexity of getting permits can significantly delay projects and tie up capital. What Permit Flow has done is create a software solution that automates much of this process. But it's not just about digitizing paperwork. They've built a system that understands the nuances of different municipal requirements and can adapt accordingly. It's a great example of how deep industry knowledge combined with smart technology can create real value."

Enrico: "What's impressive about Permit Flow is how they've managed to quantify their impact. They're not just saying 'we make permitting easier' - they're saying 'we cut permitting time by 50%'. That's a clear, measurable benefit that translates directly to cost savings for their customers. It's this kind of tangible impact that we look for as investors."

What factors contributed to Permit Flow's rapid success?

Patric: "Several factors came together here. First, they have a stellar product team that really understood the problem they were solving. They didn't just build a digital form filler - they created a system that understands and adapts to the quirks of different municipalities. Second, they focused on serving contractors directly, rather than trying to sell to municipalities. This allowed them to move faster and iterate based on real user feedback. Lastly, they benefited from good timing. The pandemic accelerated the need for digital solutions in government processes, which played right into their hands."

Enrico: "I'd add that their go-to-market strategy was spot-on. They identified a clear, quantifiable problem and offered a solution with an easily understandable ROI. Reducing permitting time by 50% is a value proposition that's easy for customers to grasp and justify. In an industry where new tech adoption can be slow, having a clear, compelling value proposition is crucial."

How does Permit Flow's approach differ from its competitors?

Patric: "The key differentiator for Permit Flow is their focus on building a superior software product rather than relying on relationships or service-heavy approaches. Some competitors have tried to tackle this problem by hiring ex-real estate agents or brokers who know the local systems and can navigate them manually. Permit Flow, on the other hand, has invested in understanding and codifying these systems into their software. This makes their solution more scalable and consistent."

Enrico: "It's a classic example of software eating the world. By focusing on a software-first approach, they're able to scale more efficiently than service-heavy competitors. And in a fragmented market like construction, the ability to scale efficiently is a huge advantage."

What challenges exist in scaling a permitting product that deals with municipality-specific requirements?

Patric: "This is where the real complexity lies. Every municipality has its own set of rules, processes, and quirks. At first glance, this might seem like an insurmountable challenge for a software solution. But Permit Flow has been clever in how they've approached this. They've identified common patterns across municipalities - for instance, most publish their requirements on their websites, often in PDF forms. By building systems to automatically extract and parse this information, they've found a way to scale what could otherwise be a very localized, manual process."

Enrico: "It's a great example of using technology to turn a seemingly unscalable problem into a scalable one. And it creates a nice moat for their business - the more municipalities they add to their system, the more valuable their product becomes, and the harder it is for competitors to catch up."

How has AI potentially boosted Permit Flow's scalability?

Patric: "AI is likely playing a crucial role in Permit Flow's ability to handle the complexity and variability of municipal requirements. Machine learning algorithms can be trained to recognize patterns in permit applications across different municipalities, automatically categorizing requirements and flagging potential issues. Natural language processing can help in interpreting the often complex and jargon-heavy language of building codes and zoning regulations. This allows Permit Flow to add new municipalities to their system much more quickly and efficiently than would be possible with a purely manual approach."

Enrico: "And it's not just about the initial setup. AI can also help the system improve over time. As more permits are processed, the AI can learn from successful applications, continually refining its understanding of what works and what doesn't in each municipality. This creates a virtuous cycle where the product gets better the more it's used, which is a hallmark of successful AI-driven solutions."

Let's move on to another interesting company with a recently interesting round, Ediphi. What makes this startup exciting?

Patric: "Ediphi is tackling one of the most critical and challenging aspects of construction - cost estimation and management. What's exciting about their approach is that they're bringing a collaborative, real-time element to a process that has traditionally been siloed and often based on outdated information. They've created a browser-based platform that allows multiple experts to contribute to cost estimates simultaneously, leveraging collective intelligence to improve accuracy."

Enrico: "What caught my attention about Ediphi is the founder's background. Dustin DeVan previously founded BuildingConnected, which he sold to Autodesk for $275 million. This isn't just about having a successful exit - it's about the deep industry knowledge and network that comes with building a major player in the construction tech space. He's seen firsthand the pain points in the industry and has a proven track record of building solutions that address them."

Why is accurate cost estimation so crucial for contractors?

Patric: "This is really at the heart of profitability in construction. Most projects require contractors to submit fixed-price bids, but the actual purchasing of materials and hiring of subcontractors often happens months or even years later. This creates a huge risk - if your estimate is too high, you won't win the bid. If it's too low, you could end up losing money on the project. And we're talking about projects that can run into millions or even billions of dollars. A small percentage error can mean the difference between a profitable job and a major loss."

Enrico: "And it's not just about individual project profitability. Consistent accuracy in cost estimation is crucial for a contractor's long-term success. If you're consistently underbidding, you'll win a lot of projects but lose money. If you're overbidding, you'll struggle to win work. Finding that sweet spot is incredibly challenging, especially given the complexity and variability of construction projects."

What challenges exist in estimating material costs for construction projects?

Patric: "Material cost estimation is particularly tricky because of its volatility. Many construction materials have high energy costs in their production, which means prices can fluctuate dramatically based on energy markets. We've seen this play out in recent years with supply chain disruptions and energy price spikes. Even data from a month ago might not be accurate for a bid you're submitting today. And remember, contractors are often trying to estimate costs for materials they won't purchase for months or even years."

Enrico: "This volatility creates a real conundrum for contractors. If they add too much buffer to account for potential price increases, they risk losing bids. If they don't add enough, they risk losing money if prices spike. And this isn't just about the big-ticket items. Even small components can have a big impact if their prices change significantly. It's a constant balancing act."

How does Ediphi aim to improve cost estimation and management?

Patric: "Ediphi's approach is all about leveraging collective intelligence and real-time data. They've created a platform that allows various experts - from quantity surveyors to subcontractors to material suppliers - to collaborate on cost estimates in real-time. This means you're not just relying on one person's expertise or outdated pricing books. You're getting a more comprehensive, up-to-date view of potential costs."

Enrico: "What's interesting about this approach is that it's not just about getting a more accurate initial estimate. It's about creating a living, breathing cost model that can be updated as conditions change. If material prices spike or labor costs increase, that information can be quickly incorporated into the model. This kind of dynamic cost management could be a game-changer in an industry where cost overruns are all too common."

Let's shift gears a bit and talk about investment strategies. What advantages do specialist investors have when evaluating early-stage construction tech startups?

Patric: "As specialists in construction tech, we have a few key advantages in the early stages before category-leaders become totally obvious by their numbers. First, we have a deep understanding of the industry's pain points and dynamics. We can quickly assess whether a solution is truly addressing a significant need and whether it's feasible within the industry's constraints. Second, we have extensive networks within the industry. This allows us to do deeper due diligence, getting feedback from potential customers and industry experts. Lastly, we understand the unique challenges of scaling in this industry - things like long sales cycles, the importance of pilot projects, and the need for domain expertise in the team."

Enrico: "I'd agree that specialist knowledge is crucial, especially in the early stages. As a generalist, it's much harder to evaluate the potential of a construction tech startup before it has significant traction. We might struggle to differentiate between a nice-to-have solution and one that's truly solving a critical problem. Specialists can often spot promising companies earlier because they can see the potential impact even before it's reflected in revenue or user numbers."

How do generalist and specialist investors' approaches differ when evaluating construction tech companies?

Patric: "As specialists, we tend to get involved earlier and can take more concentrated bets in the sector. We're comfortable leading seed or early Series A rounds in construction tech because we can rely on our industry knowledge to evaluate potential. We also tend to be more hands-on, leveraging our industry networks to help portfolio companies with everything from customer introductions to hiring."

Enrico: "As generalists, we often come in a bit later, once there's more proof of concept and traction. We're looking for companies that have already demonstrated product-market fit and are ready to scale. Our advantage is that we can bring a broader perspective, potentially identifying parallels or lessons from other industries that might be applicable. We also typically have larger funds, which means we can support companies through multiple rounds of funding as they grow."

How do investors conduct due diligence on serial founders in the construction tech space?

Patric: "Due diligence on serial founders in construction tech is a nuanced process. Yes, we look at their track record - previous exits, growth metrics, etc. But we're also keenly interested in how well they understand the industry's complexities. Have they learned from their previous ventures? Do they have a realistic view of the challenges ahead? We leverage our industry networks heavily here, talking to former colleagues, customers, and competitors to get a 360-degree view."

Enrico: "For us as generalists, we might put more weight on the quantitative success of previous ventures. But we're also trying to understand how transferable their previous experience is to their new venture. Construction tech is evolving rapidly, so a founder's past success doesn't guarantee future success if they're not staying ahead of industry trends. We also look closely at their ability to attract top talent and raise capital, as these are often good indicators of a founder's reputation and potential."

Speaking of founder evaluation, how does a founder's previous successful exit in construction or adjacent industries impact their credibility?

Patric: "A successful exit definitely boosts credibility, but it's not a blank check. What we're really looking for is evidence that the founder has gained deep insights from their previous venture. Do they understand why they succeeded? Can they articulate the lessons learned? More importantly, are they applying these lessons appropriately to their new venture, or are they just trying to replicate their previous success in a potentially different market context?"

Enrico: "I agree, and I'd add that we're also looking at how the founder is approaching this new venture. Are they still hungry? Are they willing to do the hard work of customer discovery and product iteration? Sometimes, a big exit can lead to overconfidence or a desire to skip steps. We want to see that they're still approaching this new venture with the same rigor and attention to detail that led to their previous success."

Are there any potential downsides when evaluating founders who have had large exits in construction-related fields previously?

Patric: "Absolutely. One potential downside is that founders might be less willing to do the hard, unglamorous work of validating every assumption before launching. They might feel they can rely on their intuition or past experience, which can be dangerous in a rapidly evolving industry. Another risk is that they might be too wedded to approaches that worked in the past, rather than being open to new methodologies or technologies."

Enrico: "Those are great points. I'd add that there's also a risk of what I call 'big company syndrome'. If a founder's previous exit involved being acquired by a large company, they might have gotten used to having significant resources at their disposal. This can sometimes lead to inefficient spending or unrealistic expectations about how quickly they can scale their new venture. We want to see that they can still operate with the leanness and agility of a startup."

What unique challenges do construction tech founders face when dealing with structured rounds and liquidation preferences?

Patric: "This is a critical issue in construction tech. The industry often requires more capital and longer timelines to reach significant scale compared to other tech sectors. This can lead to multiple rounds of funding with increasingly complex structures. The risk for founders is that they can end up with significantly diluted ownership and, in some cases, liquidation preferences that make it hard for them to see meaningful returns unless the exit is very large."

Enrico: "Exactly. And this creates a challenging balancing act for founders. They need to raise enough capital to reach significant milestones in this capital-intensive industry, but they also need to be careful not to give away too much of their company too early. We often advise founders to think carefully about capital efficiency and to explore alternative funding sources like venture debt or revenue-based financing where appropriate."

How do construction tech market opportunities differ between the US and Europe?

Patric: "There are some fascinating differences. In the US, we see a more fragmented market with a higher volume of smaller contractors and more complex regulatory environments. This creates opportunities for solutions like Permit Flow. In Europe, we tend to see fewer, larger contractors and somewhat simpler regulatory processes. For example, we see about 5-10% fewer permits required in Europe compared to the US. This means that solutions need to be adapted - a permitting solution might need to focus more on streamlining internal processes for large contractors rather than navigating municipal bureaucracies."

Enrico: "Another key difference is in the adoption of technology. In my experience, European construction firms have been somewhat faster to adopt certain technologies, particularly in areas like sustainability and energy efficiency, driven by stricter regulations. On the other hand, the US market has seen more innovation in areas like project management software and construction robotics. These differences create unique opportunities in each market."

As we wrap up, what final thoughts do you have on the future of construction tech?

Patric: "I'm incredibly bullish on the sector. We're at an inflection point where multiple technologies are converging to address longstanding issues in the construction industry. AI and machine learning are enabling more accurate predictions and optimizations. IoT and sensors are providing real-time data from construction sites. Robotics and automation are starting to address labor shortages and safety issues. And underlying all of this is a growing recognition in the industry that embracing technology is no longer optional - it's essential for survival."

Enrico: "I agree, and I'd add that we're also seeing a generational shift in the industry. Younger professionals entering construction management roles are more tech-savvy and open to new solutions. This is creating a more receptive market for construction tech startups. However, it's important to note that success in this space requires more than just good technology. The most successful companies will be those that deeply understand the industry's workflows and can seamlessly integrate their solutions into existing processes."

Patric: "Absolutely. And let's not forget the potential impact of macro trends. The push for more energy-efficient buildings, the need for affordable housing, and the focus on infrastructure renewal in many countries are all creating new opportunities for innovative construction technologies. We're particularly excited about technologies that can make construction and renovation more energy-efficient."

Enrico: "One area I'm watching closely is the intersection of fintech and construction tech. We're seeing interesting innovations in areas like materials procurement financing, project-based insurance, and even blockchain applications for supply chain transparency. These financial innovations could help unlock new efficiencies in the construction process."

Patric: "That's a fascinating area, Enrico. We're also seeing increased interest in modular and offsite construction technologies. These approaches have the potential to significantly reduce construction times and costs, while also improving quality and energy-efficiency. It's an area ripe for technology adoption."

Enrico: "Agreed. And let's not forget about the potential impact of augmented and virtual reality in construction. These technologies are already being used for everything from project visualization to safety training, and I think we're only scratching the surface of their potential applications."

Patric: "Absolutely. The key for investors is to identify the technologies and business models that can truly scale in this complex industry. It's not enough to have a cool technology - you need a solution that addresses a real pain point and can be adopted within the existing constraints of the construction industry."

Enrico: "Couldn't agree more. And that's where the opportunity lies for investors who can navigate this space. The companies that can thread that needle - delivering real value while overcoming the adoption challenges inherent in the industry - are going to be the big winners. It's a complex sector, but the potential rewards are enormous."

tl;dr

  1. The construction industry is a $10-12 trillion market globally, representing about 10% of world GDP, but remains one of the underfunded VC categories with historically only 0.15% of global VC which since 2022 accelerated to 0.5% of global VC, catching up its share of capital allocation.
  2. Construction tech is complex due to the industry's fragmentation, long project cycles, and varied regulations, creating both challenges and opportunities for investors.
  3. Permit Flow exemplifies successful construction tech by streamlining the permitting process, potentially reducing permit acquisition time by 50%.
  4. Ediphi is tackling the crucial issue of cost estimation in construction, using a collaborative, real-time approach to improve accuracy.
  5. Specialist investors in construction tech have advantages in early-stage investments due to deep industry knowledge and networks.
  6. Generalist investors often enter later, bringing broader perspectives and larger funding capacities to help companies scale.
  7. Founders with previous exits in the industry bring credibility but may face challenges like overconfidence or resistance to new approaches.
  8. Construction tech startups often require more capital and longer timelines to scale, leading to complex funding structures that can challenge founder equity.
  9. The US and European and Asian construction tech markets differ in areas like core problems, regulatory complexity, energy-efficiency focus, and technology adoption rates, and thus pioneer different category-creating constru-tech models.
  10. Future trends the investor watch closely in construction tech include AI/ML applications, on-site robotics, and the embedding of fintech solutions.

Keywords: construction technology, vc, venture, venture capital, aec technology, funding, construction markets, 2024, future of construction