Mitzvah-minded unicorn Cross River is on holy mission to foster bank-fintech harmony

“Then I took your ancestor Abraham from the other side of the Euphrates River and led him through the entire land of Canaan. I multiplied his descendants, and gave him his son Isaac.” That’s a passage from Joshua 24:3 in describing how Abraham “crossed over” the demarcation line into a spiritual awakening. It’s also the inspiration for the name of Cross River Bank (CR), led by its charismatic founder Gilles Gade.

The Hudson River may not have the holy resonance of the Euphrates; however, there’s no denying the special character of this Fort Lee, New Jersey-based bank that supports fintech companies including Affirm, Circle, Best Egg, Coinbase, Rocket Loans, Stripe, Upstart and Transferwise.

From its modest beginnings as a one-branch bank in nearby Teaneck, to its leading position within the marketplace lending industry, to its current aspiration to be a standard-bearer of bank-fintech cooperation, CR has been a model of adaptability. A constant, says Gade, is a belief that it’s possible to simultaneously protect customers and deliver more and better services to them. In CR’s latest iteration, those services involve a variety of technology-infused offerings which have defied skeptics, regulatory uncertainty created by court decisions such as Madden vs. Midland Funding and increased competition. To preserve its momentum, the bank recently closed on an eye-popping $100-million growth equity round led by a KKR division and purchased a sizable office building near the George Washington Bridge. That latter move may be unconventional for a fintech high-flier, but as anyone familiar with CR knows, the bank plays by the rules — but it doesn’t play by conventional wisdom. And so far, that’s working out divinely.

GS: Gilles, it’s good to see you. Let’s start with a quick overview on CR, which may not be familiar to everyone.

GG: Thanks, Gregg. We are deeply rooted as a community bank from our founding 11 years ago and we’re one of the last banks chartered by the FDIC before it shut down the program due to the banking debacle. As you know, now the program has reopened.

GS: CR’s foray into fintech is, of course, your claim to fame. That journey started with GreenSky. How did that come about?

GG: GreenSky was on the verge of signing a sizable contract with Home Depot. But it needed a home for the prime and super prime loans that it was going to generate across 1,600 stores. We signed an agreement with GreenSky so that it could use us as the balance sheet.

GS: Fast forward to today, and you’ve grown from that initial use-case into a key banking partner for a who’s-Who of fintech. But you still have a branch that does actual, honest-to-goodness banking, right?

GG: Absolutely. We would not be able to do all the things that we do on behalf of our clients without eating our home cooking.

GS: I know you’ve expanded your offerings quite a bit, but is the marketplace lending business still your biggest segment?

GG: Yes, but it’s rapidly changing because lines are getting blurred. For example, if a payments company wants to become a lender or a lending company wants to do payments, then they have the ability to do that on our rails.

GS: Yes, I get that fintech lines are blurring. Here’s the thing, though. You’re an FDIC-regulated New Jersey bank.

GG: Yes.

GS: Is it fair to say, then, that you’re wearing the reputation of your clients?

GG: Absolutely.

GS: So if Affirm’s Max Levchin were to break character and do something harebrained, the regulators would come knocking on your door—

GG: —And come after us, yes.

GS: As CR moves towards a broader model that embraces payments, you’re entering a vastly complicated world, with all sorts of different actors. I would imagine you’re turning down as many prospective clients as you are taking in new ones, right?

GG: Much more, actually. About two years ago, we saw a slew of new entrants into our marketplace, and we signed north of 250 non-disclosure agreements. But we only signed up 19 platforms, or less than ten percent.

GS: I’ve dug into your financials, Gilles, which shows the benefit of your selective strategy. Given your success thus far, and the zaniness in the crypto world, why get involved in crypto? Do you need it?

GG: That’s a great question. I would say we’re not going say no if we think we can do something right. When we do anything, we start with a white paper, a full-blown risk assessment of the enterprise and how the regulatory environment is evolving. If the policy and procedures pass muster with the third-party folks that we hire to provide an opinion on them, then and only then would we consider launching a program.

Nyca Partners’ Hans Morris hunts for great fintech investments amid volatility

Hans Morris is a name to know in fintech, and as finance and tech sectors prepare for tougher time next year, he has some incisive thoughts to share about the kinds of companies that will succeed (or not) in a financial downturn. The managing partner of investment firm Nyca Partners, Morris also serves as the chairman of the board of Lending Club and is a director of other start-ups including AvidXchange, Boomtown, Payoneer and SigFig. At Nyca, which is on its third fund, Morris spends much of his time meeting with entrepreneurs focused on payments, credit models, digital advice and financial infrastructure.

But unlike many successful fintech VCs, Morris doesn’t have to read about how Wall Street’s history influenced the trajectory of those sectors. He played an active role in shaping them. His experiences heading Smith Barney’s FIG effort (at 29 years old), overseeing Citigroup’s institutional businesses, serving as president of Visa and advising companies at General Atlantic have also provided him with an unparalleled financial services rolodex. And for those who believe that financial history rhymes, Morris’ opinions are now especially welcome. Fintech may be entering a new, post-financial crisis phase in which the low-hanging fruit has been picked and macro headwinds outweigh tailwinds. In the discussion below, Morris talks candidly about how he’s approaching investing next year and how he’s viewing fintech M&A possibilities. He was also eager to share his thoughts on ethics in financial services (a favorite topic), the prospects for challenger banks, why he’s branched out into real estate tech, the future of blockchain and some of his favorite bank CEOs.

Gregg Schoenberg: Hans, it’s always good to see you, but I’m especially glad to be sitting down with you now, given that the financial world is convulsing at the moment. Before we get into that, though, I want to kick off with something else: Do you buy into the idea of techfin vs. fintech?

Hans Morris: I don’t. My basic organizing principle, which you and I have discussed before, is around declining information costs. As these costs decline, it disrupts the traditional profit pools in financial services. It’s always been like that. What I would say is that in recent times, some tech companies have done a very good job at building a trusted relationship with consumers, and in some cases with businesses. That trusted relationship obviously provides a significant competitive advantage of information. But that advantage lessens later on. There are so many examples we could point to of companies that were ‘it.’ Then, suddenly, they say, ‘Oh no, our tech is expensive, creates a bad experience and will cost a lot to fix.’

GS: Let’s talk about the present. As you know, the Fed has been tightening, equities are hemorrhaging, the yield curve is getting spooky and talk of a recession is intensifying. To me, Lending Club, right or wrong, was one of the original poster children of the post-crisis fintech boom. But now, I think we’re in a regime change and that the next crop of successful financial innovators will look a lot different. What’s in store for an area like credit delivery?

HM: In credit delivery, I think it’s now pretty well-realized by investors, and certainly realized by capital markets investors, that credit delivery requires capital. So today, I feel that anyone who’s going to be successful in credit intermediation needs to have a very good understanding of balance sheet risk, liquidity risk, and capital requirements. I pay a lot of attention to capital requirements, and the ability to fund something in the teeth of a crisis.

GS: Let’s say we enter a recession next year and see continued volatility across the capital markets. I understand that each recession and bear market is different, but with the fresh capital you’ve closed on, where are you looking to go on offense?

HM: Among the thousands of fintech companies that have gotten some funding, there are companies that are really struggling to get their Series B or Series C done.

GS: Names that have lost their momentum?

HM: Yes. They’ve lost their momentum, and they’ve lost the perception of momentum among venture investors. But in some cases, these companies still possess some very good fundamentals, yet the valuations are a lot more attractive. If that dynamic becomes even more extreme, I think there could be some good opportunities.

GS: Isn’t it also true that the fintech names that suck up a lot of the venture money aren’t always the best underlying businesses?

So when you talk about high-valuation companies, I think it’s unrealistic for banks to be acquirers.

HM: It’s an interesting dynamic. Generally, as long as companies can continue to raise capital, they will keep going even if that isn’t necessarily a rational thing to do. But in some cases, where you see a bunch of companies pursuing a similar strategy, it would be better to pursue a merger because we don’t need tons of companies doing personal financial management, etc…

GS: Do you see the big banks with strong balance sheets, the JP Morgans of the world, getting the green light from regulators to be more aggressive in M&A?

HM: Regulators have clearly been one reason there hasn’t been more activity. The second thing is goodwill. Keep in mind that for a bank, goodwill is a 100% reduction to tangible Tier One capital. So even for JP Morgan to say, ‘We’ll take a billion dollars of our Tier One capital and invest it in a company with no income and maybe positive EBITDA, but maybe not

GS: That would take a ton of capital or a ton of conviction.

HM: Well, that company would have to be a very powerful growth engine or solution. So when you talk about high-valuation companies, I think it’s unrealistic for banks to be acquirers. Where banks can be acquirers, and this is what we’ve seen, is where you have a company valued at $60 million, maybe a $100 million, etc…

GS: A Clarity Money.

HM: Yes, a company where the acquisition moves a bank much further along in a development cycle. Where the the bank can say, “Instead of us taking two years to get our real product out, we can get out a state-of-the-art product right now, and it comes with a great team and DNA. That’s appealing.

GS: Appealing, but realistic?

HM: It’s hard to pull off. Often, the team leaves, everything dissipates, and the acquirer ends up writing off the whole thing.

GS: Moving forward, who do you think is poised to make M&A work?

HM: There’s a couple of examples where it’s worked. One is PayPal, which in recent times has done an excellent job of acquiring things and integrating talent into the company. I’m quite impressed in terms of how Bill Ready, who is now COO, Dan Shulman and the management team have changed the tech profile of PayPal.

GS: Well, they’re not a 200-year-old financial institution founded on a winding alley in downtown New York.

HM: Yes, but it was very old-school Silicon Valley, and they had a lot of technical debt. Of course, they had this great mafia 20 years ago, but all those people are gone. I don’t think there’s a single person in the top 100 at PayPal that was there 15 years ago.

GS: Let’s talk specific themes. You’ve already mentioned personal financial management, which I share your skepticism about. What’s your take on the prospects for challenger banks?

HM: I think we’re likely to have a war for deposits with too many different types of firms competing for deposits. Just look at the United States last year. All of the deposit growth we saw was explained by Bank of America, Wells Fargo, and JP Morgan Chase. Everyone else shrank. But if you have Monzo and Revolut come to the US and you look at Acorns, MoneyLion, Chime and fifteen other prepaid models or fully chartered bank models, they’re all going to have a pretty slick interface, and they’re all going to be out there competing for deposits.  

GS: How about the robos and free trading platforms?  As you know, a lot of the younger customers on these platforms haven’t experienced a sustained period of tumultuous equity market conditions.  

I pay a lot of attention to capital requirements, and the ability to fund something in the teeth of a crisis.

HM: I think a great majority of American households should be using a roboadvisor. However, the question is around the relationship between the customer acquisition and the revenue opportunity. In fact, a big part of our thesis with SigFig was to really help drive the pivot over to enterprise-based customers. But generally, and without knowing the details, my sense is that Betterment, Wealthfront and maybe Personal Capital have enough brand to get to the scale necessary to be self-sufficient. I think most of the others are not in that position.

GS: Turning to the mortgage and broader real estate sector, is your view that even if we have a deepening downdraft in housing, the real estate start-ups backed by you and others can do well anyway? Because they are essentially taking an industry stuck in the 1980s and ’90s and dragging it into the modern era.

HM: There’s a lot of room for tech improvement in real estate, and that includes residential real estate as well as institutional real estate. The problem with real estate, and mortgage-related models, is that the capital needs are also significant. So if you end up owning property, the bill adds up very quickly.

GS: I guess it depends on where a company buys them.

HM: True. Look, we remain bullish on them, but I share your concern that if activity stops or if you start having real decreases in property values in certain sectors, some of these companies may end up holding the bag.  

GS: When I saw the Ribbon deal, I was wondering how you and other backers looked at the opportunity at this point in the cycle.

HM: Well, for one thing, you can estimate the likelihood of someone getting a mortgage pretty efficiently. You can be right 99 percent of the time, but even if you’re only right 90 percent of the time, you’re going to be fine. That’s because the certainty that the company offers to the customer is worth it. They also have a great management team and a CEO who is really smart. They’re not naive.

GS: So given all the hype and ups and downs we’ve seen in blockchain, I’m wondering if you remain a long-term blockchain guy.

HM: Here’s the simple fact: The whole financial services industry is composed of ledgers. The reconciliation between entities of that information is a significant expense, particularly in the capital markets businesses. But I don’t buy into the view that it’s going to work better in all cases. The evidence so far is that it works well in some cases.

GS: Where can it work well?

HM: Distributed ledgers can work well when having synchronous data is an essential attribute, and when speed is not necessarily a central attribute.

GS: So, even if the implementation takes longer than the the hype machine suggested it would, financial institutions will get there?

Because money attracts crooks.

HM: They will get there. The cost of change is very, very high. The benefit of it is real. The question is, ‘How’s that cost of change compare to the ongoing benefit?’ In enterprise applications, the ones that will succeed are not ones where you say, ‘Lets rebuild everything within the core functions,’ because the cost and complexity are too great. The much better way is to start at the edge of an enterprise delivering immediate value, and then become an architecture for more things to move over to that.

GS: It’s easier said than done…

HM: If you take the capital markets area, I think it often requires an individual who has a bigger-than-life personality and the leadership skills to match it.

GS: Speaking of leadership, let’s talk about that within the context of fintech, where, as you know, we’ve seen mixed outcomes. You and I have talked a fair bit about how fintech isn’t like other tech sectors, because you’re dealing with money and livelihoods.

HM: Yes, and the activities are regulated, for a very good reason.

GS: When you look at a deal, does the character of the leader trump everything else?

HM: I’d say that the character and capabilities of a leader make a big difference. And to me, in financial services, the errors made, whether it’s 10 years ago or today, are similar. I mean, you have to tell the truth. You have to.

GS: Why is it so important to you?

HM: Because money attracts crooks.

GS: On that note, when I look at some of those who subscribe to the whole blitzscaling ethos, I see it as incompatible with our current climate and especially problematic to financial services. Blitzscaling doesn’t endorse breaking the law, of course, but this whole idea of consciously letting fires burn is a recipe for disaster in today’s financial services sector, right?

HM: Yes, I think so. I’d add that we have a rule in our firm: Don’t invest in any business model where you’re tricking the customer into a profitable relationship. But unfortunately, I feel that there are many business models that do just that.

GS: That’s a bold rule given that terms of services agreements remain dark dens of iniquity.

HM: Well, it’s more than just that. Look at Robinhood. I think it’s a remarkable company made up of unbelievable entrepreneurs. But I do feel that if you say, ‘Payment for order flow is the business model,’ or ‘Margin lending is the business model,’ you’ve got to spell that out. I mean, ‘payment for order flow?’ Most people would be like, ‘What does that mean?’

GS: You might as well be speaking in Ancient Greek.

A VC once said to me that we have too much knowledge about some things. I think there’s some truth to that.

HM: Exactly. I feel, in financial services, the best companies, the most successful long-run stories, will do the right thing for their customers, always. That also means not making a high-profile release of a new product, like a high-interest checking and savings account yielding way above anyone else, before you’ve actually checked with the regulators.

GS: On that latter reference, how accountable is Robinhood’s board for the company’s recent blunder?

HM: I honestly don’t know in what way the board was involved in this, but I think it’s a good example of where a board should put the brakes on an idea until the risks are clear. Sometimes management teams, and investors, don’t want to hear that, but it’s an essential role for financial services companies.

GS: In your career, you have seen your fair share of financial icons rise and fall. Have you ever passed on a deal that wound up being a huge success because something didn’t smell right?

HM: Yes, we have passed on things that turned out to be really good investments, but that’s part of our equation.

GS: In 1997, Howard Marks

HM: He’s fantastic, isn’t he?

GS: He’s phenomenal. In one of his famous memos, he asked ‘Are you an investor? Or are you a speculator?’ Given that there are quite a few VCs who have come to fintech in recent years, I’m wondering if you see a lot of speculators.

HM: Most of the folks that I interact with are investors, not speculators. The crypto stuff is pure speculation by almost everybody.

GS: Yes. I wasn’t implying that we discuss crypto.

HM: To the core of your question, I’ll tell you this: There’s this very, very successful VC investor I had a debate with over a deal. My point was that the company in question would need to raise a lot of capital to scale. But that long-term consideration wasn’t especially relevant to him, because he felt the company would have options down the road. We passed on the deal, but now, I look back and regret that decision.

GS: Are you suggesting that you could benefit from having a little more of a speculative instinct?

HM: A VC once said to me that we have too much knowledge about some things. I think there’s some truth to that.

GS: I’m sure that your institutional knowledge has been an important asset on many other occasions. I’ll move on to our last topic, Hans, because I know you have a fund to manage. You know all of the big bank CEOs, right?

HM: Yes.

GS: There’s Jamie Dimon, who defies easy description. At Goldman, you’ve got a banker as CEO. At Morgan Stanley, you’ve got an ex-management consultant. At Citibank, you’ve got

HM: You’ve got Corbat. Michael is just an excellent manager who gets things fixed. It’s interesting: Jamie is a fantastic manager of people too, but Jamie brings in his team. Corbat is very good at taking on an existing team and just making them better. Brian [Moynihan] is also really good. I mean he was a lawyer, and when he got the job, I had no idea what he was like. But I’ve noticed that the people who have worked for him are really loyal.

GS: I think the CEOs of the big banks tend to be a reflection of the times in which they operate, right? We went through the period of the trader CEO, which is now gone. As you look down the road, what are the heads of the big banks going to look like?

HM: I’ll answer that question by turning you to Microsoft. What explains the turnaround there? Is it because Satya [Nadella] is such an amazing engineer? No; he’s a great people person. He’s a fantastic manager who put in place a high-quality decision process, which is key to managing a complex organization.

GS: Implicit in my question is whether or not these organizations are going to be as big and complex as they are now. Specifically, I’m referring to the supermarket model that you were involved in helping to construct. Does that remain in place?

HM: Keep in mind that liquidity is a very, very important aspect of a financial marketplace, and having access to core liquidity that doesn’t change frequently is very important. The professional money obviously switches very quickly. But things like core deposits, pension flows and corporate cash tend to have the longest time-frames to build access to. But when a bank has access to deposits that don’t move much, it enables it to fund the liquid financial assets. That’s so important for when you hit a liquidity crisis.  

GS: So the big bank model is here to stay?

HM: Yes, I think it’s going to be around for a long time.

GS: Well on that note, Hans, I wish you luck in navigating whatever the future brings. Thanks for sitting down with me and sharing your wisdom.

HM: It’s always a pleasure speaking to you, Gregg. Thank you as well.

This interview has been edited for content, length and clarity.

TransferWise keeps growing money transfers despite global turbulence

You don’t have to follow the financial technology industry or work with developers in faraway lands to know TransferWise, arguably the world’s leading peer-to-peer money-transferring startup. Thanks to its presence in over 70 countries, low-cost rates for moving money internationally and, of course, its famous “nothing to hide” PR campaign that featured its semi-naked employees running through the streets of London and New York, TransferWise has become one of the world’s most recognizable fintech brands. Along the way, the company helped to usher in the age of the rebel-fintech adolescent startup that could compete and win against dusty incumbents on the basis of transparency, value, technology and, perhaps most importantly, moxy.

But today, the macroeconomic, business and political conditions that served as the feedstock to co-founders Kristo Käärman and Taavet Hinrikus when they launched TransferWise are ancient history. Can it keep scaling amidst heightened trade tensions, the unfortunate rise of xenophobia and capital controls? Will it continue to grow profits in the face of competition from other well-funded fintech start-ups and incumbents that look less dusty? Does the company, which has recently launched important partnerships, a revamped “borderless” business offering and a Mastercard debit card, have aspirations to provide other financial services? And, why isn’t TransferWise public? In the interview below, CEO Käärman addresses these questions head-on. In doing so, the Estonian native makes the case for his company’s future as a trusted partner for its dedicated (and growing) customer base.

Gregg Schoenberg: It’s good to connect, Kristo. I recently took a look at your financials, which show that despite your fairly large size, you’re still growing at a very fast pace.

Kristo Käärman: Yes, things are going very well. Tracking back to the very early days when we started, our hypothesis was that we can service customers about ten times cheaper than banks. That was really proven out about two years ago when we reached break-even, which is an important proof point: tech that’s paying for itself. It’s not paid for with investors.

GS: So it actually works.

KK: Yes, this thing actually works. In fact, in our original hypothesis, we thought that we could probably do our biggest trade routes for 0.5% in fees. We’ve now revised this and are now operating at 0.3% in our largest routes.

GS: I assume that’s all in? Because TransferWise always uses the mid-market or spot rate.

KK: Yes, and from the beginning, we’ve taken the approach that we never hide anything in the spread.

GS: Before we leave the topic of your financials, is there any color that you would care to give on how things are going subsequent to when you reported your numbers?

KK: Things are going in the same direction, which is consistent with the mission of the company: Grow the volume and the customer base, which gives us more scale to enable us to charge skinnier and skinnier margins.

GS: Taavet has said that he knows the moment when TransferWise’s transaction volumes will surpass Western Union’s. When is that?

KK: We’re a little bit behind Western Union, but give us a few years.  

What’s more powerful? Anti-trade factions or the natural forces leading us to become more global?

GS: So it won’t be in 2019?

KK: It might be, but I doubt it. Actually, you can kind of work it out, because Western Union is a public company and their volumes aren’t really growing very much. Today, our volumes are still smaller than Western Union’s. Then again, Western Union’s volumes are not very big compared to Citibank’s or HSBC’s.

GS: Speaking of volume, do you disclose your biggest foreign exchange (FX) crosses? I couldn’t find them on your site.

KK: It’s not disclosed, but we make no secret about this either. Let me also preface this by saying that whenever we’re in the U.S., everyone’s brain immediately goes to U.S. to Mexico. But it’s not the biggest channel by far.

GS: Is dollar-peso high on the list?

KK: Definitely, but the volumes there are much smaller. Our biggest volumes are in between the large developed countries. So you’ve got pound-euro, euro-pound, euro-dollar, pound-dollar, dollar-euro. That’s the biggest triangle. Then you’ve got Australia, Canada, Switzerland, Japan, Singapore, Hong Kong, etc..

GS: On that note, how big of a concern is it to when you see a weakening of overall relations between the US and Mexico and China and the Brexit saga? To me, TransferWise has always been predicated on more frictionless, cross-border commerce. As you know, geopolitical forces are reversing those trends.

KK: Certainly, if everyone decided that they weren’t going to trade in other currencies, there wouldn’t be a need for us. And I appreciate what you’re describing in terms of the public narrative that’s the intent of some factions. Whenever I get asked about trade tensions, I wonder, what’s more powerful? Anti-trade factions or the natural forces leading us to become more global? Technology is one of those forces. Because it’s very hard these days to be a local tech business. So while not every future business will be a tech business, most will either be tech or have a lot more tech elements, which are naturally more global.

TransferWise’s borderless account mobile card

GS: You’re saying that the global game of tariff-chicken and overall decline in immigration between certain major countries isn’t on your CEO headache list and that they haven’t impacted flows?

KK: No and no. Here’s a practical example: China has put into place capital controls, preventing residents from taking more than $50,000 U.S. dollars per year out of the country. As a result, they have already closed down the country from some aspects of money movement. I might disagree with that, but it’s their right.

GS: That sounds like it can create quite a headache for you guys.

KK: It’s a bit of a headache for us, but we’re not that worried about compliance requirements. We just won’t bother with the Chinese market. I mean, we’re operating in so many countries around the world. It’s business as usual for us.

GS: Is a global recession and/or a global shock higher up your list?

KK: I’ll answer that question by telling you about the month of the Brexit vote, which was an outsized month for us in terms of volumes.

GS: High volume?

KK: Yes, incredibly high volume, but we didn’t market anything and we didn’t do anything. In fact, we closed down the service. Actually, you’ll appreciate this as a Wall Street guy

GS: Ex.

KK: Ha, my apologies. So a couple of days before the vote happened, we knew that whichever way the vote would go, there was going to be volatility that night, and when volatility happens, the price rises, the smarter banks make a lot of money, which is usually not the case for consumers.

GS: Of course.

KK: A few days beforehand, we told our customers that a storm is coming, and that if they needed to move money between pound and euro or pound and something else, do it in the next 24 hours because we’re going to shut things down.

GS: You gave people fair warning.

KK: Yes, but we were actually very stressed on the day we put out the notice. Would people accuse us of crippling the service? Instead, people started thinking about how exchange rates were going to move. It ended up going really well and earned us kudos when things calmed down.

GS: What you’re saying is that in a recession, which will likely accompany global freak-outs, you’ll protect your customers. But what you’re also saying is that volatility can be a good thing from the standpoint of trade flows going higher.

KK: Yes, but I don’t like a recession.

There are cases where people who can transact internationally can switch from Paypal to us. If they can, they’re jubilant.

GS: Of course not. But some of the criticism hurled at TransferWise is that it’s a great service for when the weather is nice. And while large institutions charge too much for FX when times are good, in periods of volatility, they have more tools to manage risk and ease volatility.

KK: In financial services, risk is expensive, and if we’re building a product where margins are getting thinner and thinner — and we think they can get close to zero — it means that we see zero risk involved in it. So everything that we do is designed in a way that would take as little risk as possible. And I think you’re referring to mostly FX exposure, which is one of the types of risk that emerges if you don’t have balance on both sides.

GS: Right.

KK: Then you either leave some people waiting for a little bit until you can match it out somehow on the market, or you’re willing to cover that position until you’re able to take it off.

GS: Yes.

KK: So your assumption is correct, and it can be worth it to make payments instant by taking a very tiny bit of a position. We’ve comfortably managed that. I can’t disclose the numbers, but you’d be surprised how small that position is compared to our volumes. Now, in the early days, when we were running the company on my money and Taavet’s, we had no way to put up capital to facilitate transfers. But we had a trick we used then, because we often had more transfers coming in from, say pounds to euros than from euros to pounds.

GS: A big mismatch.

KK: We basically made a very large limit on the euro side — I think you could transfer like 50,000 euros at a single time — and a smaller limit on the pound side, so you could only transfer 3.000 pounds.

GS: Is that something that you would still do if a mismatch got bad enough?

KK: We haven’t done this now for five or six years, but it’s an idea to create a balance synthetically.

GS: Let’s talk about where the business is headed. I’ve seen a number of announcements that you guys have made. On one hand, you’ve hooked up with BCPE, and have deals in place with some challenger banks to help them facilitate FX transactions. These partnerships can enhance your volumes and take you one step closer to becoming the Amazon of FX for retail. But you also now offer a “borderless” multi-currency account for people and businesses that can be linked to a Mastercard debit card, which seems to constitute an expansion of your relationship with some customers.

KK: In terms of integrations with the customers of our banking partners, they now see how much they’re actually paying for a transfer. Plus, they get the same pricing as they would on TransferWise but with greater transparency.

GS: You’re trading margin for dollars, right? Because you have to share the fees with partners likes BPCE, but that’s okay because they’re bringing you lots of customers.

KK: Yes, but they also share in the cost. In terms of the debit card, it comes from two ideas. Think of an individual customer who often sends money to their own account abroad, or to their family. Why do they do this? The answer is that they probably have a student loan or a mortgage to pay back or home.

GS: Just like you did.

KK: Right. So we asked ourselves, why don’t we make it easier for our customers to do it directly? Avoid this hop from their bank in the U.S. to TransferWise, then from TransferWise to their bank in the U.K. and then from their bank in the U.K. to pay the mortgage. Why don’t we let them do it from within TransferWise? Because we actually have the payments infrastructure in 70 countries.

GS: Let’s talk about your small business customers specifically.

KK: From the beginning, we’ve always accepted businesses as users. Over time, maybe the small business side has gotten more focus because it’s a little trickier and it needs more features. Specifically, while freelancers and businesses have always been very happy to use TransferWise to pay their suppliers, they still have an issue when they get paid, or when they invoice their customers.

GS: Can you give me an example?

KK: Let’s take a Swedish furniture maker, when they sell their beautiful tables in the U.S. like the one we’re sitting at. That company would put their Swedish account number on the invoice, and then depending on how bold they are, they would ask you to pay it in either Swedish krona or in U.S. dollars. Either way, one of the banks is going to do that conversion, while the customer is going to pay three or four percent of the invoice value. So now, with the borderless account, the furniture maker can hold the balance in different currencies.

GS: That’s helpful, but not unique.

KK: It’s not exciting. HSBC has been able to do this for decades. But what they also get is a local account number in many countries, eventually in 40 countries. So now, they put their TransferWise account number on the invoice and it gets paid as a local business in the U.S..

GS: So you’re not trying to compete against domestic-oriented banks, or for that matter, even PayPal. It’s just an outgrowth of who your clients are that you offer this.

KK: That’s fair, but I think we’ll overlap with PayPal a little bit. There are cases where people who can transact internationally can switch from Paypal to us. If they can, they’re jubilant.

I think the journey of money could be something similar to email.

GS: Well, they like your fees, right?

KK: Yes, exactly. On a related point, the card is a way to give people access to that money that they have in the borderless account. So the thought process wasn’t to do a bank and start with a card. The thought process was to make it easier to facilitate international lives and international flows within the borderless account.

GS: You can’t even pay interest on that cash, because you’re not a bank.

KK: Correct.

GS: Taavet likes to give interesting quotes. One was, “We want to be as cheap as email one day.” As we all know, email is free. We also all know that when something is free, you’re the customer. It’s true in search and in trading stocks. With this in mind, have you been approached yet to sell your data?

KK: No one’s ever approached me on data, and yes, we would like to be as cheap as email one day. Actually, I think the journey of money could be something similar to email. But to be honest, my visibility goes from being able to move from a 0.5% charge to a 0.3% charge. I also think I know how to get from from 0.3% to 0.2%. But going from 0.2% to 0.1% is going to be really hard, I can tell you that now. And going from 0.1% to 0, that I don’t have an answer for.

TransferWise’s Mastercard debit card

GS: If you want to remain transparent, it will be tough. I mean, you guys used to parade through London without your clothes on to make the point that there’s no secret to how you earn money.

KK: Well, I don’t know if we need to get to zero cost; maybe 0.1% is completely fine. But if some people want zero for some reason, then we could also transparently subsidize it from something else that they are willing to pay for, or maybe someone else is willing to pay for them.

GS: Let’s talk about the future, then. Why aren’t you public?

KK: But, why?

GS: To do acquisitions, motivate employees, raise capital. There are sorts of reasons why it could make sense for a growing, diversified company like TransferWise. I guess you’ve dipped your toe in those waters a little on the debt side, and I recognize that being public isn’t a walk in the park. Still, I’m sure you’re well aware that some megafund VC out there might one day pump mounds of equity into a competitor.

KK: It’s a fair and relevant question, and we do want to be pragmatic about this. So the first question we’ve asked ourselves is: Do our customers care if we’re a public company or not? The answer is that they don’t care too much. Then, we’ve asked ourselves whether it will enable us to do more. Of course, being public probably makes our capital cheaper, but we’re not really capital-intensive. You’re right that we might need that currency to make acquisitions—

Everyone had to create something so that they could live.

GS: —But I understand that it reduces your flexibility and long-term planning a lot.

KK: Regarding a fund that would put a huge amount of money into a competitor, let’s say a half a billion dollars, for example. I think if it was important, I should’ve done this already, but we haven’t. Plus, in order to deploy 500 million pounds, our customers are going to be paying interest on this, eventually. So we’d have to have a bloody good place to deploy that kind of capital.

GS: To close, I want to ask you about Estonia, because I’ve never asked an Estonian this question: Your small nation has hatched Skype, Pipedrive and Taxify in addition to TransferWise. What’s in the water in your home country? Because not all former Soviet republics have had Estonia’s success. And while Israel may be known as the start-up nation, I think Estonia could also lay claim to that title.

KK: That’s a three-hour discussion by itself. I’ll say this: when I was a kid, the economy didn’t matter for people; independence mattered. And after having another country rule over you for 50 years, against your will, you don’t really care about how you’re going to eat next month.

GS: And then the Soviet Union collapsed.

KK: Which resulted in half the population basically becoming unemployed. Plus, we didn’t have an industry that was useful for putting food on the table or making a living at that time. Everyone had to create something so that they could live.

GS: You’re saying that it was a combination of this fierce independent streak that was embedded into Estonia’s DNA combined with the lack of industry to rely on.

KK: Yes. It’s called entrepreneurship.

GS: Ha, well in your case, it was perhaps a gift. Thanks for your time, Kristo, and great luck.

KK: Thank you, Gregg.

Kindred’s robots help retailers handle fulfillment centers — and take on Amazon

Since taking the reins as chief executive of Kindred at the beginning of the year, Jim Liefer has been focused on commercializing his company’s autonomous robots. But unlike forward-projecting use-cases for robots that may (or may not) one day take over for human beings in a wide swath of functions, Kindred’s current robots are purpose-built for the floor of retail fulfillment centers. That puts Kindred in the middle of an interesting business question: Given rising consumer expectations associated with online ordering, can anyone match or beat Amazon when it comes to speed, accuracy and efficiency?

With a background in operations at Walmart and One Kings Lane, Liefer asserts that his company’s core IP represents a significant advancement in retail operations. That’s because while industrial robots have worked well on manufacturing floors, robots have historically underperformed in e-commerce fulfillment centers, which require systems to handle objects of various shapes and sizes. Kindred’s approach is also notable because of its low-risk model that doesn’t require customers to make major capital investments. Instead of paying for the robot hardware, clients such as Gap pay based on the robots being able to successfully pick and sort items in a warehouse.

In the interview below, Liefer was eager to elaborate on his company’s core product, SORT. He was also happy to address the labor and throughput challenges facing Kindred’s clients as they look to thrive this holiday season. Finally, he offered his candid perspective on the ongoing debate over AI and jobs.

Gregg Schoenberg: Jim, it’s good to see you. I was interested in talking with you because Kindred is focused on the unsexy, but very important part of robot and AI technology that deals with e-commerce and gives insight into how our economy is changing. And by unsexy, I mean that your robots don’t do parkour.

Jim Liefer: Thanks, Gregg.  I’ll start out by saying that sexy is in the eye of the beholder. If you came from retail operations companies like Walmart, sexy would be not having to re-engineer or re-architect my building every year to handle the next peak.

GS: Fair enough. So where has that “sexy” journey taken the company today?

JL: We’ve evolved from a research and engineering company into a customer-focused organization. Today, there are four primary components that Kindred is working on: vision capability, grasping/manipulation capability, ability to identify what’s being held onto and then placing an item somewhere.

GS: And today, your solution is being applied to retail fulfillment centers?

JL: Yes, in retail fulfillment distribution centers, but not the consumer-facing side of retail. Still, there is a tremendous amount of automation in these centers. There are sorters and power conveyance, and there are forklifts running around. But we saw gaps in those in-between moments, the need to take individual pieces from automation A to automation B. That’s where Kindred now can fill those gaps, and it’s a big market.

GS: Do you make robots or do you make cobots?

JL: We’re absolutely collaborating with the humans, but we’re not letting them get that close to the robot. We’re letting the humans do what they do best, like higher-level thinking and dealing with more ambiguity than the robot can handle.

GS: But your solution is designed with the intent that there are going to be people that interact with it?

JL: For some period of time to come, I believe that is going to be true. That’s the design of what we have now. The reason I say it that way is that even today, the aspects of how product arrives at our solution varies, and some day, there might be another mobile robot that serves our robot, that brings the product to us.

Product

GS: At the core of the solution is your autograsp technology, right?

JL: The autonomous grasp algorithm is the core of our AI technology, which is combined with vision and grasping capabilities.

GS: I’m guessing that even though that grasp technology looks simple, it’s actually a big feat of both software and hardware innovation.

JL: Yes, absolutely. The grasping technology is a combination of AI that can understand the ambiguity that it’s dealing with. But there’s also the the physical side of it. Not only do you have to be able to get to a grasp-point, but you also have to grip it correctly.

Some day, there might be another mobile robot that serves our robot, that brings the product to us.

GS: What’s the inherent challenge with getting the gripping correct?

JL: It needs to be precise enough to pick up the item you want. It also has to have enough torque to be able to hold onto the item when you’re moving it.  

GS: Why is that so critical?

JL: Because you have to move at a speed that’s equivalent to a human or better in order to not lose it.

GS: What’s the installation process associated with putting a system into a facility?

JL: We literally roll them off the truck, roll them into place, plug them into 110 power and a data port, and maybe do some final provisioning of software. All in, it takes us anywhere from five to eight hours to set up a robot. So it’s definitely plug and play.

Business Model

GS: I know you don’t actually sell the solution to a customer. Can you walk me through your model?

JL: In the days when I was in a Walmart facility and I wanted to implement a new solution, I would go out to a service provider and they would tell me how many millions of dollars to plunk down. I would pay for it and then someone would come in and build it, and then they would go away and I would try to operate it.

GS: How antiquated.

JL: In our world today, they tell us their throughput need and how many products they are trying to serve with robots. We then deploy the number of robots to the customer. We have an agreement that says you need 10 robots or whatever the number is, and we deploy robots that will serve X amount of products.

GS: How does the money flow work?

JL: It’s a robots-as-a-service model, where every time we successfully grasp and stow a product or item, they pay us something.

It takes us anywhere from five to eight hours to set up a robot. So it’s definitely plug and play.

GS: A commission of sorts.

JL A commission, right. So it’s not a purchase and walk away. And there are several reasons why we think that’s compelling for the customer. One, because it’s not a capital expenditure play for them; it doesn’t have to be multiple weeks, months or even years to get onto the capital budget. It’s an operating expense play.

GS: That sounds like a key consideration.

JL: Think of it this way. When an operating expense comes into play, in many cases, a director-level person of a fulfillment center can make the choice: Am I going to hire a human to do the job, or I can hire a robot to do that job?  The other is that because we’re providing a service to the customer, we’re right there alongside them. It’s not as though we gave them something and said figure it out.

GS: Aren’t you making it very easy for clients to keep the robots around? Because it’s not costing them to have the robots sit on the fulfillment center floor.

JL: Well, okay, good question. In our model, we still have a minimum for the customer,  because we’re paying down the robot. We don’t want to have a robot sitting there idle.

GS: In that case, what’s the break-even on how long the robot needs to be on site with the client?

JL: It’s somewhere between a year and a year and half to get the payback to cover the cost of building the robot.

The Kindred.AI sorting robot in the lab.

GS: Does the counterparty risk become a factor? Because these machines are obviously expensive.

JL: Yes, that comes into play. At the same time, the robots themselves are quite… I want to say the word mobile. It’s relatively low-pain for us to roll them out and roll them to another customer facility that’s probably nearby. Of course, we don’t want to do that, but it’s possible to do it.

Amazon

GS: Of course not. But you’ve spent many years at Walmart, and you’re obviously very aware of the existential threat that Amazon poses to just about everybody that isn’t Amazon. Does Kindred aspire to help others thrive in a retail economy that is increasingly dominated by Amazon?

JL: Yes. It levels the playing field, because if our customer, the retailer, is able to have better throughput, get the products into the hands of the customer faster, then they have the ability to hold onto their customers. If they don’t do it, then those customers are going to go somewhere else.

Am I going to hire a human to do the job, or I can hire a robot to do that job?

GS: Looking to the future, do you want to go deeper within the apparel channel, or do you see other retail applications for your grasping technology?

JL: To recap, we figured out a very difficult problem, which is how to handle clothing in a polybag with a label on it. What seems like the most logical and reasonable place to go is to smaller items and maybe toy items or jewelry.

GS: But it has to be in a bag?

JL: It doesn’t have to be in a bag. In testing, we can pick up a pen or a pencil. We can pick up an iPhone and even general merchandise-related items like baby wipes or rubber balls.

Technology

GS: Let’s dive into your technology a little deeper. Is your tech based on reinforcement learning or deep reinforcement learning?

JL: Actually, both. The way that we’re operating the current SORT robot is that there are multiple AI algorithms that are running in concert together. So there’s the autonomous grasp algorithm, there’s a grasp verification algorithm, there’s a stow algorithm; there are multiple algorithms that are running to maintain that speed and accuracy. Then, there’s our team in the Toronto office—

GS: —That’s the team working on deploying more reinforcement learning?

JL: Yes, the reinforcement learning which would replace some of the deep learning algorithms that we have in place today.

GS: I read up on Rich Sutton, who, based on my research, is a big deal in reinforcement learning—

JL: —Yes. He’s a big deal and is a mentor to several of our people.

It’s relatively low-pain for us to roll them out and roll them to another customer facility that’s probably nearby.

GS: Sutton describes reinforcement learning as a learning system that wants something. Can you describe in lay terms how this is central to Kindred’s technology and how it is different than deep Learning?

JL: Here’s how I think of reinforcement learning versus deep Learning. Reinforcement learning is allowing the algorithm to determine all of the possible outcomes and all of the possible permutations. Think about something in a space where you want you to go from point A to point B. In reinforcement learning, that robot will achieve the goal by doing something called body babbling, which looks like it’s jittering around, looking at all the different possible solutions.

GS: So it takes longer to train a reinforcement algo?

JL: Yes, because in deep Learning, you are going to give it some sort of structure within parameters, because you sort of know what you want it to do. Then you look at body babbling, which is a much cleaner solution because the algorithm knows how to deal with all these variables because it’s explored every permutation.

GS: I saw that Kindred released a research paper last month. My top-line takeaway is that while reinforcement learning has made progress, it’s tough to train robots.

JL: I view it this way: In the last two years that I’ve been here at Kindred, I’ve seen things on a daily basis that I didn’t think were possible the week before or the month before. That’s a blanket statement, though, which is one of the reasons why I think people are anxious about AI and automation.

AI Anxiety

GS: So let’s talk about AI anxiety. Yesterday, I was on Bush Street and I watched this Cafe X robot serve coffee. Meanwhile, across the street, you’ve got this Blue Bottle that’s teeming with people, keeping its staff quite busy. Is that the future you see? Where workers are in demand, even in an era of well functioning robots that can grasp stuff?

JL: I  think back to Tower Records in San Francisco in the 90s. It used to be packed. I mean, that’s where I spent every weekend. You never thought that would end, perhaps like some people at the Blue Bottle today. But there’s that flip point.

GS: I appreciate that honest comment.

JL: To me, I just think it’s inevitable, and I don’t think it’s bad. But I believe that we will embrace it, just as we embrace technology in our phones, because it will improve our lives in many ways and it will also make our lives more complicated.

GS: We’ve discussed previously, too, this idea that in the fulfillment centers where the Kindred robots are operating, there’s a labor shortage.

JL: Yes, there’s no employee there to do the job.

We can pick up an iPhone and even general merchandise-related items like baby wipes or rubber balls.

GS: And that’s because fulfillment centers are in locations that are often—

JL: —They’re clustered. They’re fighting for the same resources. Big Amazon has come in, they’re paying those workers more, so they’re siphoning all those workers away.

GS: What about temporary workers around the holidays?

JL: We said earlier that the robots are collaborative, working alongside and collaborating with the humans. Absolutely, there are places for the temporary workers to come in, and I want those humans to be fulfilled. In terms of helping our customer, it’s so painful to get even a temporary worker, give them a job that’s very mundane, have them leave and then have to hire another temporary worker.

GS: But Kindred is giving jobs to people with gamer skills, too, right?

JL: Yes, on the tele-operation side. About 85 percent of the time, our algorithm can do everything on its own. But 15 percent of the time, we have a human in the loop who steps in and assists the robot for about a second and half, and then steps back out.

GS: When you’re recruiting for these people, are you recruiting in the typical places that tech companies look?

JL: These people have a wide variety of backgrounds and skill sets. They might be gamer types, but some of them have marketing degrees and some of them have engineering backgrounds. There’s also a pool of generalists, those jack-of-all-trades kind of people.

GS: But they need to have pretty good dexterity, right?

JL: I don’t think it’s highly required. A lot of it is just point and click.

GS: Well, on that non-techy note, Jim, thanks so much for your time.

JL: Thanks very much, Gregg.

This interview has been edited for content, length and clarity.

Charge card startup Brex aims for decacorn success

By now, Brex, the young startup that is trying to reinvent corporate credit and charge cards, is well-known in Silicon Valley. The tender age of the company’s co-founders, Henrique Dubugras and Pedro Franceschi, the big-name backers, the $125 million Series C announced last month, the aggressive billboard advertising in San Francisco, and the company’s torrid growth have all contributed to the swirl of attention. But, of course, it was the valuation at the last round —which placed Brex into the fintech unicorn club — that tops the list.

Recently, Brex offered up a new reason for chatter as it unveiled its new, generous rewards program that was purpose-built for the kind of entrepreneurs who aspire to match Brex’s success. But lost in the buzz are the specifics of how Dubugras and Franceschi have approached the arcane challenge of building a payments start-up.

To better understand that, chief executive Dubugras opened up about his and Fraceshi’s previous start-up, Pagar.me, which was acquired by newly public Brazilian credit card processor StoneCo, the challenges of scaling quickly, how a Brex card compares to traditional corporate card products and the company’s plan to navigate the ups and downs of business cycles. Finally, Dubugras spoken candidly but confidently about the considerable pressures facing the company now that everyone is watching.

Gregg Schoenberg: It’s good to connect again, Henrique. As you know, Brex has gotten a lot of press for having gone from from zero to fabulous in a short time. But for those who have missed the Brex story, what problems are you solving for start-ups?

Henrique Dubugras: One is a case where the founder can’t get a credit card because they don’t have a FICO score or can’t provide a personal guarantee. Another case is when a founder can get a card, but doesn’t want to provide a personal guarantee.

GS: Which is understandable.

HD: Yes, I think it’s not a very smart idea. Brex can solve that because we can issue them a card now without a personal guarantee. Finally, there’s the founder who doesn’t care about the personal guarantee, but there are other things related to the experience of having a credit card that could be much better, and we‘ve solved for that.

GS: The first two speak to a differentiated underwriting approach, but that third issue seems especially challenging.

HD: Yes. On the underwriting side, we take into consideration your cash balances, and the VCs that invested in you. It’s a Silicon Valley way of underwriting that allows you to go from zero to a working card in like five minutes. But in terms of the third use case, yes, we had all of these people telling us, “Hey, it’s impossible to rebuild credit card systems from scratch. No one has done it in the last 20 years.”
Pagar.me Success

GS: That’s why I want to discuss Pagar.me, because I think it provides insight as to how you were able to disprove doubters.

HD: Well, we had built a payments company before, so we kind of knew how to do it and just decided to rebuild everything from scratch. You saw the Stone IPO, right?

GS: I did, and buried deep in the footnotes of the S-1, it points out how much it spent on the remaining amount of Pagar.me for in 2016. So while you and Pedro built something that was a success, it wasn’t like you were able to buy an island with your proceeds.

HD: There’s another part that wasn’t part of the IPO, but no, we still can’t buy an island.

GS: And this narrative that you and Pedro were able to come here from Brazil and in short order wave in all of this amazing funding because you had a huge exit is not accurate. Instead, I see two guys who navigated a very bureaucratic financial system—

HD: Yes.

We had this experience that was pretty unique compared to US payment companies or ones from any other place.

GS: —and figured out a way to build something that was successful.

HD: Correct, but keep in mind that we built more than a product. We built an organization. It had over 100 people, was profitable, had substantial market share, and it got acquired.

GS: To me, a big aspect is that you did it in a Brazilian fintech bootcamp of sorts, because building a payments company there, that achieved scale, when you did it, was hard.

HD: It was really hard. And volume-wise, Pagar.me is a big part of Stone today.

GS: You also had to deal with the regulators quite a bit?

HD: Yes. The Central Bank decided to start regulating financial businesses around the time we started Pagar.me.

GS: Pagar.me provided the short-term financing to all of those merchants doing business online, right?

HD: Correct. We had to raise debt in Brazil in order to factor the receivables to merchants, because prepayments are a big part of the market. We also rented an acquiring license instead of having one ourselves. So, yes, we had this experience that was pretty unique compared to US payment companies or ones from any other place.

GS: I think it would’ve been very hard for someone in the US payments ecosystem to have been confronted with that kind of diverse challenge and come out on top. It seems like a big part of how you hooked those early investors, people like Max [Levchin] saying, “I want to invest in you no matter what you build. I really like your talent.”

HD: Correct. And because Max understood payments so well, he could tell that we knew what we were doing in our area. The same is true for Ribbit Capital, which knew about Pagar.me.

GS Seeing Max invest in a payments company is different than Max investing in a bunny rabbit start-up. In a space like payments, I think it matters a lot that he was behind you early.

HD: True.

GS: So returning to Brex, I’m interested in the rewards program you just announced, which is paradigm-shifting. Your rewards are designed to be used on an ongoing basis as opposed to being accumulated, right?

HD: Exactly. We want you to use all of the rewards, so that every single day you can have the best experience. Also, credit cards have these footnotes saying, “Hey, you can get up to these caps, restrictions and limits,” etc.

GS: Trying to prevent people from optimizing.

HD: Yes. We take a very different approach, where we’re like, “Hey, we’re not going to limit and punish good users and people who want to just use one credit card by adding all these limits and restrictions.”

GS: What’s the Brex Exclusive concept?

HD: The concept is that if Brex is your only card, you get all these benefits. But if it’s not your only card, you can still use Brex, but then you just get reduced benefits.

GS: Couldn’t you argue that right now, Amex, or Chase, or Capital One doesn’t care about your rewards offering? It’s akin to the early days of the roboadvisor space. But as you get bigger, wider in scope and peskier, what’s to stop Chase from introducing the unicorn card with a bounty of rewards?

HD: One is the effect on their legacy technology. You can say, “Why don’t they just change their technology,” right? Well, they have all these regulatory bodies that would say “No, you can’t change your entire technology system, because if you mess up, the whole US financial system might be impacted.”

GS: Can you give a specific example of how this would play out?

HD: Take the credit limit side. All these companies are built to have these static credit limits in which they set their credit limit today and they don’t look at it for two months, three months, six months, etc…

We don’t want to be the stupid company that raises a bunch of money and then starts doing all these stupid things.

GS: Right. But are you comparing a charge card versus a charge card, or a charge card versus a credit card?

HD: Brex is a charge card, but it doesn’t really matter for this concept, because my point is the technology of changing the limit every single day based on real-time data versus the system they have. Implementing a real-time system would be a fundamental shift for them.

GS: What about this idea that you have credit limits that are ten times the amount versus a traditional card? It’s cool, but you guys have access to lots of analytics and data, so you’re not really taking a huge amount of risk.

HD: That’s correct, which is why we have zero losses today.

GS: Today?

HD: To date.

GS: Impressive. Let’s talk about Sutton Bank, which is your issuer bank that you needed to access the Visa Network. What would you do if you got approached by another issuer bank that said, “I love what you’re doing, can we be an issuer bank too?”

HD: It would be something we would consider, but it’s not something we’re focused on right now. We use their license to issue, but we basically do everything. We do the underwriting. We do the technology and everything.
Growth Plans

GS: You’ve been public about wanting to grow out of the start-up world. Where’s next?

HD: We do want to go to a more traditional businesses, a little bit more mature and outside of technology. That’s something that we’re going to probably do sometime next year, but we have to adapt our underwriting model and our product.

GS: Rewards too, right? I can’t see a lot of traditional businesses caring as much about AWS credits.

HD: There’s nothing besides cash back that matters to these companies. We’re going to adapt because that’s what they care more about.

GS: What do you think of this whole blitzscaling ethos?

HD: I’m reading the book right now, actually, but I haven’t reached a conclusion yet. All the examples in the book seem like two-side marketplaces with a lot of network effects and a winner-take-all. That’s not us.

GS: Regardless of model, to say that you’re going to let some fires burn and ignore them… I don’t know if that flies in fintech or in financial services in 2018.

HD: Yes, fintech has this other aspect of it because it’s people’s money. You can’t let buyers burn. But I think there are other aspects to it. Are we going to reach a plan for success or hedge for failure? Are we going to hire faster or hire slower?

GS: Everybody who has raised a big round like you is in hiring mode. Have you encountered recruitment challenges given your youth?

HD: Not in the US. In Brazil, we’ve felt it. There’s so many examples of successful companies founded by very young people. I mean, maybe we’re one year younger than the other guy who did something really good.

GS: What about the idea of building a common culture, because the ink on your business cards is still sort of wet and you’re hiring all these people so quickly?

HD: The question of what kind of culture we want to build is something we think about a lot. Some companies are on the Google or Airbnb side, like, “Hey, we’re a family.” Some are more like Netflix or Apple, which is more like a professional sports team. We’re definitely more towards Netflix or Apple than we are towards Google or Airbnb.

Building a 10- to 20-billion-dollar business is hard. It’s really, really hard.

GS: What do you mean by more professional?

HD: More work-driven, and we’re not into the whole perks thing. Plus, we really like to pay people higher salaries and give them smaller stock grants, because a lot of people in Silicon Valley don’t believe in stock. We’ve said, “Yes, we’ll give you more cash,” and then we save the stock, not for the people who negotiate the best, but for the people who are performing the best over time.

GS: What’s your thinking?

HD: There’s this super premium given to risk, right? It’s for the people who joined when we were nothing and nobody believed in us. That premium is too big, I think, compared to people who will work in this company for a long period of time. I think a lot more of the premiums should be for someone who has spent six, seven, eight years busting their ass and growing this company.

GS: Let’s touch on where you going to put these people: Brazil or “Transaction Alley” in Atlanta?

HD: We’re thinking about it. I think Vancouver is the main candidate for now.

GS: Why there?

HD: You can get visas really quickly.

GS: Given your need for speed, are you worried about controlling your spending while you look to grow quickly?

HD: Honestly, we have the opposite problem. Keep in mind that Pagar.me was built with $300,000. It was the only money we raised for that company.

GS: Really?

HD: Yes. For us, not spending money is the default. But now we have a lot of money, and we need to invest it to grow faster, so we are constantly actively thinking of ways of spending more.

GS: It sounds like you’re struggling with this.

HD: It’s just hard because we don’t want to be the stupid company that raises a bunch of money and then starts doing all these stupid things. But we also need to invest to grow faster, so finding that balance—

GS: —Acquiring customers can be expensive.

HD: Yes, but for us, that’s not even the thing because our market is so niche, I can’t just put a couple hundred grand on Google. It just doesn’t work because we’re so niche.

GS: Right.

HS: But we definitely have an issue of how to deploy capital more than we have and how not to do it.

GS: Well, I suppose you could just advertise on more billboards.

HS: Actually, that’s cheap! There was an article about this. We spent $300,000 for three months for all of San Francisco.

GS: I’d like to close by talking about what it means to be one the hottest young start-ups in the Bay Area. And the fact that at some point, a recession is coming. To the first issue, are you concerned that given your rapid ascent, you can’t make mistakes quietly because everyone is watching you?

HD: Yes. I definitely feel that pressure. But I feel more confident because we’re doing this for a second time, in a market that we know. And I really like our executive team. Plus, there’s a lot of stuff we’ve already figured out with Pagar.me in terms of management and culture and what the scale problems will look like.

I think that anyone who says they know how to deal with a recession, it’s not true.

GS: Still, it’s a lot of pressure given your valuation and the expectations that come with it.

HD: Yes. I’m definitely scared because it’s a lot of responsibility, and I won’t consider Brex a success unless I give my investors a ten- to twenty-X return. Building a 10- to 20-billion-dollar business is hard. It’s really, really hard.
Business Cycle

GS: You have to become the next Stripe… Let’s conclude by talking business cycles. When I talk to many CEOs, they will feed me a line like, “Actually, we’re going to be great in a recession — even better under a recession,” right? While true in some cases, it’s mostly false.

HD: Yes.

GS: So what happens when the business cycle changes, there isn’t as much VC activity, and you still have to figure out how to grow?

HD: I think that anyone who says they know how to deal with a recession, it’s not true. Because every single recession is very different than the other. 2008 was completely different than 2001. There’s no one person who knows how to deal with all of them because they’re all very different.

GS: I agree.

HD: The only thing we can do is the big-picture playing, by one, raising more money than you need — which we did — and two, having levers of spending that you can cut very quickly.

GS: Perhaps this is where your Brazilian lineage helps, because you grew up in a country that had a lot of volatility.

HD: 100 percent.

GS: With prices changing on the store shelves from the morning to the evening.

HD: Well, we weren’t born in that time, but we heard our parents talk about it.

GS: Oh that’s right. I forgot.

HD: The thing we learned most from that is that nothing’s done until it’s done. Coming from Brazil, this fact-oriented culture was ingrained in us. We didn’t even celebrate closing the round here before the wires hit.

GS: Last question: If you ultimately face a worthy competitor focused squarely in your space, will it be from another Henrique and Pedro, or will it be from a big player?

HD: It would be a fintech company that adds this product. I don’t think it’ll be Amex or Chase. I think it will be a PayPal or a Square or an Adyen or a CyberSource. They are not the legacy guys, so they don’t have the problems that banks have.

GS: Gotcha.

HD: But I don’t think it’ll be another Henrique and Pedro, honestly. So…

GS: Well, I wish you luck on that.

This interview has been edited for content, length and clarity.

Convene uses landlord partnership model to outclass WeWork

Recent reports that Softbank may take a majority stake in WeWork has added fuel to the already hot market for start-ups in the workspace and property tech sectors. One of the more compelling companies that stands to benefit from this trend is New York-based Convene. Started by co-founders Ryan Simonetti (CEO) and Chris Kelly (President), 500-person strong Convene has distinguished itself as a top-tier provider of meeting, event and flexible workspace offerings in its 21 locations. But unlike freelance-heavy WeWork and other co-working companies who cater to 1-10 person companies, Convene puts owners of Class A office buildings at the center of its business model. The goal is to help these landlords provide tenants with the high-end of amenities of, say a unicorn tech startup.

On the back of the company’s recent $152 million Series D, Simonetti and Kelly were eager to discuss new initiatives including a co-branded turnkey workplace and amenity solution and their plans to launch additional Convene locations, including London. They also elaborate on how they plan to benefit during the next recession and open up on their differences with category giant WeWork. Finally, they explain why paintings by renowned artists including Picasso and Calder are tucked into corners of the company’s first, soon-to-be-opened members club at Rockefeller Center.

Gregg Schoenberg: Ryan and Chris. It’s great to see you both. To kick things off, I want to establish that Convene is not a typical startup in that you’ve been around for about nine years.

Ryan Simonetti: Yes, is that called being washed-up in the start-up world?

GS: Not necessarily. Tell me about where the idea for Convene came from?

RS: Chris and I met during our freshman year orientation at Villanova University, ended-up pledging the same fraternity and spent a lot of time getting to know each other. From the beginning, we were probably two of the more entrepreneurial guys at Villanova. We sold used textbooks, spring break trips, parties into Philadelphia. If there was a way to monetize something in college, we were the two guys that were trying do it.

GS: Two scrappy guys from Villanova.

RS: Yes, we’ve always joked that we were probably the only kids at Villanova who didn’t have our parents’ credit cards.

GS: So years later, what was that catalyzing moment where you said, “Okay, here’s the idea for Convene”?

Chris Kelly: I remember two phone calls from Ryan that represent the earliest seeds of Convene. The first phone call was in the middle of the financial collapse, and in that phone call, Ryan said, “We’re about to witness the largest shift of wealth that the world has ever seen and we have to figure out how to be on the winning end of that.” Then a few weeks later, Ryan called me up and introduced the crazy idea for Convene.

GS: And what was that specific pitch?

CS: He walked me through the Grand Hyatt in Midtown Manhattan and said, “Look at the way these guys are doing business. This is a $60 million a year catering and meetings operation that was in essence being outsourced to hotels.”

“Just like Airbnb would tell you that their primary stakeholder is the homeowner, or OpenTable would tell you the primary stakeholder is a restaurateur, we view the building owner as our primary stakeholder.”

GS: And you’re saying hotels weren’t doing a great job?

CS: Hotels simply didn’t have the sensibility about what people really need in a business environment. They treated a shareholder meeting like a wedding with a projector. And we saw a huge opportunity to create spaces that met enterprise workplace requirements.

GS: So fast forward to today and tell me exactly what Convene is, because I think sometimes people struggle and just say, “Well you’re a WeWork competitor on the premium end.”

RS: We partner with Class A building owners to design places where people can meet, work and be inspired. It’s not any more complicated than that.

CS: To build on that, you could say that we’re essentially allowing landlords to offer Googleplex-style workplace experiences.

RS: That’s a big challenge for even large organizations. Look at Google, Facebook or JP Morgan. These companies can deliver an amazing experience at their corporate headquarters location. But in their smaller offices, it’s really tough to deliver a corporate HQ experience if you only have five, ten, or 15,000 square feet. You can’t build the kitchen infrastructure, or the gym, or all of those other things. So to Chris’s point, we’re democratizing access to that experience, and doing it with the landlord as the key partner.

GS: So the landlords are the core client?

RS: Just like Airbnb would tell you that their primary stakeholder is the homeowner, or OpenTable would tell you the primary stakeholder is a restaurateur, we view the building owner as our primary stakeholder. And what we’re helping them do is respond to the changing demands of today’s tenant, who want increased flexibility and better agility to adapt to change.

GS: I take it marrying technology infrastructure to the physical spaces is key to that, which is why you recently bought Beco. What exactly do they do?

RS: Beco is a workplace analytics platform that’s using sensor-based technology to help us, our landlord partners and our corporate clients better understand the way that people are actually interacting with space and services.

“But what really differentiates us strategically is that we’re not trying to build our own supply chain or our own inventories.”

GS: As you contemplated that acquisition, were you worried that it might be perceived to some of your traditional clients as Big Brothery?

RS: Look, everyone today is concerned about data privacy, and rightfully so. The way that the technology actually operates is that the actual users are anonymous to us.

GS: So is that data anonymous, or anonymous anonymous?

RS: Anonymous anonymous, meaning all we’re capturing is a random ID assigned to a phone, and that ties back to the sensor and data analytics platform.

GS: Do you have to opt in?

RS: It’s all opt in.

GS: Okay, I want to turn to the big gorilla in the broader flexible workspace category, because right or wrong, everyone, including Convene, gets compared to WeWork.

RS:Look, if we think about the macro trends that are shaping and changing not just the way that we work, but also the way that we live and travel, I would argue that WeWork and us have a similar view of the world and the future. But from a business model perspective, the quality of the product that we’ve built, the level of service that we deliver, the strategic nature of our partnerships with building owners, I don’t view us as directly competitive.

GS: I appreciate that WeWork ultimately caters to smaller sized end-users than Convene, so in that way you’re different. But it’s also true that even though Red Bull and Coca Cola are different drinks, you’re not going to drink a Coke and a Red Bull at the same time.

RS: From an analogy perspective, there’s a difference between Planet Fitness and Equinox, right? Would you argue that they’re competitive? Maybe. But the way I think about office real estate is Class C, Class B, Class A. Convene is a Class A partner to landlords.

GS: Right, but WeWork, with all that current and possibly future cash from Softbank, is moving upmarket.

RS: Sure, as they move more into enterprise and upmarket, of course, they’ll be competitive. But what really differentiates us strategically is that we’re not trying to build our own supply chain or our own inventories. We’re partnering with the existing supply chain to create a new category of supply that speaks to the collective demand from our customer demographic.

GS: As a service provider, I get that. But what happens when the next recession comes —

RS: — Yes, by the way, we’re excited for the next one.

GS: Because the knock on WeWork and other companies in the broader sector is that when the recession hits, the blood will hit the fan because of those short-term tenant leases.

RS: Well, right now, you see a lot of capital flowing into the sector and you have platforms that probably shouldn’t be here as well.

GS: Let’s take Brookfield. WeWork has a relationship with Brookfield. You guys have a relationship with Brookfield. But I think the difference is this: if bad things happen in the economy, they have to hope that WeWork is going to effectively manage those short-term lease obligations. From my outsider’s perspective, that looks to me like a counterparty relationship. But in Convene’s case, it looks more like an aligned partnership. After all, Brookfield, as well as Durst and RXR, are on your cap table.

RS: Every deal structure is aligned and even the leases we have are aligned. And when the recession hits, we will use it as an opportunity to deepen our landlord partnerships and take market share.

GS: With whose balance sheet?

RS: We’re using the landlord’s balance sheet to grow our business.

CS: And WeWork is using the Softbank balance sheet to grow their business.

GS: Could you elaborate?

RS: WeWork did us the greatest favor in the world, because our strategy since day one has been to make the landlord a key partner and stakeholder. Do you want to know who has the cheapest cost of capital? Cheaper than Softbank’s? It’s the landlord’s balance sheet. Their cost of equity capital is like six to eight percent.

GS: Really?

RS: Yes. If you think about the investor-anticipated yield in asset classes, real estate sits between a fixed income expectation and an equity capital markets expectation.

GS: Okay, but how does using the landlord’s balance sheet enhance your approach strategically?

CS: Because there are elements of the way we structure our deals that allow our performance to be variable. And by using the landlord’s balance sheet to grow our business, it aligns us and the landlord to be able to ride through a recession together.

“Do you want to know who has the cheapest cost of capital? Cheaper than Softbank’s? It’s the landlord’s balance sheet.”

GS: Have many of the nation’s Class A landlords have bought into your model?

RS: If you look at our current partners that we’re actively working with, I think they globally control over 250 million square feet of Class A office space. So if 10% of that moves to flexible consumption, that means Convene could have an addressable market of 25 million square feet of inventory.

GS: So given the way you’re talking, would it be fair to say that your landlord partners have recognized that the flexible workspace trend is here for the long-term?

CS: How we consume real estate is undergoing a fundamental shift. This is the same conversation that was happening in the transportation industry 15 years ago. It’s the same thing that was happening in the travel industry when Airbnb was starting. That same conversation is happening today within the existing supply chain. So, yes, It’s a buy, build, partner decision that is being made in every landlord’s office around the country today.

GS: It still sounds odd to hear the phrase, “consume real estate.” Maybe I’m old-school, but you guys are down to earth. Do you find that language odd?

CS: Actually, what we’re seeing is the consumerization of real estate. Real estate was historically very B2B, very financially driven. Today, it’s being driven by human experience, So yes, brands matter, the customer experience matters. And that consumerization of real estate actually is happening.

GS: I take it that’s why you launched this new managed workplace solution that features the services you bring, but enables a client to use its own name?

CS: What makes that platform unique is that it’s co-branded. It’s an endorsed brand model by Convene, which means that the Convene brand standards, the Convene operating model, the Convene staffing model and the Convene university training program comes with it.

GS: So Intel inside?

CK: Yes, which gives clients the best of both worlds. It gives them the brand and reach and expertise of Convene. At the same time, they can now have something that feels more authentic and unique to them as a landlord.

GS: I want to shift to the future of work, which is something you both have spoken about in pretty bold terms. We’re at this amazing Convene members club, which sort of feels like a SoHo House except we’re in midtown. And you’ve talked about how an experiential personal life will be closer to a work life. Where is all this going?

RS: From a trend perspective, we believe fundamentally in what we call work/life integration. It used to be that you go to work and at the end of the day that stops and then you move to the rest of your life. That’s not really the way it works anymore. And when we think about some of the services that we’ve launched over the last couple years, it’s been with that idea in mind.

GS: Are you creating future offerings in-house or partnering?

RS: Actually, we’re about to announce a partnership on the wellness side, where we’re taking some of the wellness elements and starting to incorporate them into the broader Convene ecosystem.

GS: Do either of you guys have children?

RS: Yes, we both do.

GS: Because if you want to talk about quality of life and the war for talent, it seems like a natural extension to see if your plan to help the workforce addresses the challenges of working while raising young kids. Are such extensions on your whiteboard?

RS: Yes, they’re definitely on the whiteboard and some of those things are already in process. The difference is partnership. When I think about the way that we’re building our platform and the way that WeWork is building theirs, I think about us as being an open-source platform, Do you think you need to do everything yourself because you’re the best in the world at everything, or do you want to work with best-in-class partners?

GS: So for something like childcare, you’d bring in a partner?

RS: If we decide, which I’m not saying we are, to get into childcare, we’re going to do that with a proven partner that has a track record of delivering that experience and doing it really well.

GS: How does Convene fare in a world where remote work becomes an even bigger trend?

CS: Actually, there’s a difference between remote work and mobility. Remote work is the traditional concept of working from home, and we’re actually seeing some backlash now of companies who are really trying to drive culture, and want more face-to-face interaction.

GS: Does that show up in the design of your spaces?

CK: Yes, the built environments of our offices are changing from looking like cubicle farms where everybody reports to their desk and their computer to operating a lot more like a digitally-enabled campus. And the decoupling of people and their work from their desk is opening up an opportunity to build what’s called an activity-based workplace, where there are different types of spaces that are specialized and built for specific uses.

GS: You guys don’t even have offices, right?

CK: Right. None of us have offices.

RS: Also, people used to talk about remote work in magical terms. They’d say, I’m not going to need an office. We don’t believe that this is the case. We think that there a few things that will continue to matter to organizations. One is brand, two is culture, three is collaboration. And until technology can somehow magically replicate that experience, we think that the best ideas will come from face-to-face interaction.

GS: I have two important last topics to cover. First-off, why on earth, nestled into a semi-remote corner of this club, do you have a Picasso painting hanging on the wall? Because in my experience, usually people like to show off the Picasso if they have one.

RS: Ha, well, the Picasso, as well as all of the other amazing art that you’ve seen at Club 75, is part of the partnership here with the landlord.

GS: Well, it speaks to the confidence they have in you.

RS: Yes, but it also speaks to the experience we’re creating. We think about space as the body language of an organization. Space has the ability to move people and we think that art is a big part of that.

CK: It also demonstrates the extent to which landlords are committed to delivering a great experience.

RS: Right. Having a coffee next to a Calder or a Picasso can put you in a totally different headspace.

“There’s no amount of money in the world that can buy you a partnership with Brookfield or a half a dozen landlords that we’ll be powering next year.”

GS: Well, I’m glad you didn’t use shareholder money to buy these works, which brings me to my last topic. At this point, are you concerned about profitability?

CS: Yes, we are and that’s another one of the differences between us and others. In fact, we’ve been cashflow positive since Day one. And as an organization, profitability has always been something that we think is very important.

GS: It’s because you don’t have enough VCs on your cap table. Speaking of which, you’re obviously aware of the fact that Softbank and other megafunds may helicopter drop a lot more money into this space, which could change the competitive dynamics.

RS: First of all, the last time I checked, we were the second most capitalized platform in the category, by dollars raised. And if you look at our partnership-driven approach, where the landlord’s balance sheet is funding a lot of our growth, the actual capital that’s being invested in the platform is multiples of the $260 million we’ve raised.

But to your point, our concern isn’t so much about the capital that’s flooding in, There’s no amount of money in the world that can buy you a partnership with Brookfield or a half a dozen landlords that we’ll be powering next year. And money, whether its from Softbank or anyone else, can’t give an organization its corporate culture. And I think one of the reasons we’ve been selected as the partner to some of the most discerning customers in the world is because of the fact that everyday, we deliver consistently against a premium experience.

GS: Well, on that note, Chris and Ryan, I’d like to thank you for your kind hospitality.

RS: It’s been our pleasure and thank you.