How Jason Freedman and 42Floors cooked up a killer business idea that could turn commercial real estate on its head.
Jason Freedman hunches his shoulders against New York City's December chill and walks faster, nudged both by the cold and by being late. He and David Woodworth, co-founders of an Internet company called 42Floors, both stand out a bit with their buoyant, vulnerable Californianess as they swim against the trudging, elbowing crowds.
Focused on the iPhone he clutches a foot in front of his face for navigational purposes, oblivious to how dorky and unsafe this seems on these streets, Freedman races on to the next stop in a two-day string of meetings, Woodworth trailing a few feet behind.
Freedman and Woodworth are several months into the creation of 42Floors, which aims to make finding office space as easy as searching for plane tickets. They're here in New York to…well, it's not entirely clear why they're here. For sure, they hope large New York real estate companies will eventually agree to share office-space listings with their start-up, though it's too early to ask for that sort of commitment. Mainly, they're here to share their plans for 42Floors and get feedback, given that New York will be an early market for them. But they also want to open doors to possible, as yet unspecified alliances or just somehow make something good happen, whatever that might be. If nothing else, Freedman hopes the meetings will generate leads for more meetings. "If they can't help me, maybe they play golf with someone who does," he says.
Freedman believes that start-ups need a certain amount of serendipity to succeed and that this serendipity comes to those who go out and take meetings. "Serendipity is a function of how compelling your story is and how many times you repeat it to people," he says.
That theory is just one tidbit from a vast repertoire of rules and advice that Freedman, 32, has gathered as a Dartmouth M.B.A., a founder of two previous companies, and a hard-core networker in Silicon Valley. Freedman passes much of this wisdom on through his blog, humbledMBA, which has become a favorite among young entrepreneurs. They eagerly soak up Freedman's lessons on how to take a kernel of an idea and turn it into a thriving business, a process that's currently consuming pretty much every minute of his waking life.
What Freedman does not want to get out of these meetings is the one thing most people seem to think he wants: money. That's because he believes that you should take as little money as possible early on, to protect the value of your shares down the road, when you really need the cash. Plus, good entrepreneurs don't ask for money, he says. They ask for advice and partnerships so they can refine their ideas and make them terrific, after which the money will flow unbidden.
What Freedman and Woodworth are specifically sharing at the meetings is Chapter Seven of their company. Freedman calls the successive iterations of his venture chapters. "Entrepreneurs tend to get too fond of their ideas, and that makes them resistant to change," he explains. "It feels like having to let go of your dream. But calling it a chapter acknowledges up front there will be more chapters. A chapter is easier to let go of."
That trick must work, because Freedman has been able to let go of six of them so far. What 42Floors actually does has, at times, radically changed from week to week. But Chapter Seven might be the co-founders' last shot. They have just three months left to polish their business model and create a website before presenting the results to the powers that be in Silicon Valley, a showing that will probably make or break the company.
Given that commercial real estate brokers wield all the power in the industry and would seem to have little to gain from being dragged into the digital age, 42Floors's mission initially strikes almost everyone who hears about it as quixotic, naive, misguided, or outright doomed. In other words, it's clear Freedman has a lot of minds to change. Yet Freedman has in fact been steadily changing them, and in all corners of the Internet and real estate industries. His unwavering confidence is palpable. It stems, he says, from another of his many beliefs, one that happens to be a sort of prime directive. "If you have a good team, an industry with a big problem, and a product that can solve it with technology, you have the makings of a hit company," he says.
His theory is about to be put to the test in a big way.
The introduction to Freedman's seven-chapter saga started about a year ago, when he was driving to Lake Tahoe with his girlfriend, Jennifer Karol, whom he had met online a few months earlier. She had had enough of listening to his tech start-up talk and had started telling him about her job at a large commercial real estate firm. Freedman winced. He was looking for office space, and it was the bane of his existence. He didn't want to spend his time off hearing more about it.
"Fine," said Karol. "We can talk about our relationship."
"OK," he said, sinking back into his seat. "Tell me about commercial real estate."
So she told him how commercial real estate really works. How tenant brokers—as opposed to listing brokers, who represent landlords-thrive by keeping listing data as proprietary as possible, so that companies looking for office space are dependent on their broker to know what's available, what's good and bad about particular spaces, and whether they're priced fairly. How a company called CoStar dominates the listings data business, making information available only to brokers, and at a cost of $5,000 a year per computer. How the industry's opacity is the key to generating some $25 billion a year in commissions globally.
And if you were a relatively small company looking for, say, 2,000 square feet for 10 employees, your problems got worse. You really weren't worth much of a good broker's time. Though smaller deals account for 80 percent of commercial leases, they provide only about a quarter of brokers' revenues. The result: Small companies often can't get decent information.
Suddenly, Freedman's own real estate woes made sense. He started peppering Karol with questions. For someone who had tried to avoid the subject, he suddenly seemed awfully interested. In his mind, at least, Freedman had just started his third company.
From the get-go, the venture seemed to have all the makings of a loser. The Internet world is littered with the bodies of commercial real estate start-ups that tried to limit brokers' ability to lock in tenants and rake in big commissions. Why would brokers want to pass on the needed information to a company that was trying to cut them down to size?
Freedman was no stranger to the sorts of obstacles that can keep a company from getting off the ground. His first start-up flopped. Called Openvote, it let communities debate and vote on issues. Freedman co-founded it with a friend while still at Dartmouth's Tuck School of Business. They folded it after struggling for two years to reach profitability, leaving Freedman with so much credit-card debt that he had to hunt for bargains in supermarkets just to eat. "I had tried to succeed by being the smartest guy possible, and that didn't work out well," he says. "My problem was that I wasn't surrounded by a community that could help me succeed."
Freedman took a job with a consultancy and, three weeks later, was at an airport. He called a friend to kill time after his flight was delayed. "I could have told you that flight was going to be delayed," the friend said. Freedman asked him how, and the friend explained how publicly available flight and weather information could be used to predict which flights would be delayed. Freedman's wheels started turning.
A week later, Freedman and his friend were at work on a new company, FlightCaster. And having learned from his last mistake, Freedman applied to Y Combinator, the celebrated Silicon Valley incubator that twice a year provides some 65 companies with about $20,000 each, the opportunity to spend three months of intense development in a collaborative environment, and a Demo Day at the end of the session to pitch VCs. Most important, they get the chance to tap into the wisdom of Y Combinator co-founder Paul Graham, whose ability to spot and help shape potential Internet winners is legendary. In the interview for the program, Graham ripped the FlightCaster idea to shreds, and then abruptly ended the meeting by offering Freedman funding and a slot in the next session. "I'm only that hard on the ideas I like," he explained to a flummoxed Freedman.
FlightCaster took off, making money by selling apps and providing flight information to corporate travel departments. Less than three years after its founding, Freedman was offered a sum for the company he will only say was "millions." He couldn't resist what seemed to him a staggering amount at the time. As part of the acquisition deal, Freedman agreed to stay on with the company for a year. Toward the end of that year, his final assignment was to find new office space in the Bay Area.
With his employment coming to an end, he had vowed to do not much of anything for a year, especially not start another company. But the truth was, he was already itching to get back into the game. A big reason: He felt he had bailed on FlightCaster much too soon. "It's fear that makes founders do that," he says. His realization: "You have to have a big number in mind when you start a company, so you don't take the first decent offer that comes along." The experience left him yearning for another shot to take a company big.
And that's what called out to him about commercial real estate. It was one of the last big markets to hold out against the online world. Like Everest or K2, it loomed in front of him, daring him to tackle it, no matter how many others it may have crushed. And with $25 billion in broker commissions potentially in play, the payoff could be spectacular. Freedman began writing his chapters.
Chapter one: "Hackerdesk." Early-stage start-ups need much less space than any broker is going to bother with. Meanwhile, other small companies are often forced to take more space than they need. The win-win solution: Let the companies that need space rent from those who have extra. It could all be done online, no brokers needed. It was a great idea, but one month into it, a company called Loosecubes launched a similar service, which has since taken off.
Chapter two: "Lending Tree for brokers." Brokers would compete online for customers' business, by lowering their commissions and offering better service. Brokers made clear that this would happen over their dead bodies.
Chapter three: "About Me" for brokers. Brokers would simply sell themselves on the site. No one liked this idea.
Chapter four: "Ratings." The site would evaluate brokers and award the best brokers special citations. Also popular with nobody.
Now, a few months in, Freedman was discouraged. He had been determined to come up with an idea good enough to get him back into Y Combinator for the session starting in January 2012—just months away. Even worse, he felt responsible for wasting the time and effort of the other co-founders, former FlightCaster employees Jon and James Bracy and Ben Ehmke. The Bracy brothers, who are fraternal twins, grew up with missionary parents in Papua New Guinea and taught themselves programming after moving to Vermont at age 13. Ehmke is a graphic designer from Texas who proved adept at whipping up eye-catching, highly functional websites. For each chapter, the team members had thrown themselves into producing slick demos, only to have to throw it all out. "I felt I was letting them down," says Freedman. "And anyone could have told me what the problem was. I just didn't know enough about commercial real estate to build this company." He had learned as much as he could in several months. But now he felt he needed years of knowledge to get it right.
Freedman was at his desk, feeling distressed and unsure about what to do for the next chapter, when his phone rang. It was a friend of a friend looking for advice about how to break into the world of Internet start-ups. After Freedman sold FlightCaster and started his blog, he had been getting a lot of calls and e-mails like this. He never turned anyone away. The caller explained how he was looking for meaningful work, having just left a job he hated as a data analyst for a large commercial real estate firm. "Stop talking," Freedman said. "Can you meet me right now?" The caller was David Woodworth. That serendipity thing. By the following week, the two had come up with Chapter Five.
Chapter five: "Online dating for brokers and tenants." The idea was to help match tenants' needs with brokers' specialties and skills, and to alert tenants to brokers who did sleazy things.
Freedman was so sure they had a winner that he decided to bounce the idea off Graham. Graham gave him 30 seconds. "That's not interesting," he opined, after listening to the pitch. "You should be showing spaces." He walked away, leaving Freedman to slink back to his co-founders with the bad news.
"I was pretty freaked out," recalls Woodworth. "Jason told me we could still get into Y Combinator. All we had to do was come up with something completely different in the next two weeks."
The good news was that Graham's brief comments had gotten right to the heart of the issue. They had been struggling to solve a problem no one cared about—finding the right broker. What tenants cared about was finding the right space. That was what 42Floors had to be about.
Chapter six: "We're brokers." The company would be an online brokerage, employing actual brokers, who would do all the usual broker stuff, except do it online. Brokers assured them 42Floors would never win a single listing, and tenants said they wouldn't trust online brokers.
Chapter seven: "Kayak for commercial real estate." Search for the kinds of spaces you want, see photos, read what brokers say about the spaces, narrow things down to a few choices, then get handed over to a broker. The listing data would come from owners who wanted more exposure for their spaces and tenant brokers who wanted to impress tenants with their knowledge. Revenue would come from advertising from tenant brokers.
Bingo.
Chapter Seven passed the Paul Graham test: It got 42Floors into Y Combinator. A month later, in December, Freedman and Woodworth are in the lobby of the Ace Hotel in New York City, meeting Alex Bresler, an angel investor whose family owns a lot of real estate. Freedman has his Mac open on a coffee table and is showing Bresler a demo of the 42Floors site. The home page is dominated by a huge, lush photo of the sort of open, warm, sophisticated space every tech entrepreneur dreams of. Bresler loves what he sees and says he's eager to have the commercial real estate business brought into the 21st century. He points out an opportunity: After a user picks out a space, 42Floors could offer to set the user up with office furniture, which typically sells at a high margin.
Afterward, Freedman says that last idea resonates with something he had been told earlier that day by Joel Spolsky, co-founder of Fog Creek Software and a popular tech blogger. Spolsky didn't think much of 42Floors's chances, warning Freedman that he was—yet again—trying to solve the wrong problem. As someone with experience looking for modest amounts of office space, Spolsky insisted the real pain came not from the few weeks it took to find the space but from the nine months it took to build it out. Was serendipity trying to tell Freedman something?
But Freedman is wary of the idea. Besides requiring the team to lose its tight focus on helping tenants find space, providing furniture and services is the sort of business that VCs are much less enamored of, because it's "linearly scaling"-that is, as more users sign on and revenue increases, the costs of labor and goods go up proportionately. In contrast, a pure information service can handle a big increase in the number of users without incurring many incremental costs, sending profits soaring. Plus, says Freedman, being responsible for providing furniture, painters, and electricians could be a logistical and customer service nightmare.
Next, Freedman and Woodworth visit a top executive at a big New York commercial real estate brokerage. The executive quickly brushes aside Freedman's pitch, launching into an explanation of how his company needs a better online way to present listings to big clients. Freedman, who for once seems a bit flustered, tries to steer him back to their model, where listings are focused on smaller spaces. It's a way for new brokers, who normally are consigned to the deep hell of cold calling potential tenants, to differentiate themselves and win clients more efficiently, Freedman explains. The executive persists. "Big-block brokers won't benefit from this," he complains. "Why not offer something that lets you tap into big deals?" Freedman counters that the system already works for big tenants. It's the 80 percent of the market chasing smaller space that has a problem. The executive seems disappointed but does concede a crucial point: He would like to see CoStar get some competition. The executive offers to poll his brokers. If they're in favor of it, he will share the company's listing data with 42Floors.
Freedman insists that was sort of a win, in that getting data is crucial. He adds that the industry's focus on big customers is exactly what has left the door open for 42Floors to score. "Successful start-ups usually get big by starting with the small stuff that no one else was worried about," he says.
Next up is a midsize brokerage that also owns property. The manager seems receptive but emphasizes that many deals happen not with listed spaces but with so-called secret, shadow, or rumor spaces—vacancies that are sniffed out by brokers before the spaces ever hit the market. Freedman insists that 42Floors can reach that market by giving brokers incentives to share this information online. Doing so will make the brokers look good to the community of online users and help them close more deals. The manager also worries that allowing brokers to comment online will result in spaces getting badmouthed, perhaps unfairly. Freedman promises those problems will be solved by moderators. The manager seems cautiously approving and notes that he certainly wouldn't hesitate to provide listing data on the properties his company owns. Freedman seems satisfied.
A week later, the team members have moved into a rented house in Redwood City, California. They will stay there for the three months of the Y Combinator session as they whip the company into shape. The house is in a residential neighborhood miles from anything interesting. The goal is to keep everyone inside together, focused and working side by side. The main workspace is a large table in the living room topped with Apple computers. Freedman and sometimes Woodworth spend all day meeting with real estate execs and investors, while Ehmke and the Bracys mostly stay at the table. After a short dinner break, the team often works until 1 a.m.
Some distractions are needed, of course, and the house is equipped for that, too. There's a jukebox, a slot machine, a chess table, and, in the backyard, a mini-golf green, a Jacuzzi, and a Ping-Pong table. But breaks are brief. The time pressure is constant and explicit. Freedman has posted a paper countdown pad in the middle of the house that shows how many days are left until the company launch. Every night, he ceremoniously rips off the top number. "Right now we need to be obsessed," says Freedman.
Much of Silicon Valley's business is done in coffee shops, and one morning Freedman heads over to a Peet's Coffee in Burlingame to meet Bob Ghoorah, an investor who works closely with Marc Andreessen, the legendary co-founder of Netscape. Ghoorah has met with Freedman before, and that makes this meeting crucial. Second meetings are often when top Silicon Valley investors make their judgments, because they have had a chance to see how much progress the founders have made since the first meeting. Ghoorah had been interested at the first meeting but was skeptical that brokers would hand over data, and he didn't like the advertising-based revenue model. Freedman explains that the model has changed: 42Floors will now make money by taking a percentage of brokers' commissions. This will convince brokers that 42Floors wants to make sure they close deals, argues Freedman, so they will want to hand over data. Freedman also talks about possibly offering build-out services.
Ghoorah likes everything he's hearing. "We paid twice as much to provision our space as we did to lease it," he says. "It's a bigger market." He predicts that if 42Floors can establish even a small foothold in New York, it will quickly become a $100 million company. He adds that VCs are going to be fighting over who gets to fund it. Freedman asks Ghoorah if he would like to invest $10,000 as an adviser. "Absolutely," says Ghoorah, without blinking.
Freedman is ecstatic afterward. The credibility of having Ghoorah as an adviser is huge, he says. He would rather not give away shares this early, but advisers take their commitment more seriously if they are at least lightly invested, he says, and it doesn't hurt to have seed money. But the build-out service thing still makes him nervous. Is such a labor-intensive service too much to take on? And pricing could be complicated…could the company offer flat-fee pricing on services?
Next, during successive meetings at the offices of two VCs, the reviews are mostly positive. Sunil Bhargava at Tandem loves the site,but he thinks Freedman's plan to start with listings from the Bay Area is a mixed blessing—tech start-ups will be all over it, but it's a brokers' market, because space is extremely tight. Most spaces go before they are listed. And Bhargava is hesitant about offering services. "Getting into interior design is heavy lifting," he says. "That worries me a bit." But Ryan Spoon of Polaris is hugely enthusiastic about the service aspect, noting that he went through the tortures of the damned to find the people needed to get his elegant offices outfitted. "We can Apple-fy the process," says Freedman, referring to Apple's reputation for making tricky technologies user friendly. "And we can definitely do flat-fee pricing."
The last meeting of the day, and one of the last before Y Combinator starts, is one Freedman has been anxious about. It's with Jonathan Siegel, founding partner at RightVentures. Siegel knows a lot about real estate, of which he owns plenty, and technology, in which he has made a bundle as both a founder and investor. Freedman has met with Siegel twice before. The first time, Siegel saw Chapter Five and pronounced it useless. The second time, Siegel saw a very early version of Chapter Seven and said it might be workable but found 45 things he hated about it. "He may be the hardest guy to convince in all of the Bay Area," says Freedman. "And he knows what he's talking about."
Siegel listens to Freedman explain the latest version and immediately starts firing off a stream of questions and suggestions—more than everyone else had in the past six meetings combined. The intense barrage lasts for half an hour. At the end of it, Siegel asks if he can invest as an adviser.
"Now I know for sure we've got something big here," says Freedman afterward, looking exhausted and content. Then he and Woodworth try to figure out how to work some of Siegel's suggestions into their business model.
When the company launched in March—a week before Demo Day and just as this article was going to press—Freedman had a few new reasons to believe he may have a hit on his hands. The founders of the other 64 start-ups in Freedman's Y Combinator session voted 42Floors the best start-up of the batch. And a slight twist on Chapter Seven now has tenant brokers eligible to receive clients from 42Floors only if their firms share listing data with the company. That little change has brokers lining up to share information. Build-out services will be offered soon.
Paul Graham says if anyone can pull off the digitalization of commercial real estate, it's Freedman. "Starting up a company is riskier than people can comprehend," he says. "You have to give it a level of attention that will seem excessive to any normal person, and that's what Jason does." Graham adds that part of the reason he and many others are pulling for Freedman is that he's so nice. "He is genuinely the menschiest guy we've ever funded," says Graham.
VC interest in the company continues to mount. Before launch, Freedman had accepted only one substantial investment—making an exception because of the prestige it confers: $200,000 from Ron Conway, one of Silicon Valley's so-called superangels. Freedman says he will open his doors to investment negotiations at the end of Demo Day and close them two weeks later. He aims to take in $2 million to $3 million.
Meanwhile, Freedman has tied up one other loose end. He finally had that relationship talk with Jennifer Karol. They are now engaged.
David H. Freedman is a contributing editor for Inc. He wrote for the December/January issue about Evernote, Inc.'s company of the year.
Start-up Proverbs
Now launching his third company, Jason Freedman has developed several rules and principles, which he shares on his blog, humbledMBA. Here are a few of them:
- If you're worried about protecting your great business idea from potential competitors, you're not getting the feedback you need to have a chance at making it work.
- It's not the amount of money you raise, it's who you raise it from.
If your idea is really unique, you're doomed. The market is either too far behind you, or it's too small.
Don't close deals. Build relationships.
When no one has succeeded in a market, it's because everyone has missed something. Figure it out, and you've got a great business.
If you're not getting feedback from customers, it's because they don't like you, and you're going to die.
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