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Summary

This is the first article in a series on seed and venture accelerators, describing what they are, their potential impacts on the incubation industry and possible ways incubators can benefit from the accelerator model.

What are the new seed or venture accelerators?

by Dinah Adkins

June 2011

When Paul Graham launched Y Combinator in 2005, he set off the spark that created an explosion of so-called seed or venture accelerators that has excited the investing world and affected the environments in which many business incubators operate. Graham initiated a movement of investor groups that make relatively small investments (when compared with most venture capital or even seed investments) but do so in up to 40 companies a year – more than formal VC firms back in a decade. "We are mass-producing the start-up," Graham reported to Inc. magazine in June 2009.

The model has been called "spray and pray" because Y Combinator and most of its clones generally invest only $5,000 to $8,000 per founder – and no more than $18,000 to $25,000 per company – primarily in mobile apps, cloud computing, social media, gaming and entertainment, and Web services. In addition to making highly selective, small investments in multiple companies, these venture accelerators also usually bring would-be entrepreneurs together for 90-day boot camps. Mentors and serial entrepreneurs give boot camp participants an immersion course in developing their products, presenting to customers, and preparing to pitch to additional investors. (See "Common traits of incubators and accelerators" for a comparison of the attributes of seed accelerators versus business incubators.)

Blogger Robert D. Shedd, formerly of the seed accelerator DreamIt Ventures, estimates that more than 130 seed accelerators are currently in operation around the world, and they are spreading rapidly. Since Y Combinator was first explored in depth in Inc., it has had high returns. (The accelerator reportedly had three exits totaling $250 million in the fourth quarter of 2010, resulting in about $5 million in revenues.) Earlier this year, investors Yuri Milner and Ron Conway announced they would invest $150,000 in convertible debt in every Y Combinator start-up sight-unseen – a tremendous statement of confidence in Graham's accelerator model.

The successes of Mark Zuckerberg and Facebook, Twitter and other rapidly growing new media businesses have ignited dreams of wealth in the code-writing or "hacker" community. In May, the Economist reported secondary-market trade values of $76 billion for Facebook and $7.7 billion for Twitter. The investors backing seed accelerators (which take equity stakes in investees that average around 5-6 percent) would be happy both to create similar breakthrough firms and to share in the tremendous wealth these companies are generating. Like other angel investors, they expect eventually to liquidate their holdings through an acquisition or initial public offering (IPO).

Seed accelerator boot camps push releasing products or apps early ("fast test") to obtain customer feedback, and then focus on iteration of the product and business model until they can be validated. The point is to invest only enough to run a lean company, avoid costly failures and make necessary product changes before larger investments are needed. Accelerator-supported entrepreneurs are primarily young men who move to the site of the boot camp, where they may live in dorm-like conditions as they focus on their product and business.

During the dot-com boom, many Internet companies had to create infrastructure that might include warehouses and delivery mechanisms (think Zappos). But the base infrastructure of many new mobile apps and Internet products and services already exists via smartphones, Facebook, cloud computing and other resources. Thus, these firms can grow quickly on little cash.

Potential effects on business incubators

For a long time, the Ewing Marion Kauffman Foundation has pushed recognition that entrepreneurs are key to job creation and economic growth – and this has served to benefit all entrepreneur support programs including incubators. In a 2007 article, "Finding Business 'Idols': A New Model to Accelerate Start-ups," Kauffman authors lauded accelerators as "not your father's incubator," which they described as frequently just real estate.

True, there has always been real estate masquerading as business incubation, but knowledgeable industry participants recognize that graduation of successful clients is essential to true business incubation and critical to the definition of the term. Further, incubators led the way in developing comprehensive sets of business assistance services to address the needs of entrepreneurs.

Since TechStars and the Kauffman Foundation have program alumni working at the Federal Communications Commission and the Small Business Administration, there is some danger that seed accelerators will be promoted at the federal level to the detriment of business incubators. Yet despite their value, accelerators such as Y Combinator are primarily wealth creation machines – with that wealth going into the pockets of cashed-out entrepreneurs and other investors without necessarily providing community benefits or jobs.

Naithan Jones, director of Kauffman's FastTrac program, believes firms created by accelerators will not hire large numbers of people, pointing to Facebook, which brought in $1.7 billion to $2 billion in revenues with 200 employees in 2010. "The ratios have never been like that before," he says.

Accelerators are not for everyone; they have not yet been proven to work in significant science-based industries such as biotechnology, medical devices, nanotech or clean energy. And they have not as yet been shown to be significant sources of community job creation.

If accelerators are creating wealth for only a few, if they aren't focused on community development, and if the firms they are supporting are not high-volume job creators, they will not solve community problems. This is something economic developers should consider when assessing the value of an accelerator model for their community.

"Whether they can provide these services on a distributed basis [in more than major markets] is unclear," says Karl LaPan, president & CEO of the Northeast Indiana Innovation Center in Fort Wayne, Ind., an incubation program that provides services in 10 counties. What is clear is that accelerators are the "next new thing." Anybody who has a history in the business incubation industry recognizes that research parks and dot-com incubators were also once the "next new things," and that the interest they generated at various times threatened to diminish recognition of the validity of incubation.

"There are consultants saying go to stage-two businesses because that's where growth and employment is," says LaPan, "but for the life of me, I don't know how you get to be a stage-two company unless you have gone through stage one."

LaPan advocates diversifying and integrating multiple strategies for different companies at different stages. "We can't embrace these strategies – acceleration or economic gardening, another popular strategy that stresses helping companies to scale up – independently of advancing the entire innovation ecosystem," he says. He warns incubator managers not to see themselves as "niche players" but to go upstream [to earlier-stage companies] and downstream [to later-stage firms]. "Incubators need to drive the ecosystem – either partnering with others or developing the capabilities to work with companies at all stages," LaPan says. "We will be left behind if we don't."

A path forward for incubators

So what can incubators do to retain community support and not get crowded out? As LaPan says, "Go downstream," and that is what he's doing. He is positioning himself as an incubator and an accelerator, developing new services delivered in a compressed period.

"Accelerators are selling against us saying, 'We can move you further, faster and stronger than incubators.' We need to be able to say we can do that. We need to embrace the models that are out there and get the best of their ideas and marry them with what we need to do to serve our regional markets," he says.

Key elements of accelerator programs are competitive screening of applicants and the "fast test" process that quickly confirms a product, customers and business model, providing validation to investors. LaPan described this process as proof of relevance rather than proof of concept. Other major elements include the boot camps, in which entrepreneurs are brought face-to-face with successful entrepreneurs with industry experience, and "demo days," in which companies pitch to qualified investors.

According to LaPan, incubator managers can integrate all of those elements into their operations, though they would need to be tweaked to meet the needs of entrepreneurs in other sectors. These practices also can be adapted to address entrepreneurs who want to be "self-funded because they want to grow at their own pace and not be accountable to outside investors or individuals," he says.

The Kauffman Foundation might serve as a source of valuable information about accelerator best practices that incubators could adopt. The foundation operates the Kauffman Labs for Enterprise Creation, which is essentially an experimental accelerator program for a variety of market sectors.

The Kauffman Labs program surrounds entrepreneurs with skilled advisors, including successful entrepreneurs with sector expertise who fly in for intensive boot camps. Findings based on these efforts could help game-changing new businesses get started and help identify new and effective business-building practices.

Importance of incubator operational best practices

Incubators that fail to incorporate operational best practices – discussed in NBIA publications and on our Web site at www.nbia.org/resource_library/best_practices – may find the support they have received will wane in favor of new acceleration models. Further, incubators that are not best practices programs will likely not have sufficient resources to add new accelerator-like services to their mix of offerings.

Growing incubation programs and building sustainable business models by expanding services and collaborating with other agencies and providers are essential to help the incubator offer more to clients. "You can't do this with 1.6 staff members," says LaPan, who grew his program from $250,000 in annual revenues to $1.7 million.

LaPan points to the Louisiana Business and Technology Center in Baton Rouge, La., which has eight contracts from state and federal agencies and the local chamber, bringing in more than $1.1 million annually in addition to rents and service fees. These contracts – for technology stimulation, for statewide entrepreneurship activities, to fund a Small Business Development Center, etc. – provide more than 85 percent of total program revenues and expand the incubator's geographic reach and services.

LaPan also lauds San Jose's Plug & Play program for its "superior business model." P&P offers boot camps, provides access to name entrepreneurs and has developed "$200,000 in program fees from executives who pay Plug & Play to find their next gig." P&P will be a significant recipient of accelerator companies because it has a model that will be attractive to them, LaPan says.

Many incubators don't have a model that will attract accelerator companies after they are finished with 90-day boot camps. "Incubators need to be faster in moving companies through stage one (proof of concept/relevance) to stage two, where they are mentored, and providing access to follow-on third-party investment," LaPan says. "Ready-to-go infrastructure" (the idea of being able to "plug and play" the business) also will be essential if incubators want to serve as landing spots, according to LaPan.

Is a new tech-investing bubble brewing?

Many believe the answer is "yes." Bloggers and others are saying the new boom in venture accelerators is contributing to a new tech-investing bubble.

USA Today focused on the subject in a March 22 article by Jon Swartz and Matt Krantz, who wrote: "It's 2011, and here we go again."

Steve Blank, a longtime tech company founder who now teaches at Stanford, UC Berkeley and in a Columbia University/Berkeley Joint Executive MBA program, agrees. Blank's blog post, "New Rules for the New Internet Bubble," describes a history of start-up investing.

In 2000, the "bubble mantra of get 'big fast' and 'first mover advantage' demanded tens of millions more [dollars] to create a 'brand.' The goal was to get your firm public as soon as possible using whatever it took including hype, spin, expand and grab market share," he wrote.

According to Blank, Swartz and Krantz, signs of the bubble include:

  • Seed- and late-stage valuations are rapidly inflating.
  • Hiring talent in Silicon Valley is the toughest since the last bubble made talent acquisition difficult.
  • There is a rush to go public, with many new media IPOs expected.
  • Large companies are reportedly drinking the "Internet Kool-Aid," discussing acquisitions at extremely high valuations (e.g., Microsoft's acquisition of Skype for $8.5 billion).
  • Investors have dived back into technology investing due to the return of "get-rich-quick" schemes.

Jones of FastTrac also believes a bust is coming. "Everybody will go after the same market," he says. "It's me too; money follows money; it's like sheep." But Jones believes that before the bust, the companies in the sectors that accelerators are targeting will make a lot of money. This should, in turn, provide more fuel for the bubble.

Angela Jackson, co-manager of the Portland State Business Accelerator in Portland, Ore., says the potential bust may not come for several years, however. "We're coming out of a large drought," says Jackson, who is also an angel investor and co-manager of the new Portland Seed Fund, which is still raising investment. "In a couple of years, there may be a lot of money going after bad deals."

Will there be an implosion of accelerators?

If the dot-com boom and bust is a model for what's happening now, there will be.

TechStars' founder and CEO David Cohen recently projected such an implosion. Cohen and two friends started the TechStars accelerator in Boulder, Colo., in 2006 when only a few accelerators existed. In a March 29 article in Bloomberg Businessweek, Cohen suggested some 400 to 500 seed accelerators may spring up before a bust that could reduce their numbers to around 100.

But TechStars also apparently plans to play a significant role in the seed accelerator boom. On Jan. 31, the Denver Business Journal reported that the "Boulder-born incubator is expanding [its programs] to include entrepreneurship boot camps in 12 U.S. cities, creating a network of start-up accelerators that aims to create 25,000 jobs nationwide by 2015." The expanded network is part of the Obama administration's Startup America Initiative.

Additionally, TechStars in February announced a "member association" of 20 independent but dues-paying accelerators that will share resources. Almost immediately, the Kauffman Foundation provided $200,000 to this network to standardize seed accelerator application and reporting processes. The purpose of the partnership, according to the Feb. 16 news release, is "to create awareness of and simplify access to the growing number of credible seed accelerator programs globally."

TechStars will use the Kauffman money to build software for a "unified application processing and tracking system for seed accelerator programs across industries," making it possible for more firms to gain access to quality mentorship. However, the foundation noted at that time that an additional purpose of the effort is to make it possible to track the funding and business performance of companies served by the network over time.

Not all observers are convinced there will be a large implosion of accelerators, but they agree that perhaps some kind of washout is likely. Seed accelerator blogger Shedd says, "Businesses now see very clearly that this model is successful in terms of driving innovation, and there's definitely a ton of room for that."

Nevertheless, he notes that many accelerators are start-ups themselves and, "given the successful ratio of start-ups in general, a large number of them won't make it."

LaPan also sees an eventual washout, although he believes this may not occur for another five years. "Given they are well-funded and outstanding marketing machines, they will have staying power in the near term," he says.

Of course, a washout of accelerators doesn't mean the model doesn't have value. There also was a washout of incubators during the late 1980s and early 1990s. The programs that went under developed hastily in response to the buzz about the new economic development tool, and they did not have sustainable business models. That period was subsequently followed by years of stability and continuing growth.

An optimistic view

Jackson says she appreciates the tremendous growth in incubators, angel investors and accelerators. "I believe we need all parts, and the fit is really important," she says. "Companies that can move really fast and are in industries where that is the norm can really benefit [from accelerators]. But that's not everybody.

"You really cannot argue with the returns they've made to investors," she says, adding, "You can always throw money at a problem, but if you can throw expertise, money and coaching, your outcome is exponentially greater.

"In biotech, life sciences, anything where there's going to need to be a lot of grants and technology validation and exploration, that's clearly a longer trajectory and that shouldn't be a quick exit business," Jackson says. But the companies building products and services that are the focus of accelerators are probably "better placed in a boot camp because you get a quick go/no go decision … and those entrepreneurs will be itchy."

Jackson also notes that the 90-day boot camps have to end, "and all these companies have to find places to grow." Once the Portland Seed Fund closes its fund, the managers expect to conduct a boot camp, but the fund will not provide space. "We chose instead to utilize the ecosystem that we have here, which is excellent." Thus far, Jackson doesn't see competition, and she urges incubator managers to "hold to their guns."

But the best protection incubators might have could be incorporating commonly recognized incubator best practices and appropriate accelerator elements. To do this properly, incubator managers will need to tweak the accelerator model to meet the needs of local entrepreneurs, picking and choosing and, as LaPan says, "marrying" the best of these concepts with current practices.

Also, incubators that think of themselves as niche players need to stop and look upstream and downstream, he reiterates, "driving the ecosystem through partnering with others or developing the capabilities to work with companies at all stages."

LaPan sees incubation – with its rich national infrastructure for supporting entrepreneurs and innovations – as "the great equalizer," offering opportunities for both wealth and job creation. "Since entrepreneurship is place-based, any community can engage in it to grow jobs and companies locally and thus achieve these impacts in our regions," he says.

With this in mind, we can only hope that the new information developed by the Kauffman Foundation from the accelerator model will be shared – with both for-profit accelerators and the incubators that are the stalwarts of community economic development. The thousands of firms that come from these programs create both wealth and jobs, and they do so democratically, in communities across the nation. Surely, this is what Ewing Marion Kauffman would have wished.

Common traits of incubators and accelerators
  Business Incubators Seed Accelerators
Clients All kinds including science-based businesses (biotech, medical devices, nano, clean energy, etc.) and nontechnology; all ages and genders; includes those who have previous experience in an industry or sector Web-based, mobile apps, social networking, gaming, cloud-based, software, etc.; firms that do not require significant immediate investment or proof of concept; primarily youthful, often male geeks, gamers and hackers
Business Model Primarily (90 percent) nonprofit business model; for-profits created by corporations and investors Primarily for-profit business model
Sponsor Universities, economic development organizations and other community-based groups, sometimes with help from government Serial, cashed-out entrepreneurs and investors
Selection Process Competitive selection, mostly from the community Competitive selection of firms from wide regions or even nationally
Term of Assistance 1-5+ years (33 months on average) Generally 1-3 month boot camps
Services Access to management and other consulting, specialized IP, and networks of experienced entrepreneurs; assists businesses mature to selfsustaining or high-growth stage; helps entrepreneurs round out skills, develop a management team and often, obtain external financing "Fast test" validation of ideas; opportunities to create a functioning beta and find initial customers; links entrepreneurs to business consulting and experienced entrepreneurs in the Web/mobile apps space; assists in preparing pitches to seek follow on investment
Investment Usually does not have funds to invest directly in the company; more frequently than not, does not take equity Invests up to $18,000 to $25,000 in teams of co-founders; takes equity in every investee, usually 4-8 percent
Facilities Provides flexible space at reasonable rates throughout incubation period; many incubators also work with nonresident affiliates Provides meeting space during boot camps; some are beginning to provide longer-term space
Metrics Initial: revenue growth, payroll, capital acquisition, number of patents commercialized or filed, new products introduced, number of companies started, percentage of business survival and retention; long-term: ROI to community/university in the form of jobs, technology commercialization, industry sector/cluster expansion, wealth creation and economic diversification, among others Initial: sales, margins and third-party investments; long-term: ROI on investors' cash via liquidity events – sales, acquisition, larger investment rounds, etc.

 

Featured Sources

Angela Jackson, co-manager, Portland State Business Accelerator, Portland, Ore.

Naithan Jones, director of Kauffman FastTrac, Kauffman Foundation, Kansas City, Kan.

Karl LaPan, president & CEO, Northeast Indiana Innovation Center, Fort Wayne, Ind.

Robert D. Shedd, social games product manager, Paddy Power, Dublin, Ireland

Keywords: business plan – incubator, economic development, for-profit incubators, special focus incubator, technology incubator, venture capital

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