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Are We in an Accelerator Bubble?

Posted on Monday, Feb 10th 2014

In a recent special issue on digital startups, The Economist writes:

The exact number [of accelerators] is unknown, but, a website that provides services to accelerators and similar startup programmes, lists more than 2,000 worldwide. Some have already become big brands, such as Y Combinator, the first accelerator, founded in 2005. Others have set up international networks, such as TechStars and Startupbootcamp. Yet others are sponsored by governments (Startup Chile, Startup Wise Guys in Estonia and Oasis500 in Jordan) or big companies. Telefónica, a telecoms giant, operates a chain of 14 “academies” worldwide. Microsoft, too, is building a chain.

Predictably, many observers talk about an “accelerator bubble”. Yet if it is a bubble, it is unlikely ever to deflate completely. Accelerators are too useful for that. Not only do they bring startups up to speed, provide access to a network of contacts and give them a stamp of approval. They also perform a crucial function in the startup supply chain: picking the teams and ideas that are most likely to succeed and serving them up to investors.

In this post, we will discuss are we or are we not, and what is the prognosis for the trend?

It is, for sure, a trend.

For the purpose of this article, let me also get some terminology straight:

  • For the most part, incubators and accelerators are terms often used interchangeably. The distinctions that The Economist makes are not necessarily industry standard.
  • Technically, incubators are supposed to work with formation-stage companies, while accelerators with existing businesses. In reality, incubators that take equity are also looking for acceleration opportunities in ventures that feel viable. Similarly, YCombinator would work on formation-stage ventures, even though it calls itself an accelerator.
  • We (1M/1M) do both incubation and acceleration.
  • There is another category of players: co-working spaces. There has been some confusion in the industry with co-working spaces calling themselves incubators or accelerators.
  • At any rate, all of the above fall within the purview of this article.

The Economist article touts how selective the programs that are doing well are: YCombinator, Techstars, 500 Startups.

Applicants are rigorously screened and the best invited for interview. For the latest batch, 74 (including six not-for-profits) were selected from a field of more than 2,600. Those lucky few get paid between $14,000 and $20,000 to attend. In return they have to hand over about 7% of their firm’s equity.

Y Combinator is still the most successful startup school. Its boss maintains a steely control reminiscent of Apple’s late Steve Jobs, but others adopt a more open approach. TechStars, the model for most accelerators, has even created a Global Accelerator Network for startup schools. This is not an entirely disinterested move: it aims to create a platform for like-minded organisations in which its programmes will have Ivy League status.

Founded in Boulder, Colorado, by David Cohen and Brad Feld, two angel investors, TechStars is also highly selective and takes an equity stake in the companies it accepts, and it, too, admits new startups in batches for three months at a time.

And uses as success metric how much funding the portfolio companies have raised and the exits they have experienced:

It will take time to find out whether those hopes are fulfilled. Most accelerators were established after 2010, and most startups that have gone through them are still works in progress. Research about accelerators is in its infancy and there are no generally agreed ways to evaluate their performance.

Still, a financial picture of the industry is starting to emerge. Jed Christiansen, who works for Google in London, tracks 182 accelerators which have nurtured more than 3,000 startups. Between them, those have raised $3.2 billion in follow-on funding and generated “exits” worth $1.8 billion. This landscape is dominated by American firms, with Y Combinator and TechStars franchises leading the pack. This suggests that accelerators are a winners-take-most market.

The prevalent business model of the industry is equity in exchange of small amounts of pre-seed and seed capital and lots of training.

In a Harvard Business Review article last summer, I discussed The Problem with Incubators and How to Solve Them. [This applies to accelerators just as well.] I strongly recommend you read that article, as well as the discussion in the comments (over 75 of them, sorry!). It underscores the basic flaw of The Economist article:

Most incubators use funding as a success metric, which is a somewhat flawed criterion. Over 99% of companies should operate as organically grown, self-sustaining businesses — bootstrapped, without external financing. For them the goal is to achieve customer validation, not financing. Yet if the incubator uses financing as its success metric, it will try to force inexperienced entrepreneurs into an unnecessary financing round. And more often than not, they will fail.

Nowhere in the article does the question ‘how much revenue has been generated by these companies?’ get asked.

As you know, I run 1M/1M, an incubator/accelerator.

We keep our eyes focused on customers, revenue, and profit.

Financing and exit are optional in our worldview.

We are also completely inclusive, and are able and willing to work with both companies who have gone on to raise $10M+ in financing, as well as bootstrapped businesses generating $30k in revenue, and trying to grow to $1M in the next 3 years. Even zero-stage ideas or pre-idea stage entrepreneurs yet to quit their day job are within our scope.

We’re proud of the fact that we do ‘real’ incubation – taking ventures from idea to revenue – which can seldom be done in 3 months.

We’re also proud of our acceleration work in taking companies already doing a million in revenue to $3M. That requires significant  strategic and operational tinkering.

And all that leads me to believe that the accelerators that try to focus on financing and exit, for the most part, will get wiped out. Perhaps the top 10-20 will survive with that model. The government sponsored ones will also chug along, because they don’t have to show performance or success. But those that are trying to be businesses with a viable business model will mostly fail, simply because developing venture-fundable and exit-worthy businesses is a highly specialized skill. It just doesn’t exist in large numbers – not among entrepreneurs, nor among incubator managers. And most regional eco-systems lack yet another resource – seed financing. Most seed eco-systems are very small, and even investors with that skill-set are limited in number.

If you follow this logic, I think, you would conclude that yes, the accelerator/incubator bubble will, inevitably, burst.

But wait, there is hope. In the HBR article, I conclude with that promise of an alternative model that needs to emerge:

My primary conclusion is that incubators need to be decoupled from financing. While they need to continue to act as a bridge to capital, predicating their success on getting businesses funded will keep them focused on trying to find the less than 1% of start-ups that are fundable.

Trying, and not finding.

Better, focus on customer, revenues, building profitable, sustainable companies instead of being obsessed with financing and exit.

Tweak the business model to either dividend-generating equity, or interest-generating debt. Or a small fee for the services.

Those are the options if the industry is to become a thriving, sustainable one.

And like The Economist, I do believe incubators, accelerators and co-working spaces all have useful roles to play in the nurturing of large numbers of entrepreneurs, and checking the massive infant entrepreneur mortality we see in the startup business.

I just hope that the industry doesn’t kill itself by being stupid.

Note: 1M/1M’s business model is a $1000 annual membership fee. Companies can keep using the program as long as they wish to.  ROI: Equivalent of $375k + 5-10% equity.

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