I’ve run two business incubators targeting start-ups. It was exciting to work in an environment where you’re in essence building a community of like-minded entrepreneurs with the goal to build a successful company. Sounds relatively easy – you’d be surprised!
In the incubator that I ran for 10 years, I incubated cohorts of 15 entrepreneurs three times a year. They were the definition of start-ups, meaning, in most cases, they had the beginnings of an idea but needed it to be fleshed out in a business plan to prove it’s viability. We provided support financing while they proved the concept, found growth financing and developed the business over the course of a year.
We gave them 12 weeks of intensive workshops on everything from choosing a business name to income statements coupled with access to an Entrepreneur in Residence as well as mentor/coaches. Many pivoted from their original idea but most proved that with support businesses could thrive.
Successful businesses in Canada are defined (by the government) as still being in business after a year. Certainly not a dynamic threshold or a milestone to be proud of but nevertheless it does provide a benchmark. The stats are frightening – only 15% – make it one year so there are a lot of failures. My incubator had it’s own milestone. The government strictly monitored our stats as they were part of the funding model. Our success rate for all businesses that went through the program and were still in business 2 years later was an astonishing 93%. It definitely proved that with mentoring and education businesses could be successful.
There are few resources available that can match what we gave entrepreneurs because money is being funneled into high tech accelerators instead of the basic ideation start-up. Investors, and founders, want, and demand, more complicated and more financially based support for their corporations and accelerators are filling the need.
While traditional business incubators are often government-funded, offer training versus seed money, generally take no equity, and focus on product-centric companies, accelerators can be either privately or publicly funded and focus on a wide range of industries.
According to The International Business Innovation Association (INBIA), an organization dedicated to advancing incubation and entrepreneurship, “Business incubators nurture the development of entrepreneurial companies, helping them survive and grow during the startup period, when they are most vulnerable.” Quite often, incubators take the shape of physical spaces where startup companies work alongside other startup companies until the startup has grown in size to the point it needs its own space.
INBIA reports that 93% of incubation sponsors are non-profit organizations, the majority being academic (32%) in North America, and followed by economic development organizations (25%) and government entities (16%).
Alternatively, the organization sponsoring the accelerator could be a successful founder or venture firm that has a proven business growth methodology that they use to train the participants and scale their businesses.
The differences make the accelerator more appealing to the aggressive start-up wanting faster growth versus ideation support.
- Accelerators focus on scaling a business while incubators focus on innovating new business ideas.
- Accelerators operate in a set timeframe. Incubators largely have no schedule.
- Accelerators have a more competitive application process. Incubators have application and graduation guidelines.
- Accelerators use experienced Entrepreneurs-in-Residence to focus on the specific growth needs of the start-up. Incubators give access to mentors from across the industry
Accelerators typically provide seed financing in return for equity so they are in much demand making the application process highly competitive. Incubators are more founder focused while the accelerator is concerned with the company and its talent pool.
While incubators have been around for more than 30 years accelerators are relatively new to the start-up scene. The first seed accelerator Y Combinator, started in Massachusetts, in 2005 followed by Techstars (in 2006). With the huge success found in tech companies’ liquidity events and M&A’s, accelerators have become the place to get into and the scene has ‘accelerated’ to a world-wide phenomenon. The competition to get into the big accelerators in the US is tough at a 1-3% chance but the benefits are staggering.
Accelerators have become known for fast growth of top selected companies so they provide a feeding frenzy for investors wanting to capitalize on the accelerator’s selected start-ups.
A feeding frenzy? You bet! When you look at the first accelerator, Y Combinator, now based in Silicon Valley, it has spawned some billion-dollar startups notably, Airbnb, Dropbox, Reddit, Zenefits, and Instacart. it’s success has fuelled the accelerator field resulting in hundreds of copycat accelerators, using Y Combinator’s best practises.
That’s not to say that all accelerators are bringing investors into a dog and pony show. Most accelerators are actually Venture Capital funds that feel that by nurturing these start-ups they will be the first in line to benefit from their investment.
What’s the typical business model that creates this success?
- Raise a private fund from angel investors and venture capital firms. Sometimes start-up mentors and accelerator founders also invest in the fund. The fund usually has a limited purpose and lifespan and is intended to support a single accelerator class or cohort of startups in a single year or a small number of years.
- Actively recruit and then select a group of startups at the right stage of development for admission to the program. Some accelerators admit up to 10 startups per class. Some admit dozens per class. Upon admission to the program, invest from $10K to $100K into the startups for a set amount of equity or as a convertible note, to be held by the accelerator investment fund. The equity amount is usually a maximum of 10%, so there’s lot of wiggle room for investors in future rounds.
- Put the startups through a 2 or 3 month development program that usually involves free office space, mentors, research, development, coaching, training, networking, investment pitch practice, etc. There’s usually a package of free and discounted services available to the startups, like PR, accounting, web hosting, graphic design, etc. Almost all provide some mix or variation of this list. Networking in the form of open houses, pitch nights, forums and others, is usually considered the most important and impactful component.
- Put on a Pitch Day where the startups make public pitches to investors and the community. Follow-up is an important part of the pitch with ongoing mentoring of the startups about how to attract, structure and accept investments.
- Some accelerators do follow-on investments into their top performing startups at the end of the program, often as a co-investment with other outside investors.
- Eventually (usually within 3 years) a liquidity event occurs. A few of the startups will get bought by larger companies, get re-capitalized in some way, go through an IPO, or otherwise reach liquidity for shareholders. The accelerator will then liquidate its shares, pay back its investors their initial capital and split the remaining profit between the investors and the management of the accelerator.
The accelerator space is very crowded with thousands of quality operations looking for the most talented start-ups. The accelerators have a simple philosophy, get the best, get many and hope that one in ten is a mega hit. It’s certainly a numbers game but for the most part accelerators are good for venture building as well as for the investor.
The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer