ntrepreneurial finance is like a glacier. What you see above the surface is little compared to what lies beneath it. Decades of government funding, university support, personal relationships—they all play a role in the success of startups. Increasingly, a critical actor in producing viable startups is the relatively new entity known as the startup accelerator. The most prominent of these is Y Combinator but there are many others.
As the name implies, accelerators act as catalysts to help accelerate an incipient business from a basic prototype to a refined product with a well-thought-out business model. In so doing, these businesses are often brought to the attention of venture capitalists who may elect to provide seed capital. Accelerators are part-lab, part-business school, and part-networking opportunity.
The benefits flow to both the startups who can audition before top venture capitalists and the VCs for whom accelerators are often a premium reservoir for deal-sourcing. Indeed, the power of the accelerator model is evident in that as of 2020, the top 10 graduates of Y Combinator were valued at $150 billion:
To be precise, an accelerator is a cohort-based mentorship program for startups that provides guidance, support and access to funding in exchange for limited equity. It is an intensive bootcamp with a streamlined timeframe of typically about three to six months.
The goal is to transform the initial prototype into a minimum viable product, validate the market, develop contacts to build the business and ideally obtain funding not just from the accelerator but from a VC to take the enterprise to its next phase of development. In the US, there are over 200 accelerators and many more globally which is a testament to their growing popularity as a tool to help support the viability of startups while providing venture capitalists with the deal sourcing opportunities that the industry craves.
Indeed, the VC connection with the accelerator industry is profound as many venture capitalists regularly serve as judges in accelerator programs. It is not uncommon for a startup that lost the grand prize in an accelerator competition to be contacted by VCs who were so sufficiently impressed that they decided to invest in what their colleagues regarded as a “loser”. It is in this way that the accelerator process can derisk a startup for investors by providing them with the confidence that the founders have actively thought through the profound complexities of bringing a new product or service to market. In a very real sense, there are participation trophies in accelerators which is just one of the reasons that competition to be admitted to them is so intense.
Aside from networking and access to funding, other advantages of accelerators include assistance in developing both product-market fit and a go-to-market plan; enhancing the communication skills of entrepreneurs by explaining how best to pitch an idea to VCs; articulating lessons learned from similar startups that failed; demonstrating the dynamics of a fund-raising cycle; and helping entrepreneurs to understand the potential pitfalls of term sheets.
Access to workspace and the ability to network not just with venture capitalists but with other entrepreneurs can also help as so much of success in entrepreneurship is human capital driven. In effect, an accelerator is an intense, time-bound, mini-cluster that can yield enormous benefits to motivated entrepreneurs.
The Benefits and Risks of Startup Accelerators
Arguably, the most important aspect of accelerators is risk management. While technologies will change and not every startup will initial obtain significant funding, the challenges of running a business are constant. According to Rehan Yar Khan, a Managing Partner at Orios Venture Partners: “For a startup to succeed, various functions such as product development, pricing, technology, operations, customer service, marketing, finance and HR management have to be cohesively performed. Execution of each of these elements has a direct impact on the performance of the venture."
The opportunity to help entrepreneurs understand how best to coordinate these functions with the unique pressures of resource-constrained startups can significantly reduce entrepreneurial risk which is a great benefit to startups and a major reason that venture capitalists flock to accelerators.
Another benefit to startups of participating in an accelerator program is that it can serve as a powerful signal to the investing community. Graduation from a top accelerator is a lot like graduating from a top business school in terms of the credibility it offers. Since entrepreneurship is inherently uncertain, these signals and credentials are important because as the saying goes: “Venture capitalists don’t invest in products, they invest in people.”
The more a team has been vetted by other rigorous actors, the more likely it is to be trusted to receive capital. At a minimum, the indication of participation in a top accelerator as a part of the business plan will make it more likely that the venture capitalist will read beyond the first few pages and consider following up. This ability to increase the chances of getting one’s foot in the door is critical in a venture capital and angel investing market that is rife with rejection.
A study of the academic literature on the impact of accelerators indicates that this observation is credible and that the impact of accelerators is even broader. According to the study:
- When compared to similar companies that did not participate in accelerator programs, those that graduated from top programs experienced faster realization in achieving key milestones such as time to raising venture capital, exit by acquisition, and gaining customer traction. Graduates of accelerators tend to have a 23% higher survival rate than new businesses that do not participate in one. However, this is not true of all programs because as the sample size of accelerator programs increased, impacts diminished. This suggests that there is a bifurcation in the accelerator industry with top programs having a disproportionate impact.
- When comparing graduates of top accelerators with similar startups that raised angel funding from top angel investment groups, it was discovered that the graduates of top accelerator programs were more likely to receive their next round of financing significantly faster and were more likely to be either acquired or fail. Hence, for good or ill, the top programs do accelerate the process.
- More so than access to financing opportunities, the key advantage of the programs is the intensive learning that they provide, particularly with regards to the ability to obtain insights and tacit knowledge specific to the startup experience.
- Accelerators have a beneficial impact on regional entrepreneurial and innovation ecosystems, particularly with regards to entrepreneurial finance. The accelerators attract capital and increase the number of investors in an area. Specifically, metropolitan areas with an accelerator have more seed and early-stage entrepreneurial financing activity; and it is not restricted to the startups in the accelerators but spills over to companies and startups outside the accelerators.
These benefits, particularly those related to regional economic development, indicate that accelerators are of salient importance not just to venture capitalists and startups but to the broader business community. They are now a foundational tool to nurture and support all business across an area, which has implications for public policy.
The benefits offered by accelerators are not without cost. The typical founder will be required to sacrifice 5-10% equity. Interestingly enough, the value of the investments of the top accelerator, Y Combinator, parallel important trends in the venture capital market. For example, the top 137 companies in Y Combinator’s portfolio of over 2500 companies have a combined market valuation of $300 billion so the top 5% of investments have an enormously disproportionate impact.
This is the norm in venture capital and why VCs are constantly trying to hit grand slams. But the figures for Y Combinator are particularly staggering as just 3 companies—Airbnb, DoorDash and Stripe account for 56% of its portfolio value and the top 10 companies account for 75% of that value:
The regional dynamics of Y Combinator’s investments are also quite interesting as they highlight a growing trend:
As can be seen, over half of all its investments are located in the San Francisco area. However, the rise of remote work in the wake of the Covid-19 pandemic, the decline of San Francisco as a desirable work location, and the growing attractiveness of different locales is driving a trend towards geographical diversification that is impacting the heretofore highly concentrated venture capital industry:
The younger startups in the Y Combinator portfolio are increasingly located outside of San Francisco. This bodes well for alleviating the overconcentration and regional myopia that the venture capital community has long been accused of.
It will also provide an incentive for venture capitalists to diversify their operations so as to gain access to opportunities in these other areas. Successful startups that migrate to other areas often generate other startups as talented employees cash out and then leave to start their own firms. So, while the requirement to sacrifice equity to participate in an accelerator is a cost of the program, increasingly, it is not restricting startups from migrating to burgeoning new areas to operate their business.
This data also speaks to the globalization of top accelerators like Y Combinator as they are increasingly admitting candidates from abroad who always attended to take the lessons learned in the accelerator and return to large growing markets like India to take their product or service to market.
Another important trend is the growth of the B2B market and fintech. Again, using the Y Combinator portfolio as a prism into how the market is evolving, it is evident that almost two-thirds of the startups in their portfolio are either B2B software and services or fintech:
Furthermore, although consumer is listed as 11% of the overall Y Combinator portfolio, that segment is in dramatic decline as it is not even included amongst the younger investments:
Part of the reason that venture capitalists look to work with accelerators as implicit deal sourcing partners is that their patterns of investment, which are typically subjected to high standards of due diligence, provide clues as to critical trends in the startup community.
Aside from the imperative to sacrifice equity, accelerators are not for every startup. There is a high opportunity cost as the startup team must be willing to sacrifice months away from their full-time jobs to work on the program. Not every startup team member may be able to do this financially.
Also, as noted earlier, unless one is admitted to a top accelerator, the benefits may be dubious. There is significant bifurcation with regards to value creation in the accelerator market. Mere participation in any accelerator is not a magic bullet. In addition, the program of the accelerator must be carefully considered. Some activities can add great value but there are also ones that may be mere distractions.
During the early phases of getting a business up and running, time is as important as money. An accelerator that wastes the founders’ time with useless meetings could put the team at a disadvantage in intensely competitive markets. There is always someone else working to address the market opportunity so unless the program is truly accelerating one’s chances of doing so, it is probably not worth it. Entrepreneurs need to vet accelerators carefully.
Incubators vs Accelerators
Arguably, the most important question that an entrepreneur should ask of themselves when considering whether or not to apply to an accelerator is: Given the stage of my project, is it best suited for an incubator or an accelerator? This requires introspection. While accelerators start with prototypes and refine them into a minimum viable product, an incubator is designed for an even earlier stage idea that needs to be developed into a prototype.
Accelerators are intense and time-bound, and participation in an incubator is more flexible and can extend over years depending upon the product being developed. If all one has is an idea and a business plan, an incubator is the best place to start as there is nothing substantial to accelerate. The advantage of an incubator is that one usually does not have to sacrifice equity but there are still some of the same benefits of an accelerator such as access to workspace, mentoring, and networking opportunities:
Due to the value that they add, admission to the top accelerators is a rigorous process with only the top 1-3% of candidates being selected. Again, this is part of the reason why graduates of these programs have an easier time obtaining funding as investors know that they have already been subjected to a rigorous evaluation process.
How does one navigate that process? The key is “the vision thing”; and clarity of communication. Like venture capitalists, the gatekeepers to the top accelerator programs are looking for startups that are both seeking to transform large markets and can provide evidence that they are able to do so through the team they have assembled or the prototype they have built. Good applicants focus not just on what the product does but also on its capacity to transform the world in which we live, work and play. Google is great not just because it is a great search engine but even more profoundly because it “organizes the world’s information.” Rapidly searching the web can be functionally done by many companies but organizing the world’s information is a visionary aspiration that only Google has truly achieved.
Secondly, it is important to demonstrate not just a product-market fit but a founder-market fit. Why is this team uniquely capable of capitalizing on this market opportunity? Thirdly, and not surprisingly, the market needs to be huge. The economics of entrepreneurial finance—and accelerators are as much a part of that ecosystem as venture capitalists—are that they need grand slams to cover for the consistent failures that are characteristic of the industry. This can only be achieved by disrupting and generating value in huge markets.
With that in mind, preliminary work to demonstrate that customers exist who will want to buy the product should also be provided. Finally, as part of the application process, a solid prototype with an idea about how to commercialize it to win market share from competitors should also be presented. All of this has to be expressed with clarity and precision because the reviewers are combing through thousands of applications. No matter how technically proficient and experienced the team, good writing skills are essential to the application process.
Top Accelerator Programs
There are a number of elite accelerator programs in the US:
- Y Combinator: Founded in 2005, Y Combinator is the pioneer startup accelerator. New cohorts of startups are admitted twice per year (January to March and June to August) with Y Combinator investing $500K (a $125k post-money SAFE in exchange for 7% equity and a $375k investment on an uncapped SAFE). Only 2% of 10,000 applicants are accepted. The program is three months in length and ends with a Demo Day during which startups present their achievements to an invite-only audience of venture capitalists and industry stakeholders. Aside from its financial impact, it is a thought leader in the industry.
- TechStars: Founded in 2006, TechStars has facilitated the establishment of over 1,000 companies valued at over $21.3 billion. The program is three months long and global in scope with over 50 TechStars accelerators across the world. Some of these are specialized around certain industries such as agriculture or proptech. It invests up to $120K in each startup for 6% equity. Overall, TechStars has made 5,536 investments with 434 existing.
- 500 Global: Formerly known as 500 Startups, 500 Global was founded in 2010. Its 500 Global Flagship Accelerator Program accepts applications in a rolling basis throughout the year and offers a $150 investment in exchange for 6% equity. The program is four months long. As the name implies, it is global in scope with operations in San Francisco, a Latin America Accelerator for Spanish-speaking founders in Mexico City, and accelerators in Seoul, South Korea as well as Kobe, Japan. It has made 3,061 investments with 359 exits.
- Google for Startups: Just as corporations have delved into the venture capital market, they are now participating in the accelerator industry. Google has a number of accelerators for underrepresented minorities and women as well as climate tech. Each cohort accepts 10 to 15 startups and receive training, credit for Google products, and three months of equity-free support. Google has made approximately 1,443 investments with 51 exits.
- Microsoft Accelerator: Microsoft also has its own incipient accelerator program which has graduated three cohorts. The focus is on cloud-based startups. This 10-week program includes $25 or more in Azure cloud computing services, licenses for Microsoft 365, a GitHub Enterprise license, and the opportunity to network with Microsoft professionals. To date, there have been 234 investments with 45 exits.
- MassChallenge: One of the biggest accelerators on the East Coast is MassChallenge which leverages its proximity to MIT, Harvard and the deep knowledge base in the Boston area to generate strong cohorts of startups. Unlike many accelerators, MassChallenge is a zero-equity, nonprofit startup accelerator which adds to its appeal. There is no cost to apply and startups compete for cash prizes instead of investment opportunities.
- IndieBio: Based in San Francisco, IndieBio is a four month long accelerator program that is focused on the biotech sector. Companies work on-site with IndieBio providing laboratory space as well as assistance with research and development. Since biotech is a uniquely technical and even academic field, arguably the greatest value to the participants in this specialized accelerator is market analysis and business development skills. IndieBio also provides access to scientific staff and local partnerships to help the startups conduct the science faster. Their goal is to train academic researchers to work at the pace of industry which is what they must do to build a successful enterprise. IndieBio is administered by the VC firm SOSV. Each participating startup earns $200K in cash and $75K in kind in exchange for 11.2% post-debt equity.
There are many accelerators both in the US and globally, particularly in developing countries, where the accelerator model is regarded as a great tool to jumpstart the development of an innovation infrastructure in countries just starting out. These accelerators are now beginning to compete with each other for the best startups just as venture capitalists do which will likely lead them to consistently upgrade their offerings while also producing a much-needed shakeout in the industry with the lesser quality accelerators falling by the wayside.
The entrepreneurial finance ecosystem is becoming more complex. The road to commercialization is no longer as direct as get an idea, write a business plan, and seek funding. There are now additional mechanisms such as accelerators that have a growing degree of power in the startup community. The top accelerators may even be considered gatekeepers in terms of validating whether or not startups can obtain funding, particularly with funding now becoming so scarce. Just as trusting graduates of elite institutions to be the only ones capable of running our country has proven foolhardy, we must be careful to avoid the same mistakes with accelerators.
Fortunately, there are multiple kinds of accelerators being developed from different sectors of society—corporate accelerators, nonprofit accelerators, and government-funded accelerators—so that we may be able to avoid this trap. The best accelerators add enormous value but we must strive to understand why they are the best so that we can replicate that value proposition instead of being held hostage by a few elite actors who have command of it.
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