Technology

Disrupting the Disruptors: Startup Accelerators Feel Pressure to Evolve
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startup

 

A decade ago, eager entrepreneurs with little business acuity and in need of funding turned to startup accelerators for help. From the outside, these programs had an air of exclusivity with the source code to build successful businesses.
 
Now that image seems passé.

“New models are emerging on how to create ventures and scale them,” says Martin Ihrig, an adjunct professor of entrepreneurship at Wharton and practice professor at Penn’s Graduate School of Education.

The global explosion of interest in entrepreneurship has spurred the growth of tailor-made accelerator programs to service a startup culture no longer tethered just to Silicon Valley. The evolution of accelerators — business immersion boot camps that usually take a percentage of equity to help launch companies — can be found in scores of new programs offering budding entrepreneurs all sorts of incentives to join.

The original startup accelerators — Y Combinator and Techstars — have spawned a cottage industry with estimates ranging from 300 to more than 2,000 worldwide, according to business professors Susan Cohen of the University of Richmond and Yael Hochberg of the Massachusetts Institute of Technology.

The reduction of entry-level costs has played a primary role in the growth of the startup ecosystem, says Wharton management professor Ethan Mollick. He adds that the cost of launching a web-based startup has fallen by three orders of magnitude since the late 1990s by some estimates. “What used to cost $3 million to do now costs $300.”

The easy access not only has led more people to launch businesses, it also has affected the way to fund entrepreneurs, leading to questions about the value of early stage seed-fund programs.
“It used to be that VC investors were very important,” says Mollick, whose research includes early-stage entrepreneurship and crowdfunding. “When you needed $2 million to launch your website there weren’t many people to give you $2 million. You had to go to a venture capitalist.”

Mollick says the new equation has led to competition among venture capitalists. It started with the rise of super angel investors in the mid-2000s who spent $100,000 to $200,000 on Silicon Valley pet projects before venture capitalists got involved. “They were starting to take more value of the startup because they got a big chunk of the startup early.”

Then the landscape changed again in 2005 when computer scientist and essayist Paul Graham co-founded Y Combinator, which has since graduated such companies as Dropbox, Airbnb and Disqus. Investors realized accelerator programs could get them in on the ground floor with promising companies while they could shape their progress from the start.

Incubators Grow Up

Accelerators were born out of the incubator concept that began in the late 1950s. Although many entrepreneurs use the words interchangeably, incubators generally are collectives where infant businesses share working space and resources, and get occasional mentorship. Accelerators are fixed-term programs generally lasting from three months to six months that target projects showing promise.

Accelerators help entrepreneurs develop operations and strategies with guidance from advisors and mentors, as well as providing rent-free office space and other infrastructure benefits. The programs usually culminate with graduates pitching their ideas to potential investors. About half raise capital, which are good odds considering about one in 100 startups overall get funded, according to George Deeb, managing partner of Red Rocket of Chicago and author of 101 Startup Lessons — An Entrepreneur’s Handbook.

However, entree into accelerators can cost a startup from 2% to 10% equity. Dave McClure, the founder of Silicon Valley accelerator 500 Startups, cautions entrepreneurs to choose wisely when considering a program. “The best programs have a substantial impact,” he says. “The worst programs can probably cause damage.”

Techstars of Boulder, Colorado, followed Y Combinator in 2007. Over nine years, Techstars has become one of the world’s leading accelerators, with programs in Berlin, London, New York, Cape Town in South Africa, and Tel Aviv, among other locations. “Ten years ago, you would have been forced to relocate to Silicon Valley before they would have cut that check,” says Deeb.

According to Techstars, a $100,000 convertible note is automatically offered to all startups upon acceptance. The note converts at a pre-money valuation [the valuation before outside funds or the latest rounds of funding are accounted for] of $3 million to $5 million, the company says.

Those who enter the program give up 6% of common stock for the loan. They also receive lifetime access to Techstars’ resources, hands-on mentorship in a three-month program with office space, $20,000 in living expenses and connections to more than 5,000 experts.

Deeb, a founding Techstars mentor, is a staunch proponent of the model that vets startups before investors hear about them. Techstars Chicago picks 10 companies out of 1,000 applicants, says Deeb. This way investors hear pitches from only the most promising startups as determined by the accelerator.

But of course, well-known accelerator programs are not the lone path to funding and support.

Another tentacle in the ecosystem can be found in Techstars’ collaboration with major corporations.

Since 2015, Techstars had partnered with such heavyweights as Barclays, Disney and Sprint to create accelerator programs for each company.

Disney did not renew its contract with Techstars in early 2016 but continues to operate a startup accelerator. Kevin Mayer, Disney’s executive vice president of corporate development, has said the company isn’t investing in startups in order to make a quick profit like a typical venture capitalist. The entertainment company is more interested in creating cutting-edge products it can use, as well as revitalizing its leadership by staying at the forefront of innovation.

Corporate leaders figure they can train and support aspiring entrepreneurs to be part of innovative projects in-house instead of having to pay millions later on to acquire them. “Opening an accelerator is a strategic decision that allows big corporates to stay relevant and competitive in a rapidly changing economy,” Microsoft’s general manager of accelerators Zack Weisfeld wrote this year in an opinion piece for Forbes.

Many Tracks

Charles Bonello, a New York entrepreneur, investor and startup tinkerer, is playing the classic role of disrupter as co-founder and managing director of Grand Central Tech.

His New York City startup hub offers companies a yearlong program without charging rent or taking equity. The catch is companies that complete the program agree to rent office space for four years in the accelerator’s extensive 1.1-million square foot building overlooking Grand Central Station. The building is owned by the accelerator’s billionaire backers, New York real estate investors Milstein Properties.

Bonello has made a career out of partnering with companies and entrepreneurs to support their growth. With Grand Central Tech, he and his team want to promote startups across a broad spectrum in one communal setting. “Our goal is to create a single point of density of the best technology companies in New York,” he says.

Many of the startups entering Grand Central Tech aren’t looking for seed money. They are attracted to the program’s impressive list of corporate partners that include Google, IBM, L’Oreal USA, Microsoft, Pepsico North America and JPMorgan Chase.
Bonello and partner Matt Harrigan have a long-term goal of finding emerging companies trying to solve problems. One of their first startups was Nagare Membranes, a developer of water filtration technology. By keeping like-minded entrepreneurs in the same office the men hope for cross-pollination in problem solving.

Researchers, however, caution against blindly accepting civic leaders’ cheerleading that locally grown startup clusters can transform economies.

“Looking at emerging markets, many see entrepreneurship as solving unemployment issues,” says Wharton’s Ihrig. “Then the question is, looking at statistics, do those tech startups and incubators really produce jobs? Many don’t. And many jobs are outsourced to other countries like India for IT.”

Wharton’s Mollick says while community and political leaders have many motivations for accelerating business in their region, “it’s not clear it is working.”

The questions about value have yet to mute enthusiasm, though. Even the Obama Administration’s Startup America Initiative uses many of the fundamental accelerator ideas to promote small businesses nationally.

New Directions

England’s Entrepreneur First has a similar idea with its new-model accelerator. Instead of looking for companies, it recruits what officials say are Europe’s top technologists. Entrepreneur First then partners with the talent to build a company from scratch. This is a way to attract a variety of experts to work on a specific issue.

The first accelerators recruited all types of companies instead of focusing on specific industries.

But as these programs proliferated they became more nuanced in targeting companies to accelerate.

Benjamin Böhle-Roitelet found a niche in southwest France with his accelerator Blue Builder.

It caters to ocean and other outdoor sports in the picturesque fishing village of Saint-Jean-de-Luz, located in the heart of the surf alley in the Basque country. It also lies beneath the Pyrenees Mountains, providing a testing ground for all kinds of adventure sports products.

The French accelerator offers a campus with prototype studios, workshops and a safe environment to experiment with materials such as polymers and resins used for building surfboards and snowboards.

“There are places to build companies and places to finance or do business development for startups,” says Böhle-Roitelet. “Places like Saint-Jean-de-Luz are great because they are close to the market and audience without the solicitations and noise of major ecosystems like Silicon Valley.”

For an industry such as adventure sports, it is more important to be connected to the core audience than prospective funders. Böhle-Roitelet also sees an upside in these entrepreneurs staying true to their lifestyle while improving the products they use themselves.

Blue Builder doesn’t have a regular program with “demo days” such as many other accelerators.

Instead, it works with entrepreneurs on specific projects to get them launched when they are ready to be presented to investors. It surrounds these creative trailblazers with brand designers, user experience designers, business developers and finance and legal experts to increase the likelihood of success during a yearlong assignment to build a product, such as one involving a sensor that measures surfboard movements in real time.

Böhle-Roitelet’s group determines how much equity it gets based on the valuation of each company instead of taking a uniform percentage at the entry point.

Government Role

Halfway across the world, Muhammed Mekki, a founding partner of AstroLabs, has extended a corporate connection to Dubai in the United Arab Emirates.

The bridge to the corporate world makes sense to the Iraqi-American who helped create tech startups in Silicon Valley while still earning his MBA. AstroLabs has partnered with Google to build a startup hub and training academy to promote online and mobile business throughout the Arab world. The relationship is not surprising because Google for Entrepreneurs is designed to promote startups worldwide. It also makes sense that AstroLabs has strong government backing for its project. Local and regional governments have a stake in the success of these programs to create 21st-century Jobs.

“It becomes part of the culture, and when it becomes part of the culture, it becomes part” of the government “to integrate this idea of startup mentality,” says Bambi Francisco, whose company Vator is one of the largest social network platforms dedicated to entrepreneurs.

In 2011, the Chilean government decided the best way to promote homegrown entrepreneurship was to create its own accelerator. The country’s economic development agency hatched the idea with Stanford University experts to create Start-Up Chile. Government officials offered entrepreneurs from around the world $40,000 of equity-free capital, infrastructure and work visas for one year to develop their companies over six months. The program also gave selected startups access to Chile’s financial network.

The idea is the recruited entrepreneurs would serve as role models for Chile’s budding startup culture. “I know a bunch of guys who went to Start-Up Chile, but I don’t know any who stayed in Chile,” says Mollick.

Diego Saez Gil of Argentina was one of the first entrepreneurs to join Start-Up Chile. He got seed money for his former company, WeHostels, a social hotel booking application for mobile platforms that was sold after its launch. Saez Gil was attracted to Chile’s program because he wanted to help grow the Latin American ecosystem.

But his latest venture is located in Silicon Valley, underscoring Mollick’s point of view. Yet, Mollick says homegrown accelerators worldwide could provide a valuable financial service because of Silicon Valley’s lack of diversity. “The problem with conventional funding sources — and quite honestly it doesn’t look that different at Y Combinator or Techstars — they overwhelmingly tend to fund men, they overwhelmingly tend to fund white men, they overwhelmingly tend to fund white men from top schools,” says Mollick. “Either those are the only people who are interested in going into startups or the system has built-in biases.”

He adds that the mean distance between a venture capitalist and a company they invest in is only 80 miles. “So, if you’re not in San Francisco or New York or a few other places, you’re unlikely to get access to funding.” He is skeptical of some accelerators that advertise a new approach with more access. They might have a savvy marketing angle, but still target “the exact same pile of mostly white, mostly male, mostly coastal, already connected people who make up the most classes at Y Combinator and other programs,” says Mollick. “There are reasons to have accelerators in cities Europe-wide because these people are cut off from the funding system and support system that exists for the lucky few in the U.S. But you can’t just copy Y Combinator and expect it to work.”

Hybrid Approaches

The University of Pennsylvania is pioneering a new approach to entrepreneurship by combining academic applications with practical experience. Karl Ulrich, the vice dean of entrepreneurship and innovation at Wharton, has argued that college is the best time to launch a business because of the proximity to so many people to test the product and gather feedback.

“We encourage our students to work on their own projects while in school,” says Ihrig, who directs the Strategic and Entrepreneurial Management of Knowledge (SEM-K) research initiative at Wharton’s Snider Entrepreneurial Research Center.  “They can experiment with their venture ideas and consult their professors if they have problems.”

Penn’s Graduate School of Education (GSE) has created the country’s first executive master’s degree program in education entrepreneurship. The school also helped create an Education Design Studio, a hybrid incubator and seed fund for education startups. Entrepreneurs who chose the incubator route have access to GSE’s professors to get the latest research on what is working in their areas of interest. But they do not earn degrees.

The model of offering two routes to launching businesses with academic support — in school while pursuing a master’s degree part-time or through an incubator program — is not limited to education startups. “We can bring research to practice by including the university in the entrepreneurial ecosystem,” says Ihrig, who is the founding academic director of GSE’s master’s program.

Saez Gil doesn’t think a degree is necessary for those already itching to launch a business. “Probably if you know you want to be an entrepreneur you should just go and do it,” adds the co-founder and chief executive of Bluesmart, a travel products startup that is a Y Combinator alumnus.

According to Francisco, it is easier than ever to create a startup. Her company Vator — short for innovator — is another example that underscores the changing environment in seed funding.

Started in 2007, Vator holds entrepreneur conferences in Los Angeles, London and Oakland, California, that can lead to investment deals. One of Vator’s backers is Silicon Valley darling Peter Thiel, best known for co-founding PayPal in 1998, being the first outside investor in Facebook and co-founding data analysis giant Palantir Technologies. Francisco said accelerators provided just what the emerging ecosystem needed a decade ago. “At one point their value proposition made a lot of sense,” she says. “They could introduce you to so many investors. Now there is a lot of backlash.”

In 2015, Techstars initiated an equity back guarantee program to address the shifting paradigm. With the preponderance of competing accelerators and other avenues to reach investors, Techstars officials now offer their startups a chance to lower or eliminate how much equity they give up. Startups have three business days after the program ends to reject the standard plan if they aren’t satisfied with what Techstars offers.

Continual Evolution

Yet, Francisco sees a more basic issue for early stage businesses. “The value proposition for accelerators has gone down,” she says. “There is a lot more information out there and a lot more investors. There’s not a funnel any longer to get to a few investors because capital is pretty abundant.”

Vator, for example, has promoted about 175 companies through its startup competitions in the past five years. The winners get to pitch to investors at the end of their Splash events just like they would at an accelerator “demo-day.” Francisco said Vator startups have raised $700 million in capital without releasing any equity to the facilitator.

The glut of accelerators also could lead to a downturn for all but the biggest players and those, such as France’s Blue Builder, that cater to specialized markets. An example of this trend occurred in June 2015 when Techstars acquired accelerator UP Global.

“There are just too many incubators and accelerators and some of them will merge or disappear,” says Ihrig. “Only the best will survive.”

Veterans of entrepreneurship are not the only ones questioning old models. Startup newcomer Erica McLain of Palo Alto, California, wonders whether any immersion program is worth it.

“Accelerators are a very expensive source of capital,” she says. “If you’ve never launched your own startup before it’s great validation, and maybe you need that leg up. If you need a stronger network and you definitely need advisers – those are the key things accelerators provide you that is worth that 7%.”

McLain, the founder of PATHworks, says joining an accelerator indicates the company is immature. “If you’re a vetted entrepreneur or you’ve been at Google as an engineer and you’ve been at a fast-moving pace, an accelerator might even be a negative signal for a venture capitalist knowing that you’ve already committed 7%,” she adds.

Yet, the 2008 Olympic triple jumper sees a big upside for anyone who goes through the application process. McLain gained valuable insight by applying to education tech accelerator Imagine K12. She advanced to the interview stage at the Silicon Valley accelerator but ultimately didn’t get selected.

“The questions that they ask you are something the entrepreneur needs to think through regardless,” says McLain.

At the time McLain answered the Imagine K12 application questions she had already invested 10 months in her for-profit summer and after-school program to promote STEM and language arts education through structured sports participation.

“But I hadn’t framed my answers in the way they asked the questions,” says the Facebook operations manager. “It is a really great exercise to spend six to six and a half  hours.  Those are the same questions you are going to be asked if you get into a room with an angel investor.

If you haven’t thought about that stuff, going to a VC might not be the best route for you.”

Wharton’s Mollick also sees a need for more introspection from the accelerators. He says they haven’t taken the time to analyze their real value and contributions to accelerating businesses.

“Is the mere act of being selected by the accelerator most of the benefits?” he asks. “Is it the mentoring that you get? Is it the money you get, is it the pitch day? I don’t think accelerators are trying to learn as much [as they can.] They have philosophies but I don’t know if they are gathering data on what is working and what isn’t.”

Future of the Valley

Looking ahead, does Silicon Valley’s stranglehold as the center for innovation show signs of erosion as technology hubs surface worldwide? Some industry experts think so. Today, thriving startup communities can be found in Bangalore, Beijing, London and Los Angeles. All possess the same entrepreneurial spirit as Silicon Valley.

“People say nobody’s going to duplicate Silicon Valley, nobody’s going to beat Silicon Valley,” says McClure. “Both answers are wrong. It wouldn’t surprise me that in 10 years Beijing is more active than Silicon Valley.”

It should come as no surprise that an area priding itself on “disrupting” industries through invention would experience a disruption of its own. In many ways, it is part of the natural evolution that turned the San Francisco Bay Area into a global economic powerhouse with Apple, Facebook, Google and Twitter among the current stars.

Mollick warns against summarily dismissing Silicon Valley’s influence, however. “It has gotten easier in other places, but there is no doubt by every stat that it is the hub of entrepreneurial activity, especially in the web software services space. You could be anywhere, but there is a difference between saying you can do startups anywhere and to say the Valley’s not important anymore.”

The big brands keep the Bay Area at the heart of American innovation. But the environment has changed, says Red Rocket’s Deeb. “Silicon Valley is still an epicenter, but it is slowly going to lose market share over time,” says the author of 101 Startup Lessons — An Entrepreneur’s Handbook.

With investors more dispersed these days, entrepreneurs can create companies closer to their homes, which, in turn, can lead to organically grown startup communities that include accelerator programs and localized funding. McClure says it requires the “minimum critical mass” of startups and investment in entrepreneurs to develop a thriving hub. As many as 100 metropolitan areas worldwide have the potential to reach that threshold.

The type of industry plays a big role in where a community develops, according to Vator’s Francisco, who adds that Silicon Valley won’t lose its standing quickly because entrepreneurs still want to attract heavyweight venture capital firms such as Sequoia Capital and Kleiner Perkins Caufield & Byers.

Judging by the job growth and building frenzy in the Valley and San Francisco, the northern California technology corridor is experiencing boom times. But not every startup has to move there to find success.

Notes Mollick: “I don’t see a huge slipping of the advantage of California — I just see that other places you can make a good go of it, too.”

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