Editor’s note: Peter Relan is a former programmer and Internet executive, as well as a successful serial entrepreneur, Silicon Valley executive, angel investor, and technology veteran for over 25 years. Relan founded YouWeb Incubator in 2007, spinning out a string of successful mobile and gaming companies.
Incubators are now an industry segment in their own right. Before starting YouWeb Incubator in 2007, I began to explore the idea of an incubator with friends and colleagues. Most people told me that Idealab and CMGI had tried the model in the 1990s and didn’t really work out (with the exception of Overture, which spun out of Idealab). CMGI imploded in the dot-com bust.
However, I noticed one model gearing up: Y Combinator by Paul Graham. At least in Silicon Valley, YC was pretty much the only well-known incubator. Today the total number of incubators (broadly defined to include incubators, accelerators, and “seed starter funds”) must be in the hundreds, each one slightly different from the other — versus a few years ago, when the space had YC, TechStars, YouWeb, Idealab and a couple of others.
I would like to present the claim that 90 percent of incubators will fail. By “failing,” I mean they don’t return (or don’t exceed) the money that was put into them. On what basis do I make my claim? Well, the hundreds of incubators are really startups, and the oft-cited rule of thumb is that 9 out of 10 startups fail.
Is there any reason why incubators would be different from other startup spaces? Just as we’ve seen with daily deals, mobile apps and games, it’s clear only a few (maybe four or five) will become leaders in the category. The rest will absorb more capital than they can return, shut down, or pivot into something else.
1. Too Many Companies, Too Little Mentorship
Simply having a portfolio of companies and providing access to capital is not enough for most incubators to get off the ground. It’s important for inexperienced entrepreneurs to learn the ins and outs of the game. A great idea will fall by the wayside without being properly executed.
Take a recent startup, Goko, for example. They had a great idea and a great, well-publicized launch, only to find two days later that there were serious issues with their product. So mentorship is everything. It’s how you build products, sell your products or businesses to big corporations, hire, market, do PR — everything. Time matters. It’s crucial that you explain all facets of the business, share war stories and help them — especially when they are on shaky ground.
Mentorship aside, too many companies still go after the same concept. Hundreds of startups innovate in every “white space” available, each one with a different angle or a twist that the founder believes will make their startup come out on top. This convoluted process of differentiation causes many companies to lose sight of the fact that, first and foremost, they need to solve a very compelling problem. Then overcrowding naturally leads to too much capital, which leads to bubbles and busts. Daily deals anyone?
2. No Clear Funding Path After The “Program”
During the incubator program or at demo day, start-ups can expect a flood of funding. However after this initial phase, I see too many companies struggle with continuing the flow of funds.
People who run incubators are often professional fundraisers; it’s what they do. The silent crash you are not hearing at the moment is the sea of seed-funded companies that won’t find the light of day into a Series A. Why? Not enough traction, a valuation that is too high and too much noise in their particular segment. Many start-ups are just features. They are not products, let alone businesses.
3. Lack Of Business Development Resources
Business development muscle and track record are huge factors for entrepreneurs picking between sources. SV Angel famously creates the partner list of everyone in the Valley, while other early-stage groups appoint business development partners. BD gets you your first client, your next financier and potentially your future acquirer or a good investment banker for an IPO. Incubators with the best exits and IPOs under their belts will have the best shot.
90% Failure Rate And Why This Is Still Great For America And The World
America needs new ideas, and citizens can’t expect the government to foster tomorrow’s disruption. With diminished funding and donor pools, public institutions can barely scrape by. So private institutions, like MBA programs, are creating their own programs in fear of becoming marginalized by these incubators. Every region and vertical could benefit from a new business acceleration approach.
Incubators have become a pathway to achieve this approach; they give people an opportunity to make their dreams come true. And even if most of these ideas fail, they will still create innovations that can be reflected in the product technology in other spaces.
And incubating companies is cheaper than ever. With lower risks for investors, incubatees can benefit from the network effect of the incubator. One incubator startup’s success raises the prospects of others.
The culture of American innovation has changed rapidly over the past few decades. Being accepted into an incubator is beginning to hold the same weight as being accepted into a university – and like universities, there are different tiers: the Ivy’s, private schools, the state schools and all the rest. We are creating a new education system, one where relevant real-world experience has begun to trump degrees. The right program can provide the same connections that accompanied acceptance into the right university 15 years ago.
But why stop at America? The world needs incubation just as much — if not more. In fact, cities with less tech culture could benefit from participation in a group of startups learning and earning together. Whether it’s Berlin, Rio or New Delhi, the future of urban development around the world will be impacted by the strength of incubators. We now see successful executives like those from Brazil’s mobile content powerhouse Movile going back to incubate tomorrow’s disruptors at the 21212 accelerator.
If 90% Will Fail, Which Models Will Succeed?
There may be hundreds of incubators, but business models are much harder to come by. Most execute one of a few distinct business models, while some execute hybrid models. Here are a couple of examples of incubator business models that have been good for investors:
One business model that YC executed brilliantly is (as Paul Graham called it) the seed fund model. The thesis of the model is based on a combination of “high-quality filter” and “broad portfolio” approaches. The high-quality filter approach attempts to ensure that the very best minds, teams and ideas get into YC. After their acceptance, they spend three months getting to the next stage. On the other dimension, the broad portfolio approach, statistically, discovers a few breakaway companies, like Airbnb and Dropbox, in order to provide the big returns to investors. YC is funding close to 200 companies this year. So it is reasonable to say that a broad portfolio approach is fundamental to its strategy.
A second business model is the “high-quality tech founder” + “constant pivot” model. I’ve placed my bets on this model for YouWeb. YouWeb doesn’t accept teams, ideas or business plans. We only accept incredible hackers, developers and technologists. Entrepreneurs receive one year of program participation, versus the three months offered at seed starters like YC. The Entrepreneur-in-Residence spends time building a product, launches it and measures traction. If the entrepreneur gets no traction they will pivot to a new idea or space.
This pivot process can continue for up to a year. If the entrepreneur can find traction, we will spin out a company and fund it with $250K. We currently have nine companies but have executed at least 50 ideas. In a different world, they might as well have been 50 different companies. But I find it more efficient to kill ideas rather than companies, so we don’t spin a company out without traction. Jason Citron is a good example. He attempted three failed ideas before OpenFeint, the largest mobile social games platform in the world, was acquired by GREE last year.
Let’s not forget TechStars, BetaWorks, Obvious and others. They might be executing similar models, defining new ones, or combining models in creative ways. Which models succeed over the long term? Time will tell, but I’d love to hear your thoughts in the comments section.