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DaVinci Coders
December 5th, 2012 at 10:51 am

Accelerators are headed for a shakeout

Incubators and accelerators are churning out thousands of startups a year.

There has been a glut of tech incubators and accelerators and  for over a year now we have been warned about them. With at least 100 such programs churning out thousands of startups a year and the expectation that 90 percent of them won’t return their money, the seeming launch of a new accelerator program each week is a valid concern.

 

 

Now a backlash is brewing toward The Accelerated Ones in the form of a “Series A” crunch. And their leader, the pioneer of the model and most prestigious program in the country, Y Combinator, is pulling back. First the smaller investment sizes. Then the decision to have a much smaller class in its next batch. The last group had 84 companies; Robert Scoble compared the demo day to “sitting through a bunch of advertisements” with no context. The next batch will be closer to 50. “We grew too fast,” Graham wrote.

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YC did this on its own with no pressure from the market. Many others won’t be so lucky.

With such a move, YC is leading by showing a willingness to adapt to the current environment, which is increasingly challenging for seed-stage startups. As Sarah wrote last week and again today, theSeries A crunch is real. It will hit accelerators and incubators pretty hard. It echoes a sentiment I’ve been hearing from investors all year, which is that accelerators increasingly churn out too many low quality companies. Let’s face it: If you make the bar to becoming an entrepreneur too low, at some point you just get shitty entrepreneurs.

For example, Greycroft Partners founder Alan Patricof didn’t mince words at Business Insider’s Ignition conference last week. He bemoaned the proliferation of accelerators and incubators in New York and said most of the companies they produced were not innovating, but mimicking and duplicating other companies. “We have had a plethora of startups in this country in every city,” he said. “A lot of these people should probably get jobs instead of starting the next company that duplicates something else.”

TechStars NYC managing director David Tisch (who’s since moved on to focus on his own investment firm, Box Group) had similarly harsh words for his competition. “The majority of accelerators are not good for companies and will fail. There are too many of them,” he told Fast Company in August.

Many investors I’ve spoken with have come to expect the demo day pitches to be full of hypothetical bullshit. “You are wowed by the pitch and ready to invest. Then you meet with the company and find out half of what they showed you is not real yet,” one investor said. Scoble commented on the lack of demos at YC’s demo day: “The fact that (YC companies) don’t demo their product keeps the focus on the wrong thing.”

It’d be much more useful for companies to give their demo-less pitches at the beginning of the program, a second investor posited, because then investors could compare before and after and see of how much progress the startup made in the program.

Making matters worse is the expectation to deliver something on demo day, even if the founder’s original idea didn’t work out while in the program. It leads to a common scenario that gives all accelerators a bad name. For example, the founder of a Dreamit company I met told me that, a month into the program, he realized his business idea wasn’t going to work. Under normal circumstances, the idea would be discarded and that would be that. But since his team was in an accelerator, they felt they had to deliver something, so they cobbled together a site around a harebrained late-night idea they seemed to half-believe in and pitched it on demo day. Needless to say, outside funding hasn’t come pouring in.

Then there’s the story of the Techstars Boulder company, 27 Perry, that pivoted three weeks before demo day. The buzz around it was “can you believe they made this much progress in just three weeks?!” You mean someone put together a pitchdeck and mocked up some wireframes? Yes, that’s fairly believable for three weeks. It’s still closer to an idea than it is a real company.

I asked the managers of a few programs whether they plan to adapt to the new reality. They didn’t seem fazed by the news, or worried about a more general ecosystem backlash to their business model. They mostly touted their small class sizes — YC is huge, which was the problem, they said.

“TechStars has always kept class sizes small (about 10 companies per class, with 100 mentors focused on them), choosing to focus on quality over quantity,” says founder and CEO David Cohen. “Our funding remains the same — no plans to cut back as we feel we right sized everything from the start.”

Jonathan Axelrod, head of the ERA program, had a similar reaction. New York-based ERA has 10 companies in its program twice a year. “Given the relatively few number of accelerators in New York, we don’t see anything like the glut they see on the West Coast over here — and, as a result, we don’t anticipate seeing much of a backlash,” he said via email. Nine of out the 10 ERA companies in each of its classes are operating (and 10 out of  10 in its October class).

Dreamit Ventures managing partner Kerry Rupp emphasized her program’s selection and quality; 75 percent of Dreamit companies are still operating. With locations in New York, Philadelphia, Israel and Austin, the program has expanded geographically but continues to choose 10-15 companies per class, emphasizing not fundraising, but sustainability, for their graduates. The program offers cash to its companies and is raising a $50 million fund.

While 10 companies per incubator doesn’t sound like a lot, when you have a glut of incubators those tiny little classes all add up. I only spoke to a few of the largest, more well-known programs in the country; there are hundreds of smaller ones below it. Like the venture business, everyone thinks they’ll be the exception — they’ll hit on that home run that brings in 95 percent of the industry’s returns. By sheer math, it doesn’t happen for most.

And here’s the thing: In incubators, deal flow matters. YC may have the biggest classes but they also have hands down the best economics, get the best terms, raise the most money and have the highest hit rate. And that means everyone prioritizes YC first. And even with all that: Just two companies make up the vast majority of YC’s (projected) returns, Dropbox and Airbnb. If that’s what every little incubator in the country is waiting on, it might be a long winter.

Photo credit: Chron

Via Pando Daily

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