Recently I wrote a blog post on things to think about when starting a startup accelerator. I pointed out that most accelerator programs take between 5-12% or thereabouts for a fairly standard amount of money and time. Year One Labs is a bit different (more money and more time = more equity taken); our belief being that early stage startups need more time to bake. But even Year One Labs only takes 20%, and we only invested in 5 companies, and we don’t follow-on, so we get diluted just like founders do as they take on more financing.
In thinking about alternative models for startup acceleration or incubation, I can’t help but ask the question, “What if the incubator owned 80% instead of 20% and the people working on the startup owned 20% instead of 80%? How could that work? And does it make sense?”
In some cases it might.
Here’s how this could work:
- The incubator recruits talented people who may have the potential of becoming founders, but aren’t required to do so. The incubator takes 80% and the employees/entrepreneurs/founders-to-be take 20%.
- The incubator invests more money, effectively paying salaries, but they’ll be discounted. This is the risk that people take joining, but they’ll earn more than a couple thousand/month. The flip side is that people will be getting much more equity than they would have otherwise as Employee #1 or #2 at a startup. And they have the potential to grow into founder roles.
- The incubator isn’t funding startups, it’s funding projects. The projects may eventually become startups – if they get enough traction (which needs to be defined by the incubator) – and will need founders to run them. The people working on the projects may become the founders or CEOs/CTOs/etc. But not necessarily.
There’s clearly a risk here – a project takes off, has the right traction, but no real founders. This scenario is possible, and these types of startups will have a very hard time raising follow-on capital because there’s no leadership. So the incubator has to have a great network in order to bring in a CEO and leadership team, or be prepared to have one of its own take over the company (in the case where the people working on the project aren’t founder / C-level material.)
- If a person in the incubator is C-level / founder material, then the equity split changes. It might not flip completely (from 80-20 to 20-80), but the executive / founding team should own the bulk of the company.
So why even start with the incubator owning most of the company at all, if it’s just going to change after?
- The incubator needs to be structured in a way that allows it to sell projects (or “near-companies”) very early. In these scenarios, the incubator owns the bulk of the equity and gets a good return. The employees still own a good enough piece that the reward is meaningful and they get fantastic experience being involved in an entrepreneurial endeavor.
For these kinds of early exits, the incubator needs to have great relationships with acquirers. Creating a niche incubator focused on a narrow area of expertise can help with this. Having strong industry relationships will also be critical.
- It’s easier in this model to kill projects more quickly and get less attached to them. It’s also easier to transfer people from one project to another. This is especially true if there’s a vertical focus to the incubator, where it’s likely that people in Project A will be interested and familiar with Project B. People can shift between projects, you can double down on those that are moving in the right direction, and potentially continue funding them for some time (if you have the resources), so you don’t require external financing as quickly.
- It’s also easier to start projects quickly, resource them, see what happens and shift quickly (if necessary). If you’ve got enough talented people inside the incubator it can become an innovation machine.
- Talent is easier to find, because you’re not looking exclusively for founders (which is extremely hard to do). You’re also not waiting for fully baked teams to come to you with fully baked ideas. You’re plucking individuals, building teams, brainstorming ideas together, etc. True incubation.
Incidentally, I think this incubation model could work inside larger corporations too, and be an interesting way to revitalize companies and innovate.
- In Canada, with our strong tax credit system (that pays a significant percentage of R&D costs back to a company), there’s a definite financial benefit to this approach as well. If everyone is an employee of the incubator, and paid a salary vs. receiving an investment, a lot of that money can be recouped.
For any place outside of Silicon Valley (and possibly New York and Boston), it’s near impossible to have all the pieces in place to build a strong startup ecosystem. There are just too many moving parts. That doesn’t mean companies can’t emerge out of any place and be hugely successful. But an accelerator or incubator is an attempt to build a “formula for success”, which does start to break down when pieces are missing. The model I’m proposing here is an attempt to circumvent some of those issues, including:
- A lack of successful entrepreneurs
- Inexperienced entrepreneurs without the supportive infrastructure
- Lower risk tolerances (i.e. Not enough entrepreneurs)
- Slower funding cycles (and in some places a lack of funding options)
- Competition with other accelerators (i.e. What’s your differentiation and unique value proposition vs. other accelerators?)
There are clearly risks, and it’s far from a guarantee that this would even work. You might only find employee-like individuals who never grow into founders. If you can’t drop in C-level executives, you’ll be building projects and never any actual companies. People who consider themselves entrepreneurs and founders might be insulted by the equity split. Investors might be wary of the model. But all over the world right now, people are looking at starting accelerators built on the Y Combinator or TechStars model, and it’s not entirely clear if those models are feasible or sustainable elsewhere. It’s at least worth discussing alternatives that may be more appropriate in certain geographies, under certain circumstances.
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