2.1 Incubator
The study of business incubators is crucial since accelerators derive many of their characteristics from them. Both accept early startups that show potential economic viability, and they both provide an environment that is meant to serve the needs of startups (Barrehag, Larsoon, Mardstrom, Westergard, & Wrackefeldt, 2012).
The first incubator was started in the U.S. at Batavia Industrial Center in New York in 1959. But the concept of incubation did not become popular in other communities until the late 1970s. Today, there are approximately 1,400 business incubators in North America, about 200 in Mexico, 120 in Canada, and over 3,500 worldwide (Knopp, 2012).
According to Aaboen (2008) the development of incubators’ can be divided into three generations. The first generation focuses on job creation while the second generation focuses on supplying services such as networking, training and connecting to venture capital. The third generation on the other hand, focuses on Information and Communication Technology, where the most promising startups are prioritized (Aaboen, 2008).
Recently, in the report Startup Factories, Miller and Bound (2011) investigate a new way of incubating technology startups, the accelerator concept (Miller & Bound, 2011).
2.2 Accelerator
2.2.1 Background
Business accelerator is a relatively new phenomenon. It is usually involve of a group of experienced business people to serves the basis need of the ‘nascent’ firms. (Fishback, Gulbranson, Litan, Metchell, & Porzig, 2007). Incubator and accelerator are similar, but Menell (2010) argued that business accelerators more evolved form of profit then incubators.
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The distinguish between business incubator and accelerator are :
- While both are open to anyone, accelerator have application process and it is highly competitive.
- Another difference is that accelerator provide seed funding, but in the context of return for equity in participant startups (DesMarais, 2013).
- Next, the focus of accelerators is on group, not on individual founders. It is because one person is considered insufficient to handle all the work associated with a startup (DesMarais, 2013).
- Further, startups must “graduate” by a given deadline, typically after 3 months.
During this time, they receive intensive mentoring and training. They are expected to absorb all the information rapidly. Virtually all accelerators end their programs with a “Demo Day”, the day where startups can pitch their ideas in front of investors (Gilani, Aziz, Dettori, & Gianluca, 2011).
- The last is for startups accepted are supported in cohort groups or classes. The peer support and feedback that the classes provide are an important advantage. If the accelerator does not offer a common workspace for startups to meet regularly, the teams will meet periodically (Christiansen J. D., 2009)
The goal of accelerator business is to give startups a necessary resource to grow and scale quickly, so their product can reach to the market faster; in contrast to the entrepreneurs bootstrapping, they may need three years or more for reach their product to the market whereas an accelerator can cut down into a year (Chang, 2013).
2.2.2 Accelerator Programs
A paper name’s Copying Y Combinator: A framework for developing Seed Accelerator Programmes (Christiansen J. D., 2009) illustrate that accelerator programs may consist of five fundamental elements; funding, company founders, cohort support, education (business advice and product advice), and networking. Christiansen also mentioned that accelerator programs may or may not include office space, whether free or subsidized, and usually programs are culminated with a “Demo Day”, which is startups can earn extra funding from investors.
According to Shieber (2014), most of the accelerators provide seed funding investment, mentoring, workspace and professional services in exchange for an equity stake company. Typically, seed funding around $25,000 is exchanged with equity stake 6%.
Accelerator selecting their startups in intent to gain financially outcome from their
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initial investment. Take Y Combinator, one of the most successful seed accelerator programs, as an example, Y Combinator usually provided seed funding around $11,000 to $20,000 with exchange for equity around 2-10%, they have been funded over 634 companies since 2005 (April 2014). Omnisio was Y Combinator Winter 2008 cohort; it was purchased by Google in July 2008 for $15 million in cash. Assuming a 6% initial stake with no dilution, Y Combinator’s get return from Omnisio’s sale alone was
$900,000 (Christiansen J. D., 2009).
Business accelerator program creating a valuable ecosystem for new companies, such as Y Combinator hosts a weekly dinners with entrepreneurs and investors, providing a rich structured sources throughout the programs, Seedcamp, a well-known European accelerator’s company, offer startups an opportunity to interact with investors and pitch theirs ideas to variety of potential investors throughout Seedcamp Week, TechStars, another famous accelerator company in U.S., host a talk show by entrepreneurs and investors in a structured manner throughout their programs in an effort to form connections. The most close relationship with a broadly, helps startups companies more easy in obtain fundraising.
Accelerators also provide value to their startups with intensive and high quality mentorship during the programs. One of the greatest obstacles that startups companies usually face are they are not understanding their target market, they don’t have a strong marketing expert working with them for their business, difficulties in reaching their customers, and lacked of overall experience in their proposed business (Hoffman &
Radojevich-Kelley, 2012). In the accelerator program, they pair a technical expertise to each startup, offering a professional advice, typically in various business concepts such as branding, marketing, and customer development, and helping them to achieve more additional funding from investors.
Finally, accelerator programs are culminated with a ‘Demo Day’, the day where all the startups companies can demonstrate their products to investors. It is a big change for startups to get an additional funding from investors.
2.2.3 Startups
According to case studies, Miller and Bound (2011), Startups is one of an essential element in the accelerator programs because the initial of accelerator program is to help startups in developing their business ideas and also trying to connect them with worldwide investors. The important aspect that startups usually consider before joined
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accelerator programs is the connection to future capital. It was extremely important to secure an additional funding once the program is over.
From startup’s point of view, financial support and initial funding are important, but they are also concerned about running appropriate business issues, such as; hiring right workers, a good public relations, marketing channel, and pricing strategy. If they started their business with a wrong step in the beginning, then it could be harmful in the long-term period (Christiansen J. D., 2009). Accelerators are very beneficial in helping startups avoid making early business mistakes; through their guest speakers and educational talk, startups can consider common problems that they may face in the future issues and need to pay attention for the growth of their company. It is also the best place to seek future funding.
Besides, accelerator companies are seeking startups that have a potential commercial viability. So during the selection process, accelerators will look at several aspects; high growth potential, team composition and experience, existing prototypes, intellectual property, market opportunities and what value that they can add and carry out in following three months or more. Most of the accelerators companies will have an interview and a review of startups applications prior to selecting their candidates. They may have various screening process and/or criteria to do the selection. Like TechStars as an example, the most important criteria for selecting candidates are their technical expertise and working prototype, different with LaunchBox Digital; they are more considered with strong lead founder and how idea solves a real problem. (Hoffman &
Radojevich-Kelley, 2012)
2.2.4 Investors
According to Miller and Bound (2011) “investors are the most reoccurring in the accelerator context”. Angel’s investor typically is seeking a high return within a ten years period of investment. They usually asked for 25% Internal Rate of Return (IRR), and it is considerate of an appropriate claim because they need to inherit a risk in the early-stage investing (Christiansen J. D., 2009). Similar with VCs, they are also invest in high-risk with high-return investment. They like to invest in earlier startup venture because in business accelerator they can easily find a number of promising young companies to do more save investment since startups need passes a strict selection process set by the accelerator companies before they can join the accelerator programs.
The final goal of VCs is either take the public offering or trade sale.
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Why investors like to invest in accelerator business, let’s take Y Combinator accelerator programs as an example. In each program cycle, Y Combinator are expected 50 % of their startups companies to fail. “Despite in those failure rates, the programs is expected to generate significant returns for investors through early investment in companies with large exits” (Christiansen J. D., 2009). Takes one program cycle of accelerators as an example :
Investment : $20,000 for 5% equity Cohort size : 10 companies
VCs investment : $100,000/each companies for 10% equity Total Investment accelerator required : $200,000
Total VCs investment : 1,000,000
Assume 1 company achieves a large exit : $ 100,000,000, accelerator has 1% ownership at exit, VCs has 10 % exit, exit value for accelerator : $1,000,000, VCs : $10,000,000 Assume 4 companies achieve break even exit: $300,000, accelerator has 2 % ownership at exit, VCs has 10% exit, exit value for accelerator : $6,000, VCs : $30,000
Assume 10 companies lose all value : exit value for accelerator : 0, VC : 0
From the example above, we can see that this program generates return of investment 5x for accelerator and 10x for VCs. And since it is still in the early stages of investment, but it has already started to prove that this kind of business model generalized a high return for accelerators and investors. That why investors are interesting invest in accelerator programs companies.
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