Business Accelerators

UNIVERSITY OF CAMBRIDGE, JUDGE BUSINESS SCHOOL

Business Accelerators The Evolution of a Rapidly Growing Industry Michael Birdsall, Clare Jones, Craig Lee, Charles Somerset and Sarah Takaki 5/1/2013

About the Authors Michael Birdsall grew up in an entrepreneurial family taking part in start and growing business in the oil and gas industry, motorcycle manufacturing and retailing, and hospitality. After serving in the United States Navy as a nuclear reactor operator, Michael carried on his family's tradition starting businesses by following his interests and passions. In 2005, he started a retail beading and jewelry store, in 2007 he started a tutoring company, and in 2010, a wine events business. Michael is currently reading for an MBA at Cambridge University's Judge Business School with a concentration in strategy and marketing. Clare Jones has five years of experience in strategic investing and mergers and acquisitions in the financial technology space. Before joining the Cambridge MBA programme, Clare was a manager on PayPal’s Corporate Development team, evaluating payments and e-commerce M&A opportunities both domestically and internationally. Prior to her time at PayPal, Clare worked on Visa’s M&A team as well as Rothschild’s Restructuring team. Craig Lee has over five years of combined pharmaceuticals and finance experience. He holds a Ph.D. in Pharmacology and he is an author of 17 publications in peer-reviewed journals. Before joining the MBA programme, he worked as an equity analyst responsible for the valuation of pharmaceutical, biotechnology, and healthcare companies. Charles Somerset has been an investment manager at venture fund Loudwater Partners for over five years, investing in growth stage companies in technology, media and telecoms sectors in UK and US. He is the non-executive director of two portfolio companies - a retail fund management business and a media production company. He previously worked in management consultancy at Accenture for two years and is a CFA charterholder. Sarah Takaki worked as an operational consultant at BMO Financial Group based in Toronto, before joining the Cambridge MBA class of 2012-2013. She has a background in engineering and the non-profit sector, and she’s passionate about leveraging the power of business to achieve social change.

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With thanks to the following for assisting us with our research:

Entrepreneurs

Accelerators

Venture Investors

Adizio

Startupbootcamp

#1seed

Arachnys

Springboard / TechStars London

Accel Partners

Believe.in Birdback Blottr Duedil eaziGet TagStand Likeminds Mixlr On Device Research Rummble Labs Silicon Fen Diagnostics Vinetrade WeStore

Accelerator Research Program in Israel Upwest Labs Bethnal Green Ventures Betafoundry Mentor at Startupbootcamp The Junction Paypal Accelerator Relations Eleven

Amadeus Capital Partners Atomico Balderton Capital Ballpark Ventures Connect Ventures IQ Capital Passion Capital Prime Ventures Samsung Venture Investment Corporation

dotforge Accelerator Startup Highway Microsoft Accelerator Seedcamp H-Farm HealthXL Healthbox

Also with thanks to: Franck Nouyrigat at Startup Weekend Jared Konczal at the Kauffman Foundation Stewart McTavish at Ideaspace Robin Evans at the Cambridge University Stats Lab Jerry He at Cambridge University’s Judge Business School Simon Stockley at Cambridge University’s Judge Business School Tian Luo at the US Bureau of Labor Statistics Annette Kramer Coming to America Mini-Accelerator

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Table of Contents 1. Executive Summary .............................................................................................................. 4 2. Aims..................................................................................................................................... 5 3. Background on Accelerator Programmes ............................................................................... 5 3.1 Introduction .............................................................................................................................. 5 3.2 Methodology ............................................................................................................................. 6 3.3 Analysis ..................................................................................................................................... 6 4. Viewpoints from within the ecosystem ................................................................................. 9 4.1 Founders ................................................................................................................................... 9 4.2 Follow-on Investors................................................................................................................. 10 5. Are accelerator programs successful? .................................................................................. 13 6. Conclusions and thoughts for the future.............................................................................. 15 6.1 Accelerator Best Practices ...................................................................................................... 15 6.2 The Evolution of a New Asset Class ........................................................................................ 15 References ............................................................................................................................. 17

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1. Executive Summary This research report examines the accelerator ecosystem, looking at how accelerator programmes have developed over time and what value they create for different parties within the ecosystem, including founders, angel investors and venture capital funds. It then examines the performance of companies that have been through accelerator programmes, using company survivorship and acquisition data, as compared to benchmark comparators. In conclusion, it identifies a number of findings, including key success factors and best practices for accelerator programmes, and proposes the development of accelerator funds as a new type of asset class. A variety of research methods were employed in preparing this report, including interviews with 14 accelerators, 15 investors, and a survey of over 130 entrepreneurs. This research was sponsored by Playfair Capital, a seed fund and a potential investor in accelerator programmes. The origins of modern day accelerator programmes lie with early incubator models, but bear a number of differentiating features. These differentiators include low-level funding in exchange for equity and a focus on time-limited initiatives with training, events and mentoring. Most accelerator programmes employ a similar approach and design, though some points of differentiation exist. In examining different viewpoints from within the ecosystem, we sought to investigate a number of key questions including why entrepreneurs select particular accelerators programmes and how accelerators affect follow-on funders’ investment decisions. Findings showed that quality of the mentors, brand of the accelerator, and networking opportunities are the three major factors entrepreneurs consider when selecting programmes. For follow-on funders, accelerator programmes provide a filtered source of dealflow, but have little impact on investment decision making. Our performance analysis indicated that accelerator programs increase the level of company survivorship by 10% to 15% by the fifth year following the exit from such a programme. Furthermore, we found that the rate at which companies get acquired after completing top tier US programmes is significantly higher than the average rate for US VC backed companies. We identified a number of best practices for accelerator programmes including the development of a strong brand and a positive international reputation, as well as the use key performance indicators and quantitative data to drive programme development. Based on our findings, we believe that accelerators have the potential to evolve into a new asset class. This is predicated on differentiated investment strategy, involving a large number of small, early stage investments, and a higher success rate than a typical venture capital firm, albeit in a wider range of achieved valuations, through the evolution of alternative exit routes, including technology transfer and acqui-hire processes. We believe that this asset class, which we term ‘value-based venture capital’, provides an alternative to traditional models of venture capital, and will satisfy currently unmet demands of LP’s and other investors. 4

2. Aims The aim of this research is to examine the accelerator ecosystem, with particular regard for three groups of actors: entrepreneurs, follow-on funders, and accelerator programmes. The objective is to answer the following three questions: 1) Why do entrepreneurs choose accelerator programmes? 2) How do follow-on funders choose investments and to what extent does an accelerator programme influence their decision to invest in a company? 3) What are the best practices in accelerator programmes? This research intends to provide a strategy for positioning accelerators and investors within this market.

3. Background on Accelerator Programmes 3.1 Introduction Accelerators are the focus of intense interest yet constitute a challenging research topic due to ambiguous definition, fast growth, and little data suggesting their success. Accelerators are compared to business incubators. Barrehag et al (2012) states that an “accelerator . . . derives many of its characteristics from the business incubator.” Yet Christiansen (2009) describes the two as having a “dramatic difference in business model[s]”. Li et al (2012) captures the situation stating “the distinction between business incubators and accelerators is subtle and, at times, ambiguous.” The definition used in this research is provided by Miller and Bound (2011), distinguishing accelerators from incubators by five features. 1) 2) 3) 4) 5)

An application process that is open to all, yet highly competitive. Provision of pre-seed investment, usually in exchange for equity. A focus on small teams not individual founders. Time-limited support comprising programmed events and intensive mentoring. Cohorts or ‘classes’ of startups rather than individual companies.

The number of accelerator programmes is increasing. In 2011, Miller and Bound stated that, “The number of accelerator programmes has grown rapidly . . . ” In 2012, Li et al reported that in the Los Angeles area there are “more than 15 accelerators housing more than 200 startup companies,” and questioned whether demand will sustain this rapid growth. Carr (2012) quotes David Tisch, Managing Director of TechStars New York, as saying, “The majority of accelerators are not good for companies and will fail. There are too many of them.” Rapid growth and little demonstration of returns have resulted in the success of accelerators being called into question.

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However, the definition of success is unclear. Viewed from a policy perspective, Konczal (2012) suggests that one measure of success might be job creation. Hochberg and Kamath (2012) evaluate a variety of criteria, including financing activity, exits, and alumni network, to rank accelerator programmes. Based on our research, accelerators define success based on follow on funding and investor returns. Using exit valuation as a success metric aligns with the interests of investors in accelerator programmes. This metric is offered by Paul Graham, founder of the first accelerator, Y-Combinator, “… the best measure of something like Y Combinator is the average value of the companies it funds” (Graham, 2011). However, conflicting or absent data and evidence that standard techniques result in unrealistic valuations (Damodaran, 2009) prevented our use of valuation data to measure success. As a result, we constructed proxies.

3.2 Methodology We looked at quantitative data to confirm the success of accelerator programmes, and also researched best practices through secondary sources. The lack of published research on accelerator programmes resulted in researching best practices of incubators and venture capital funds. We formulated hypotheses based on the secondary research. These hypotheses were tested by interviewing 14 accelerator programmes and service providers to these programmes. These programmes were located across the United Kingdom, Eastern Europe and Israel. Most of the accelerators had limited historical performance data. The practices identified through these interviews were contrasted with the practices identified as most valuable to entrepreneurs and venture investors. Our research objective was to gain an understanding of a typical accelerator’s programme structure to identify key similarities or differentiators that mark the most successful programmes. We investigated how each accelerator measured success, in order to provide a framework for performance measurement. Finally, we researched the programme funding structures to identify how funding sources affect performance.

3.3 Analysis 3.3.1 Accelerator Points-of-Parity and Points-of-Difference Each accelerator programme had a structure similar to that of TechStars. The major points-of-parity between accelerator programmes are summarized below:

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TABLE 1. Accelerator founders identified their target audience as their major differentiator. Many programmes are beginning to target specific industry sectors or given geographic areas. They are limiting their target market and thereby offering sector expertise or local knowledge as their primary point-of-differentiation (Kotler et al 2009, p. 280) Although not identified as a “key differentiator,” there were observable variations in the structure of some accelerators. A few notable differentiators aligned with our findings of entrepreneurs’ needs from accelerator programmes. Some of these different features included: - Longer programme length: Some programmes allow companies to use the workspace after programme completion with continued support from mentors and staff. - Follow-on funding: Many programmes offer follow-on funding after programme completion. - Demo Day road show: Some programmes located outside of investment hubs offer road shows to provide investor exposure in major cities. - Investor participation in selection process: Many programmes involve their investors in company selection. 3.3.2 Measuring Accelerator Success All accelerators interviewed indicated follow-on funding and exits / investor returns as key success metrics. However, many programmes were too young to have exits or returns. Follow-on funding was used as the key short-term metric. Many top tier US programmes had exits within their first two years of operations. The lack of short-term exits at European accelerators indicates that European programmes exhibit different patterns than those in the US. Accelerators which operate outside a main investing hub indicated secondary success metrics. These included local jobs created or number of outside firms investing in the region. Some accelerators were partially government funded. These programmes are used to spur the local economy; therefore, growing the local startup ecosystem is a key goal. 3.3.3 Accelerator Funding Structure The accelerators interviewed raised their funds from angel investors, venture capital funds, government grants, or NESTA. Later stage venture capital firms were occasionally investors, but this was uncommon. This is notable. We believe that accelerator companies may have a difficult time 7

obtaining Series A funding due to the relatively small amount of early stage funding in the UK (see Chart 4). SeedCamp, one of the perceived top tier accelerators in Europe, includes later stage venture firms in its investor base. SeedCamp companies regularly receive follow-on funding, which we believe is due to involvement of later stage venture firms in the startup selection process.

CHART 1.

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4. Viewpoints from within the ecosystem The chart below illustrates who the principal actors are in the accelerator ecosystem.

DIAGRAM 1.

4.1 Founders 4.1.1 Methodology To answer the first research question, “Why do entrepreneurs choose accelerator programmes”, we began with a review of secondary materials, which informed the development of hypotheses that were tested through interviews. The entrepreneurs were selected from referrals from Playfair Capital, a Startup Bootcamp event, and Google Campus, an entrepreneur workspace. Fifteen interviews were conducted. The results of the interviews suggested survey questions. The survey was distributed through the Playfair Capital network, the research team’s personal networks, and entrepreneur- and startupthemed online communities on Facebook and LinkedIn. The survey reached 182 respondents, of which 131 indicated they were entrepreneurs. This survey included a conjoint analysis question and a net promoter score question. Please see the web appendix for the design of the conjoint question. 4.1.2 Entrepreneur Interviews Through the interviews, entrepreneurs highlighted the importance of the reputational effects of accelerator programmes. The majority believed that graduates of top-tier programmes gain a stamp of approval. Interview responses indicated that entrepreneurs anticipated benefits of programmes were alumni network, investor networking opportunities, and follow-on funding. Mentoring and training were also mentioned. Pitch training, however, was seen as an over-emphasized programme component. 4.1.3 Quantitative Survey

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The quantitative survey identified the top three factors entrepreneurs consider when selecting accelerator programmes: Quality of mentors, brand or reputation of the programme, and networking opportunities. Chart 3 below illustrates the distribution of responses.

CHART 2. The conjoint analysis question asked respondents to make a series of trade-offs on accelerator programme features to identify the value of each feature. The two most highly valued features were the brand and the location of the programme. The other factors, in order of value, were likelihood of follow-on funding, alumni interaction, and the equity for funding offer. Respondents were further asked to select one of two levels for each feature. Respondents perceived an international brand to be nine times more valuable than a local brand. Respondents perceived a programme that has had 80% of graduates receive follow-on funding to be eight times more valuable than a programme with a 50% follow-on funding rate. A complete summary of responses can be found in the web appendix. These findings are suggestive due to a small survey response rate to this question. Not all survey respondents had applied to accelerators, and therefore did not respond to the above questions. These respondents were asked to select the reasons for not applying to accelerator programmes. The top two reasons were lack of understanding the benefits of and lack of awareness of the programmes. Eighty percent of respondents who had participated in accelerators said their expectations for the programme had been met or exceeded. When asked whether they would recommend the programme they had participated in to a friend, 100% of respondents answered positively. The themes for suggested improvements centred around the timing and structure of the programme, including providing support beyond three months and facilitating connections with investors earlier and more frequently.

4.2 Follow-on Investors 4.2.1 Methodology

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To answer the second research question, “how do follow-on funders choose investments and to what extent does an accelerator program influence their decision to invest in a company”, we first consulted secondary sources and identified four principal areas of research: 1. Do accelerator programmes represent a linking platform in a multi-sided network (Eisenmann, T., Parker, G. & Van Alstyne, M.W., 2006), between startups and venture investors? 2. What value do accelerators programmes create for venture investors? 3. What do venture investors regard as the principal benefits of accelerators to startups? 4. Do accelerators programmes affect certain aspects of venture investor decision-making? We then explored these research areas through meetings with fifteen venture investors. These comprised a cross-section of investors, including large VC firms and smaller seed and angel investors. 4.2.2 Accelerators as Linking Platforms We found a ‘disconnect’ between the startups coming out of accelerators and the primary focus of many larger venture capital funds. The principal target investor for these startups was an earlier stage of venture investment, which we identified as a type of seed funding in the $100k-$1m range, coming from a combination of institutional seed investors, dedicated seed funds within larger VC’s, and angel investors. Additionally, we found that accelerator programmes averaged 5-10% of deal flow for venture investors active in this category, a smaller percentage than initially thought. These findings are illustrated in the diagram below.

DIAGRAM 2. 4.2.3 Value Creation of Accelerators for Venture Investors The first, and most direct source of value to venture investors, is the role accelerators play in providing a small, but highly filtered source of deal flow. The advantage cited by venture investors is that these programmes filter hundreds of startup applicants down to an average of 10. This process can save investors considerable time and effort. 11

The second source of value for venture investors is the general role accelerators play in supporting a startup ecosystem. This is can be particularly beneficial for new technology sub-sectors and provides opportunities for investors for interaction, knowledge gathering and general networking. This interaction can provide investors with early visibility of new technology developments and trends and provide an input into future investment strategies and future deal flow opportunities. For investors who take commercial interests in accelerator programmes, this may be a source of significant value. 4.2.4 Principal Benefit of Accelerators The majority of venture investors regarded branding as the principal benefit conveyed by top accelerator programmes. This is closely linked to the filtering effect previously described, and we attempted to capture this brand value effect in the following conceptual map.

DIAGRAM 3. Nearly all respondents cited Seedcamp and Springboard as the top UK programmes both in terms of perceived quality of the brand and perceived quality of startups emerging from the programmes. Beyond the reputational effects, venture investors suggested that the additional value of many programmes was variable. The most positive cited features of the programmes were business development, in particular the establishment of a Minimum Viable Product (Ries, E., 2009) and early customer validation. Pitch-training and networking received mixed responses. Some investors stated that many programmes over-promote the value of these features. 4.2.5 Effect of Accelerators on Venture Decision-Making Our final research objective was to establish whether the fact that a startup has been through an accelerator programme affects the engagement or foreshortens the diligence process, and whether there would be any direct influence on the final decision making process. In both cases, the response was that these programmes have no discernible effect.

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5. Are accelerator programs successful? After gathering ecosystem viewpoints on accelerator programs, we turned to quantitative data to investigate the success of existing programmes. Without publicly available valuation data on most companies that had participated in accelerator programmes, we settled on two proxies of accelerator success: the survivorship of startups that have completed these programmes and their mergers and acquisition activity. Data from the Bureau of Labor Statistics in the United States provided us with two benchmarks of survivorship of startups: national survival rates and California’s survival rates. We compared survival rates of Silicon Valley firms and two of the most widely referenced accelerators, TechStars and YCombinator. This data is illustrated in Chart 1, below.

Average Survival Rate of Startups 100% 80% US National Data

60%

California Data 40%

Silicon Valley Data Y-Combinator

20%

TechStars

0% 1

2

3

4

5

6

7

8

Number of Years Since Birth of Firm

CHART 3. These data indicate accelerator programs increase survivorship by 10% to 15% by year five. For a complete description of the methodology, data sources, and applicability to the United Kingdom, please see the researchers’ website. After establishing that accelerators increase survivorship, we investigated accelerators’ effect on acquisition activity of programme participants. We used Seed-DB to gather data on the percentage of companies acquired in each Y Combinator and Techstars Boulder class between 2007 and 2010. As a control group, we gathered data from Thomson Reuters on the number of companies that received first round funding from US VCs each year from 2007 to 2010 and the percentage that were acquired. This data is illustrated in Chart 2, below.

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CHART 4. These data illustrate two points. First, the rate that companies get acquired after completing top tier US programmes is higher than the average rate of US VC backed companies. Second, companies from top tier accelerators are likely to see earlier exits than the average VC backed company. This is indicated by the relatively high exit rates for Y Combinator and TechStars Boulder in 2009 and 2010. US VC backed companies take 6 years to be acquired on average; thus, the control group’s exit percentage steadily decreases from 2007 through 2010, as companies that were funded in later years have not been acquired yet. Y Combinator and TechStars Boulder show no such trend. Data gathered on Seedcamp, the longest running UK accelerator, can be found on the researchers’ website. These data indicate that our finding holds true in the UK.

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6. Conclusions and thoughts for the future 6.1 Accelerator Best Practices Once evidence was produced that accelerators produced positive outcomes, we began an analysis of best practices. The analysis of the above identified accelerator programme best practices. Some practices appear to serve a similar purpose to Herzberg’s hygiene factors (1959) in that they do not provide positive differentiation when present, but negatively impact the programme or the perception of the programme when absent. Other practices appear to deliver unique value and can be considered best practices. One hygiene factor is the provision of seed funding by the accelerator to startups participating in the programme. The amount of funding offered is relatively consistent amongst programmes, ranging from approximately €10,000 to €50,000 per startup. The opportunity for follow-on funding was one of the top four reasons identified by survey respondents for selecting accelerator programmes. Other hygiene factors include an effective mentor network and active alumni community. The best practices indicate that the following practices should be increased or decreased. 

Increase: o Accelerator brand o Product development support o Measurement of KPIs o Rapid programme design iteration

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Decrease: o Pitch training o Large scale demo days

6.2 The Evolution of a New Asset Class Accelerated startups perform differently than businesses in which VC funds typically invest. As noted above, a smaller percentage of businesses fail and the percentage of businesses that are acquired in the years immediately after funding is greater than that of businesses that receive VC investment alone. Further, the investments themselves are different. Accelerators invest in companies that have neither a prototype nor revenue and diversify across a greater number of companies. Smaller investment amounts for low equity stakes further decrease risk. Due to these differences, we predicted smaller, more consistent returns than are typically achieved by venture capital funds. Christensan (2009, pp. 9) predicted 3.5X returns for an estimated 13.35% IRR. This figure was confirmed by one of the accelerator founders.

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Due to the different risk profile and the steady but smaller returns, we suggest that accelerator portfolio businesses constitute a different asset class from venture capital. This asset class might be described as value based venture capital. All entrepreneurs surveyed by our team indicated that they would recommend their accelerator programme to a friend. Reichheld (2003), suggests that a positive answer to this question can foretell the growth of a company. With all firms receiving a positive answer, the industry as a whole is likely to grow. With moderate returns and high growth, this industry falls into what Henderson (1970) called a star. To choose a firm within the industry, Hadida (2013) recommends investing in companies with a competitive advantage. Based on interview and survey responses, the competitive advantage most valued is a program with an international brand name. Programs that qualify include Y Combinator, TechStars, and Seedcamp. Investment in these accelerators should be considered by seed and early stage investors. The view of accelerators as a new asset class presents challenges. These companies that participate in accelerator programmes may grow slower and have fewer exit opportunities than VC backed peers. They may need a greater amount of funding. Fundraising from limited partners could be challenging due to lack of historic returns. In the United Kingdom, where early stage investments are supported by government schemes, changes in the political climate could weaken the industry. To mitigate these risks, we recommend that accelerator investors focus on exit opportunities from the outset. Ideally potential future purchasers would engage with the accelerated business throughout the programme. To protect an investor’s position, we recommend allocating a majority of its fund to follow-on funding, preventing dilution at later rounds. Further, those programmes with the best brand names tracked performance. Investors should track KPIs of any programme in which they invest. Finally, much of the research on accelerator programmes is still evolving. It is recommended that investors continues to monitor the evolving body of research on accelerators.

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