In the past, the best venture investors were found at the later stage, where traditional growth equity brands were considered the go-to partners to successfully scale one’s company. Since then, the top investors have focused on earlier and earlier stages, to where even emerging micro-VCs have generated considerable returns.
In the past decade, the most valuable technology investors have evolved to become platform-enabled incubators and accelerators. The opportunity to generate outsized returns at seed and pre-seed stages has become increasingly evident. In fact, Pitchbook data shows the number of incubators and accelerators has grown from 334 in 2006 to 1525 in 2016 (CAGR of 16.4 percent).
Accelerator and incubator models have become the supreme investors in the venture space for several reasons:
Incubators or studios assemble specialized teams to work together on several ideas. As an idea proves successful, the incubator scales the team and capital accordingly. Typically, incubators can take a meaningful piece of the company, at times up to 90 percent.
Accelerators are ecosystems that accept startups into their program. Once accepted, startups receive support from in house experts and the accelerator’s network while participating in the program for a fixed period of time, usually 3-9 months or longer. Accelerators provide $50,000 to $150,000 in funding for 7-15 percent in equity.
New VC models are outperforming at a different order of magnitude.
As outsized returns are concentrated on a few startups, these new models now capture much of potential early-stage returns.
Lower costs for starting companies have increased the number of startups and their ability to scale. The increased number of companies requires platforms to source at scale.
As the cost of starting a company has decreased to almost zero, series A is no longer the first round of financing for a lot of startups. Marc Andreessen has made the point that traditional VCs are no longer the first round of financing in startups. In fact, companies nowadays have up to five rounds of financing before they even reach their Series A. As a result, traditional series A and B venture investors with large-size checks no longer fit with the “to-go-market” round for startups. Founders now primarily seek seed investors who have previous operating experience and can help with various aspects of building business.
Traditional venture capital has become a later stage of financing that is similar to private equity and has a difficult time generating outsized returns.
Large fund sizes in the range of $500 million to $1 billion have prevented traditional VC firms from investing in seed rounds. As mentioned above, with decreasing capital requirements of launching a technology startup, seed and pre-seed rounds are usually where the highest growth occurs; these are the rounds that are most primed for outsized early stage returns. Yet, only 4 percent of institutional capital is allocated to non-traditional VC firms, including accelerators, incubators and seed funds, according to Pitchbook data.
An increasing amount of top breakout companies are now funded by non-traditional VCs like seed funds, incubators and accelerators. 70 percent of the top 10 companies in the past 10 years are backed by such investors.
These models can be as simple as an accomplished serial entrepreneur creating companies methodically to large-scale operations like Y Combinator. A study by the Academy of Management shows that companies from top programs accomplish more key milestones than non-accelerator-backed companies. Milestones includes time to raise follow-on financing, exit by acquisition, or increased customer traction. Given these advantages, top accelerators are attracting quality founders and therefore enable them to grow breakout companies faster. On the other hand, TI Platform Fund finds that top entrepreneurs are now applying their learnings and networks to incubate numerous breakout companies.
Models with a network effect platform are able to capture breakout companies early.
Incubators and accelerators are continuously scaling their rippling network effect. For example, while Y Combinator only has one office location, unlike many other accelerators, it is no secret that its biggest advantage is an impressive network of alumni founders.
New models of incubators and accelerators will continue evolving while disrupting the venture capital asset class.
Incubators and accelerators have a few structural advantages: they are able to source companies at scale; create platform-enabled, multi-disciplinary networks of experts, founders, customers and investors; and launch companies at extremely low costs, creating a favorable environment for company creation.
Venture Capital has been disrupted by these models since Y Combinator’s early days. The effect of this disruption will be increasingly prevalent in upcoming years.
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