TL;DR: As the smartest VC money has continued moving earlier-stage, its value proposition for early checks starts to resemble what’s offered by high-priced startup accelerators: signals, coaching, and a network. That means elite early-stage VCs and accelerators can be substitutes, and the accelerators know this. This may lead the latter to recommend financing strategies to entrepreneurs that, from the perspective of the startup can be counterproductive, but enhance the market power of the accelerator relative to investors who can offer similar resources at better “prices” (valuations). Entrepreneurs should understand the power games everyone is playing, and become beholden to no one.
Background reading: Startup Accelerators and Ecosystem Gatekeeping
First, a few clarifications on definitions. When I speak of “smart money” in the VC context I’m referring to investors who bring much more to the table, in terms of useful resources and connections, than simply raw cash. They often bring an elite brand that serves as a valuable signal in the market (which itself raises valuations and helps with follow-on funding), credible insight and coaching that they can use to help founders and Boards of Directors, and a network that they can tap into for helping companies find talent and connect with commercial partners.
Classifying some money as “smart money” doesn’t necessarily mean that any money that isn’t “smart” must be stupid in a classic sense. It just means that the other money isn’t useful other than to pay for things. So in short, “smart money” refers to value-add investors who can do a lot more for a company than simply write a check; while “dumb money” means investors willing to pay very high valuations because they are simply happy to get access to this deal at all, and have very little else to offer beyond money itself.
Another clarification: for purposes of this topic, I am referring to high-cost, high-touch startup accelerators; meaning the traditional kind who “charge” 7-10% of equity and put in significant resources into programming, education, nurturing their network, etc. As I’ve written before, various organic market dynamics that are eroding the value proposition of traditional accelerators (see above-linked post) have produced a new “lean” form of accelerator that has dialed back its proposition, and reduced its “price” to 1-2% of equity. That latter kind of accelerator is not part of this discussion, because they behave very differently, and interact with smart money very differently.
Ok, so now to the main point. “Smart” very early-stage money (seed and pre-seed) can be viewed as a bundle of a few things:
- Green cash money
- Signaling and Branding – simply by being publicly associated with them, raising follow-on money, and getting meetings with other key players, will become dramatically easier.
- Coaching – they’ve seen lots of successful (and failed) companies, and can provide valuable coaching to entrepreneurs.
- A network – they’ve built a rolodex/LinkedIn network of lots of talented people that they are heavily incentivized to make available to you.
Now, let’s compare that bundle to the value proposition of traditional accelerators:
- Signaling and branding
- Coaching
- A network
See the overlap? Startup accelerators are basically a service provider whose core service is the above bundle. In exchange for equity and the right to a portion of your funding rounds, their “service” is that they’ll (i) apply a brand on your company that makes it (at least for the good accelerators) easier to access money, (ii) provide you some coaching and education, and (iii) share their network with you.
The core value proposition of early smart money can be effectively the same as an accelerator: a brand to leverage in networking and fundraising, coaching, and a network to navigate. Accelerators and smart early money are, therefore, substitutes; and substitutes inevitably compete with each other. Some might argue that the “programming” (the educational content) of accelerators is a key differentiator, but realistically the smartest entrepreneurs aren’t joining accelerators to get an education. They’re joining for the brand, the network, and to make it easier to find more money and talent; all of which entering the portfolio of a resource-rich and well-respected early stage investor can provide.
The earlier in a company’s life cycle that smart money is willing to go for their pipelines (and many smart funds are going very early), the more startup accelerators will find themselves competing with lots of market players offering a very similar bundle of services. Given that smart early money can challenge the value proposition of accelerators, aggressive accelerators are incentivized to, in subtle ways, push startups away from smart very early-stage money and toward dumber money, because it increases a startup’s dependency on the accelerator’s resources, and therefore helps justify the accelerator’s cost.
How does this fact – that aggressive, elite startup accelerators want to cut off smart early-stage money from competing with them – play out in the real market? Some of the ways I’ve already described in Startup Accelerators and Ecosystem Gatekeeping, but I’ll elaborate here.
Demo Day – Aggressive accelerators can push entrepreneurs to not do any fundraising other than through channels that the accelerator can control, like Demo Day, and then they can restrict access to Demo Day to investors who serve the interests of the accelerator (don’t compete with it). As I’ve written before, it is not in startups’ interests to restrict their fundraising activities solely to channels that accelerators can influence (because it allows accelerators to serve as rent-seeking gatekeepers). Many accelerators aggressively restrict how their cohorts are able to fundraise, enhancing the accelerators’ market power relative to VCs.
Fundraising Processes that Select Against Smart Money – One thing that’s been interesting to observe in the market is how entrepreneurs who go through certain accelerators are much more likely to emerge with a view that early-stage venture capital has largely been commoditized. If you think that all early money is the same, and all that matters is getting the best economic terms possible, you are going to approach fundraising in a very different way from someone who better appreciates the very subtle, human-oriented dynamics of connecting with value-add (smart) lead investors. “Party rounds” where entrepreneurs don’t allow anyone to serve as the lead are a very visible manifestation of this.
Entrepreneurs who treat fundraising as a kind of auction process, where you amplify FOMO and aggressively get the money to compete for the best price, are often creating a fundraising system that much of the smartest money will simply opt out of. Quality smart money players are looking to build long-term relationships, and that takes time. Their resource-intensive approach to investing also requires building meaningful positions on a cap table; a slot in a party round won’t work.
Elite value-add VCs know that they bring much more to the table than a random investor willing to pay a high valuation, and so the end-product of a hyper-competitive fundraising process that forces them to compete with a swarm of dumb money simply isn’t worth their time. The valuation will be too high, and their allocation on the cap table too low.
Aggressive accelerators know this, and it’s why they often nudge founders toward engaging in these kinds of hyper-competitive fundraising processes that push out smart money, because by removing other “smart” early market players with their own networks and brands, the accelerators enhance the relative value of their own network. The strategy is to marginalize any potential substitutes, so startups see the accelerator and its own network as the only “smart” player they need.
If you, as a founder, have come to believe that value-add VCs – who can deliver A LOT more value than simply cash – don’t exist, you may have fallen for a lot of the propaganda on social media pushed by traditional accelerators and the “dumb money” funds affiliated with them. Value-add VCs most definitely exist, and founders who’ve raised from them will say they’re worth their weight in gold. Accelerators may spin a story as to why it’s in founders’ best interests to be hyper-aggressive with their fundraising, and alienate many value-add VCs in the process, but startups need to understand this is driven far more by what’s in the accelerator’s interests than the startup’s.
It’s also worth pointing out the irony in certain accelerators telling founders that they should maximize valuations and minimize dilution in fundraising, while the same accelerators keep their own admission prices (valuations) fixed; and in the case of accelerators who’ve moved to post-money SAFEs, the price has actually gone up. If the market has become flooded with early-stage capital and signaling alternatives, should accelerators themselves not be subject to market forces?
I’m not an investor, nor do I even represent investors. I’m a lawyer who represents companies, including in lots of financing rounds. Read my lips: relationships matter, and smart relationship-oriented money can really make a difference. Want to know what a possible end-result is of startups pursuing a naive, hyper-competitive, relationship ignorant fundraising strategy that treats getting a high valuation as the only goal; long-term relationships and “value add” VCs be damned? Failed unicorns (getting SoftBanked) and thousands of employees burned because people guiding the company in the earliest days were just lottery-ticket chasers instead of smart players who know how to build viable businesses. Treat investors like it’s all just about numbers, and you’ll inevitably surround yourself with people for whom you are just a number.
As I’ve written many times before, it’s extremely important that new entrepreneurs entering startup ecosystems understand the power dynamics operating in the background. See Relationships and Power in Startup Ecosystems. Different market actors compete for access and control over pipelines of entrepreneurs; and they “trade” access to deals with people who serve their interests. Startups are much better served when they are in the driver’s seat for what relationships they build in the market, as opposed to allowing repeat players (like accelerators or VC funds) to trade access to them as currency. Don’t let your company become a pawn in another power player’s game.
The smartest investors in the market have realized that outsourcing their business development to a handful of “sorters” (accelerators) is a losing strategy, because those sorters have their own agendas. One of those agendas is to make the earliest money in the market “dumber,” so that the accelerators can continue giving startups $125K for 7-10% of their cap table (which translates to as low as a $1.25 million valuation) when many smart early funds would offer multiples of that. It is an own-goal for founders to help accelerators do this.
Scout programs, pre-seed funding, exclusive “meet and greet” events, open “application” processes for intro meetings, and many other activities are ways in which smart money is moving earlier in the startup life cycle, to find early startups that they can “accelerate” themselves. That can be useful to founders, saving them both time and equity. Competition with accelerators is why most elite VCs no longer require warm intros.
All of these ecosystem players are here, in one way or another, to make money; endless PR about friendliness, “positive sum” thinking, and saving the whales notwithstanding. Frankly, so are you, and so am I. The more they can cut off competition, the more money they can extract from the market that would otherwise go to entrepreneurs and their employees. That means the most logical strategy is: become beholden to no one. Nothing better ensures good behavior by your business relationships than a little optionality.
That does not mean treating everyone as a means to an end, nor does it mean preventing serious VCs from taking lead positions on your cap table. To the contrary, it means slowing down and building a diverse set of long-term and durable relationships, with a mix of value-add and “dumb,” that you can leverage toward your company’s goals. The emphasis, however, is on the diversity of your relationships, so no particular group has more leverage than is justified. Diversify your network.
Let everyone offer their service, but don’t naively become over-dependent on any single channel. If you have access to smart early money, take it, nurture that relationship, and respect the fact that smart money deserves a better price than party round “dumb” checks. Just don’t agree to any terms that cut you off from raising from alternative money later if it makes sense. Independent counsel will help ensure that.
If you’re in an elite accelerator, fantastic. Use them. But don’t let them push you into myopic fundraising approaches that just increase their control over the market, which keeps their “prices” high relative to where the market should move. Keep connecting with smart money, and diversify your network. Understand that it’s in founders’ interests to not let a handful of very expensive accelerators cut off smart money from competing on the same playing field (the earliest checks); often at much better valuations.
Startups thrive best in actual ecosystems, where market players aren’t able to gain so much control that they start to “charge” more than their real value proposition justifies. Let the smart money and accelerators compete, and build your long-term relationships accordingly.
Note: a few examples of elite value-add VCs competing head-on with traditional accelerators include Sequoia Arc, a16z Start, Accel Atoms, as well as the Neo Accelerator, which “costs” less dilution than traditional accelerators. Examples of elite VCs who haven’t formed formal accelerators but invest very early (pre-Seed) include Nfx and First Round Capital. Many founders are finding that, after weighing all the factors, entering these kinds of pipelines or programs leads to substantially less dilution relative to going into a traditional accelerator (paying 7-10% in dilution for that) and then doing a seed round.