Why VCs No Longer Require Warm Intros

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Once upon a time, the startup and VC ecosystem was a very opaque and fragmented place. Each non-SV market had at best a handful of meaningful check writers who were very geography-centric (local) in their funding. Even Silicon Valley had only a few dozen VCs, who very much expected you to move closer to them if they were going to fund you. Seed funds and accelerators were not a thing. The idea of a “pre-seed” round would be considered comical.

In that earlier, simpler time, much discussion revolved around the importance of the “warm intro.” So much so that I had to write posts like: “Why I (Still) Don’t Make Investor Intros.” Venture capitalists used the way that you were introduced to them as an important signal for a founding team’s chops. Candidly, this is not entirely unreasonable. A whole lot of what a founding CEO does is build relationships with key people in the market, and “sell” the vision so that other players will make an incentives-aligned contribution to the cause: join the team, buy the product, write a check, etc. There is some logic to the idea that if a CEO can’t convince anyone credible to introduce them to a VC, well, can they convince key employees, or key customers, or key commercial partners?

Times change. Now the image of elite VCs sitting in their gilded towers waiting for founders to jump through X or Y hoop just to be given 15 minutes to sit in a conference room chair seems… a bit dated. Sure, the go-go years of 2020-2021 have ended and we’re now in a bit of a reset of power dynamics between founders and funders, but nevertheless the whole process of how top founders get connected with VCs today looks very different from 10-15 years ago. In fact, at the high end of the market, it’s flipped. Rather than founders scrambling to get intro’d to VCs, it’s now VCs scrambling to get intro’d to founders. Multiple articles were written about “VC burnout” as VC partners and associates were, in some cases, under extreme stress trying to get access to good deal flow.

What changed? The Disney-fied story you’ll hear is something like “VCs have become more enlightened.” Relying on intro’s was too “good ol’ boys” chummy. It excluded talented people without connections. It reinforced biases and prejudice. Now our far more modern funding ecosystem is “open,” transparent, meritocratic, with a more level playing field.

Okay, perhaps. I won’t say that narrative is entirely false, but it’s most definitely incomplete. The bigger-picture reason is: competition, and a proliferation of alternative signals for team quality.

In How Angels & Seed Funds compete with VCs I wrote about how changes in the structure and timing of funding rounds produced an entire industry of check writers who preceded VCs in a company’s funding pipeline. Angel investors have been around for a long time, but as the SaaS revolution started dramatically dropping the cost of starting a startup, resulting in an explosion of people trying their hand at entrepreneurship, angels started professionalizing. You now had angel networks and syndicates that could collectively fund an entire round of millions of dollars. They were soon followed by “seed funds,” leaner, faster VCs who led rounds much earlier in a company’s life-cycle relative to more traditional VCs who typically dove in around Series A.

Parallel to the professionalization of angel networks and seed funds came startup accelerators, which were a result of the then-newly emerging seed ecosystem, but also a catalyst for its further evolution. The explosion of young startups who weren’t yet looking for millions of dollars, but for whom a few hundred thousand would make a meaningful impact, begged for a university-like talent sorting service provider that could apply a branded signal onto credibly vetted teams, thus helping them get later funding.

For a period of a few years, there was an elegant symbiosis between the “seed ecosystem” of accelerators, angel networks, and seed funds, on the one hand, and larger VC funds who showed up around Series A, on the other; much like how elite universities sort and credential students, for a price, and funnel them into top-tier employers.

We can pause for a moment here to recognize that this development alone significantly eroded the importance of the “warm intro.” Accelerators and angel networks rarely required warm intros. They had “open application” style ways of connecting with founders, which rarely required references or other connections. This meant a higher volume of applicants of more varied quality, but because the checks were smaller (less concentrated risk), and these orgs staffed themselves with people trained (in a way) to separate wheat from chaff, this significantly expanded the top of the funnel for startups entering the funding market.

At the tail-end of the seed pipeline, once you were accepted/funded by a top accelerator or angel network/seed fund, this served as a credible alternative to the less institutionalized “warm intros” of yesteryear. Someone had already put in effort to get to know you and filter you from the volume of B and C-players in the market, and so VCs grew more comfortable taking those meetings even if a classic introduction wasn’t part of the package.

But unlike centuries-old non-profit universities, the seed ecosystem was made up of dynamic businesses and service providers eager to claim more market share. And so they did.

Elite accelerators and other seed players started forming their own later-stage funds, or investing in VC funds much more tightly aligned with their own interests. If there was money to be made in later-stage rounds, why let some other fund make it? Seed players also started leveraging their control over the top of the funnel to exert pressure on later-stage VCs, requiring them to accept higher valuations, weaker governance rights, and other forms of limits on VCs freedom to operate. See: Startup Accelerators and Ecosystem Gatekeeping.  What had started as a nice complement to the business needs of VCs had now evolved into a direct competitor and gatekeeper.

VCs, being who they are (hardly tender souls afraid of competing), were not simply going to accept these seed-stage upstarts taking control of the ecosystem. The stakes are too high. VCs started evolving and competing, in many cases very successfully. See: Why Startup Accelerators Compete with Smart Money. The significant weakening of the “warm intro,” with many 7-figure check-writers openly inviting founders to send cold e-mails, is a result of this competition. If VCs didn’t want accelerators and seed investors choking them off from the entire pipeline of top startups, they had to get comfortable stepping out of their gilded towers a bit and spending more time filtering through the masses themselves.

Thus the erosion of the VC warm intro is less the result of a newly enlightened VC industry, and more a response to changing market dynamics requiring VCs to loosen up if they want meaningful deal flow. Making the warm intro merely optional is just one way VC is evolving. VC “scouts” – often very young people aligned with a VC fund and incentivized to identify early talent – are a kind of VC-aligned white-label of angel investors. See First Round Angel Track. Some VC funds are going further and creating their own accelerators. See Sequoia Arc.

My personal impression is that elite VC funds identifying and responding to competition from seed players, and themselves creating seed-stage arms of their funds, has been the nail in the coffin of the “golden era” of startup accelerators. It’s very true that some meaningful accelerators still exist, most notably Y Combinator, but it’s quite obvious now that accelerators no longer serve the central role in the seed ecosystem that they once did. It’s hard to imagine accelerators regaining their prominence among the very top tier of entrepreneurs without a significant revamp of their business models, including their pricing.

Ironically, elite startup accelerators once branded themselves as an alternative to a stodgy and antiquated university system, and yet now they themselves are seen, in some circles at least, as unnecessary and overpriced. The truth is accelerators are a service provider, with a relatively high price. It should surprise no one that the market responded by offering similar services (sorting, signals) at other price points. In the golden era of accelerators, a hustler would flaunt dropping out of Stanford or Harvard and joining YC or Techstars. I see a lot more elite founders today skipping accelerators entirely and just getting funded by a seed fund or nimble VC, accumulating a less centralized portfolio of signals, while saving significant dilution in the process.

This is not at all to suggest that the most elite startup accelerators are going away anytime soon. They absolutely have their place, particularly for founders in contexts where they struggle to acquire credible early signals; one key example being international founders in smaller markets. But all accelerators are facing credible competition and erosion of their pricing and brand power, as entrepreneurs at all levels, including those at the very top, realize that the value proposition of accelerators (signals for follow-on funding, a network, advisory) is often replicable at substantially lower levels of dilution.

At one level, the big picture story here is competition between different kinds of funders: angels, seed funds, accelerators, and VCs, all competing for each other’s turf, with different business models and price points. The number and variety of check writers grew significantly, changing power dynamics between founders and funders, and forcing the latter to become more flexible in order to access deal flow.

At a higher level, we see competition between signals. This post is ultimately about warm intros, which are one of many possible signals for the quality of a founder team. The “open application” style of accelerators and seed funds demonstrated that there were other ways to vet the quality of founder teams, and VCs eventually started integrating those other signals into their filtering repertoire.

We may be moving away from the warm intro as a central signal for startup quality, but we will never move away from the need for signals themselves. When people criticize the university system, they’re often criticizing its price, or its effectiveness, but they’re not criticizing the fundamental underlying “service” that elite universities and even standardized tests provide: talent sorting and signals. That service still needs to be provided somehow. The emerging theses are that there are ways of doing it better, cheaper, faster, etc. This is most definitely true, even if it’s also true that the older systems still have their place.

Developing alternative signals that produce results is legitimate improvement and market evolution. Competition between signals is not zero-sum. There’s room for more. But complaining about how existing signals are unfair or exclusionary without offering viable alternatives is (candidly) just whining. Not helpful. What we want to work and what actually works are two separate things.

Similarly, celebrating the weakening of the warm intro, much like celebrating the weakening of institutionalized education and testing, is not the same thing as pretending (delusionally) that we don’t still need effective + efficient talent sorting and signaling. Universities letting go of the SAT as a hard requirement does not mean some highly talented students won’t still use it as their preferred talent signal.

It’s the same with the warm intro. Sure we can talk about how it’s unfair and exclusionary, and that it’s a good thing that there’s a broader menu of signals available, but the fact is for many teams it still works. In fact, given how much bigger the market has become, with a larger diversity of credible intro sources (respected founders, senior executives, and angels being the best options), the warm intro today is arguably much less “chummy” than it was in the tighter, narrower networks of a decade ago. If you can get a strong warm intro (note: lawyers are not strong warm intros), I highly recommend you use it. In a crowded market, anything that can credibly differentiate you is worth using.

The wheat will somehow get separated from the chaff. That’s a fact. More ways of doing that (a wider variety of effective signals) is a good thing. But I would caution anyone from turning this story into some kind of “you can be whatever you want, if you try” warm-and-fuzzy narrative. Startup entrepreneurship is still brutally competitive and meritocratic (albeit imperfectly); exclusionary by design, just like any high-stakes industry or sport. Some barriers, like the warm intro requirement, have been loosened. But that’s meant the number of entrants has multiplied 10-fold.

The competition among funders has gotten much more intense, but so has the competition among entrepreneurs. The strongest teams will always use credible, unambiguous signals to differentiate themselves from weaker players in an increasingly crowded and noisy market. Some of those signals will be elitist, because the entire point is to identify the elite.

End-note: The topic of intros and signals often gets understandably lumped into discussions of “diversity” in the startup ecosystem. If you’re interested in my candid thoughts (as a latino from a low-income background) on that topic, see: Diversity in Startups: Whining, Warring, Winning. 

Crisis, Relationships, and VCs

TL;DR: Startups who resisted building durable relationships with professional institutional investors, and instead pursued the “party round” competitive fundraising mindset promoted heavily by certain SV voices, are going to get a rude awakening in this current crisis. But the same may be true of startups who failed to reasonably diversify their funding options. The easiest money in good times is the first to leave the stadium in scarier times.

In talking with various market players in startup ecosystems, you’ll hear a wide spectrum of philosophies on how early-stage startups should engage with investors, particularly institutional investors (VCs). On one end of the spectrum are, of course, the VCs themselves. Predictably they tend to favor fundraising philosophies that minimize competition between investors, emphasize qualitative over quantitative (valuation, ownership %) variables, and keep the number of players on the cap table low; which improves their leverage and ability to get a bigger piece of the limited pie. Terms like “marriage” “value add” and “partnership” tend to dominate this perspective. We’ll call this “relationship maximalism.”

On the other end of the spectrum are players who might be called “competitive maximalists” as it relates to VC funding. From their perspective, there is so much capital chasing deals, and the true “value add” of institutional investors is minimal, so any smart set of founders will focus on maximizing valuation, and minimizing control given to investors. This often means “party rounds” in which lots of funds write smaller checks with no true lead. This perspective finds its greatest proponents in Silicon Valley, where the largest concentration of capital (and therefore competition among capital) can be found.

It’s important to point out that there are “money players” in the market who, at least historically, have themselves promoted the competitive maximalist view of early-stage fundraising. Prestigious startup accelerators are, effectively, a service provider whose “bundle” of value is in many ways competitive with “smart” relationship-oriented venture capital, which encourages them to promote a narrative that downplays relationship-based fundraising and promotes competitive processes. See: Why Startup Accelerators Compete with Smart Money.

In order to get more control over their pipelines, institutional VCs have moved much earlier-stage in their investing, often writing seed checks for a few hundred K as a way to get a meaningful foot in the door on a promising but very early startup. If you manage to build strong relationships very early on with VCs and “value add” angels whose brand/signal can give you access to a helpful network of talent, resources, and other investors, then your need for an “accelerator” is reduced significantly. The whole point of an accelerator is to make it easier to access talent, money, and other resources. That means your willingness to pay their “fee” of 6-8% of your cap table goes down if you can access that “bundle” via smart money, or other people, that you’ve hustled connections to on your own.

Naturally, those accelerators don’t like that, so they’re incentivized to promote a philosophy that makes founders believe all institutional investors are effectively the same, and that relationship-oriented early-stage VCs who resist competitive fundraising processes and very high valuations are largely blowing smoke. They want to, in the eyes of startups, marginalize a potential substitute (smart VCs with their own networks and value add) and promote a complement (dumb money).

Now how does this all relate to the current environment, in which the COVID-19 market shock has clearly slowed down early-stage funding? The length and intensity of the slow-down is still of course an open question with all the uncertainties around how long quarantines/lock-downs will last, and the fact that many funds are sitting on cash that they still need to deploy; but it is certainly real. How should founders approach VCs? As a venture lawyer who doesn’t represent a single institutional investor – see: Relationships and Power in Startup Ecosystems if you want to understand why – my opinion from experience is that the correct approach for most startups lies somewhere in the middle.

I have seen “party round” culture result in so many blowups that it clearly is reckless and should be avoided. Even some of its most vocal evangelists find themselves back-tracking on the approach as the results play out in the market. But I’ve also seen the extremely negative consequences from becoming too dependent on a single VC or syndicate of closely affiliated VCs, which increases their ability to play power games on Boards and extract value that they otherwise wouldn’t have if the cap table were slightly more competitive.

Relationships matter, and it is unquestionably the case that some institutional investors truly are worth accepting a lower valuation, a larger “lead” check, and giving more control away to, in order to “partner” with them long-term. This is obviously the case in a bear market, but it’s also true in a bull market because even in bull markets no founder team ever knows when a crisis – personal or systemic – will slap them in the face. A VC with a sizable percentage of your cap table has “skin in the game” to help you through a crisis. A party round investor for which you are one of 40 investments is far more likely to sit out a crisis and play it safe.

That being said, you can still build strong relationships with VCs, and give them meaningful skin in the game, without being foolishly over-dependent on them. It is wise, if you have options, to include on your cap table a sufficient diversity of un-affiliated investors such that if one group becomes unreasonably “uppity” you have other supporters to turn to. Too much optionality turns into a party round, but some optionality is wise and valuable.

Clearly the startups that will have the easiest time in this crisis, however long it lasts, are those with enough cash in the bank to weather the storm. But for those who will need to enter the fundraising market in the next 3-6 months, without a doubt the competitive maximalists who’ve filled their cap tables with lots of small checks, and refused to let anyone participate in governance and build a relationship with the executive team, are going to be in for a rude awakening. They’re going to learn the hard way how “easy come, easy go” applies to early-stage fundraising.

Build meaningful, durable relationships with professional investors with the character and resources that can provide valuable insurance when an unpredictable crisis hits. Just ensure you’re well-advised throughout the process, so the “relationship” develops in a way that is balanced, and your company isn’t over-exposed.

Why Startup Accelerators Compete with Smart Money

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.

Startup Accelerators and Ecosystem Gatekeeping

TL;DR: Startup accelerators face a fundamental challenge to their value proposition: they don’t “own” their networks, and therefore struggle to continue extracting fees for accessing them. Classic disintermediation. Their responses to that challenge take a number of forms, and generally involve either dropping their price or attempts at controlling ecosystem players; the latter of which is misaligned with the interests of entrepreneurs and startups.

Related reading:

As I’ve written before in the above posts, Startup Accelerators became “a thing” in ecosystems because they were a reasonably optimal method for solving the “noise” problem faced both by startups and investors; a problem which became more visible as the cost of starting a company went down. With far more people “starting up,” early-stage investors needed someone to help them filter out duds. The solution, referred generally as “sorting,” is similar to the value prop offered by elite universities to employers needing talented labor, and students needing credible ways to signal their talent.

By creating credible brands (signals) for quality entrepreneurs, accelerators reduced the search costs for early-stage investors who, instead of needing to filter through lots of duds themselves, had a concentrated place to build their pipeline. That value proposition attracted investors, advisors, great employee hires, etc., and over time successful “alumni,” which magnifies the value proposition to entrepreneurs who, in exchange for equity, got a fast-track to building their network and raising capital.

For some time, you had a virtuous cycle with clear “network effects.” Attract great entrepreneurs, which then attracts investors and other key people, which then attracts more great entrepreneurs, and so on and so forth; just like a classic network effect for a software platform. During this period, accelerators can build significant leverage over their ecosystems as gatekeepers to talented entrepreneurs, and use that leverage to push the market in directions the accelerator wants.

The “Network” Can’t Be Controlled

But accelerators face a distinct problem that doesn’t get talked about a lot publicly, but local market players absolutely know is there: they can’t lock in (air quotes) “their” network. It’s not proprietary. The “networks” of startup accelerators are really just compilations of individual peoples’ networks; not at all like a “network” of a tech platform for which the tech “owner” can sustainably charge access fees. Those people in the accelerator’s “network” aren’t employees of the accelerator, nor are they paid out of its returns, and so they aren’t aligned in propping up the network’s “access fee.” Inevitably, people find it worth their while to simply bypass the accelerator and makes themselves accessible to founders directly, after having built their own personal brands with a few iterations with the accelerators’ initial cohorts. If a team needs X, Y, and Z, and I know X, Y, and Z and can help them get access with my own branding/signal, why should they have to pay this 3rd-party a fee to access those people?

So after a few years of an accelerator having filtered and aggregated a network, helping great people find great founders, and great founders find great people, the network takes on a life of its own. Suddenly with a little hustle and networking, it’s not nearly as hard as it was 5 years ago to simply navigate the “network” without ever needing to pay the gatekeeper. I’ve seen this play out in a number of startup ecosystems across the country, where accelerators faced an initial golden age when they were seen as prime “sorters” of an opaque ecosystem willing to pay for the sorting, and then suddenly the quality of entrepreneurs they can get to pay their “fee” starts to take a clear downward turn. Top entrepreneurs are, by definition, fantastic hustlers. They aren’t going to pay you for something once they’ve realized they can do it themselves with a little effort, or that someone else is offering similar “access” at a lower “fee.”

Once top entrepreneurs realize that they can bypass the accelerator and access its “network” directly, and word gets around, the value proposition of the accelerator can begin to unwind. Suddenly the accelerator cohorts start to fill not with the most highly skilled entrepreneurs (those hustle it out on their own now), but with lower quality entrepreneurs less capable of making things happen “in the wild” and therefore more needy of the accelerator’s high-touch, high-priced assistance. As the quality of the accelerator’s average entrepreneur goes down, the leverage over key people on the other side of the “market” – investors, advisors, etc. – goes down, and fewer of them show up to the accelerator; which then reduces the value prop for entrepreneurs, and you get the exact reverse of the original virtuous cycle.

Seeing this dynamic play out, accelerators have three ways of responding, and I’ve seen them in different markets.

Drop the Price

The first is to simply acknowledge that the accelerator cannot maintain the original value proposition they had before the ecosystem/network had matured, and drop their price accordingly. With less significant of a signal, and less leverage over the market, the high 6-8% fee can’t be sustained, so build something leaner that can be offered at a 1-2% level perhaps. I’ve seen these “leaner” accelerators enjoy some success. Some accelerators started out with the expectation that they were going to dominate a startup ecosystem with high “access” fees, and then over time got humbled when the market delivered a reality check.

Employ the Network

Another option is to convert the accelerator into a kind of “startup studio,” where the main pieces of the network are actually employees paid by the accelerator, or at least with deeper economic ties to the accelerators’ performance; reducing their incentive to leak out of the network. The key challenge here is whether the accelerator really has the cachet/leverage, and resources, to employ those people; or whether A-players find it far better to simply stay outside and keep their pipelines more open.

Another way to “employ” certain network players doesn’t require actually employing them, but simply maintaining some economic control over them. For example, a prominent accelerator might use referral relationships with certain law firms as a way to keep those firms from questioning the accelerators’ behavior, even if it’s clearly at times not in the best interest of the startups the firms represent. That strategy is straight out of the playbook of VCs. See: When VCs “own” your startup’s lawyers and Relationships and Power in Startup Ecosystems. Offering or restricting “access” to potential investments, clients, employers, etc. has always been a currency used by startup power players to keep other market participants loyal and “well-behaved.”

Try to Lock Down the Network

This is where things start to get interesting. So I’m an accelerator enjoying success, but I can clearly see that over time my ability to keep extracting gatekeeping fees over my “network” is weakened by my inability to maintain control over the investors, founders, advisors, etc. within it. Possible solutions:

  • Lock Down Demo Day – Maintain tighter control over who gets access to demo day and, importantly, “discourage” founders from raising financing outside of demo day.
  • Lock Down Financing Structures – Maintain tighter control over how financings within the network occur, by “soft mandating” that they follow templates created and controlled by the accelerator.
  • Lock Down Network Communication with Technology – Create proprietary message boards, mail lists, and other media platforms for communicating within and navigating the network, to “incentivize” networking in ways that give the accelerator visibility and control.

Of course, none of this will ever be communicated openly as mechanisms for the accelerator to maintain power over an ecosystem/network, including founders. They’ll be spun as ways to provide efficiency and value for founders and other people. But as with much spin, there is a point at which it fails to pass the laugh test.

Listen in the market (what gets said privately rarely mirrors what is said publicly), and it becomes clear that the more aggressive accelerators have for some time been building local resistance; irritating investors who resent having a “big brother” dictating how to do biz dev and deals, irritating founders who don’t want to pay a gatekeeping fee for accessing specific ecosystem resources, and irritating other market players who don’t want a rent-seeker standing in-between them and potential business.

When an accelerator “discourages” a startup team from fundraising outside of demo day, it’s going to offer some paternalistic platitude about how having a controlled process helps “protect” the entrepreneurs, but what it’s really about is ensuring the accelerator has (i) leverage over the investor community via ability to deny and control access to its founders, and (ii) leverage over founders by controlling the venue in which they fundraise; which sustains the power of the accelerator to charge high gatekeeping fees.

Once I’ve publicly announced my cohort, the sorting is done and the signal is out. Investors don’t need me (the accelerator) anymore, and in many cases nor do the founders whose main purpose of joining the accelerator was to get “branded” to make getting meetings with investors easier. That threatens the power of the accelerator, which wants to charge not just for sorting/signaling, but for access to a network. “Locking down” outside fundraising, with some clever spin as to why it’s good for startups, is the response.

If an accelerator builds proprietary communication channels for alumni to utilize, maybe that’s to be helpful. Or maybe it’s a way of preventing the network from doing exactly what networks do organically, which is resist gatekeeping and build multiple nodes/channels to prevent a single point of entry through which a rent-seeker can extract access fees. Accelerator’s don’t hold monopolies on brands/signals that startups can leverage to get funding, and therefore other people (like angels, seed funds, and respected founders) within a “network” who can connect founders to money/other resources (offer cheaper “signaling”) are, in a sense, competitors whom the accelerator has a strong incentive to control. Maintaining control / visibility over communication channels is a way for accelerators to prevent leaner competition.

Accelerators are Service Providers, Like Everyone Else

The general conclusion from all of the above should not be that startup accelerators are bad or good; on an individual level many are of course full of great people. Instead, it should be that accelerators are profit-driven service providers and political actors, just like everyone else. They want to charge a higher price, and will do what they can to maintain their power to charge that higher price. Other market players will attempt to build alternatives, and drop that price, and the accelerators will respond by trying to compete with, block, or control those other market players. It’s just like VC, Law, and any other industry that caters to startups.

When transparent meritocracy and markets start to challenge a player’s ability to charge high fees, they often turn to politics; using backdoor relationships to build loyalties and amplify supportive messaging. Accelerators who maintain tight referral and economic relationships with specific funds, firms, and other market players do so in order to ensure there’s a loyal base of people out there toeing the party line, even as opposing voices in the ecosystem start to emerge.

For entrepreneurs, the message is simply to understand where their interests are aligned, and where they’re misaligned, with the interests of accelerators. Branding and signaling are useful. To the extent they are useful to you, use them, at the appropriate price. But by no means allow them to dictate how or when to fundraise, or how to navigate the network. It’s in startups’ interest (and that of ecosystems generally) to stay flexible and keep their options open, even if accelerators would prefer having a tight grip. The golden era of accelerators is almost certainly over, as startup ecosystems and networks have begun to mature, offering multiple accessible paths to networking and investment. But they will still have a place and function for a pocket of the ecosystem that needs them.

To the extent accelerators use politics and leverage to lock down ecosystem resources that founders could otherwise access on their own just fine, or demand that startups and investors do things in a specific way favored by the accelerator, they are no longer transparent market players; they’re rent-seeking gatekeepers. If there’s anyone that startup entrepreneurs love painting a bullseye on, it’s gatekeepers.

After-note: see Why Startup Accelerators Compete with Smart Money for some observations on how early-stage VCs are eroding the value proposition of accelerators further by bundling new roles/services alongside their investments, and moving up-stream.

Trust, “Friendliness,” and Zero-Sum Startup Games

Background reading: Relationships and Power in Startup Ecosystems

TL;DR: In many areas of business (and in broader society) rhetoric around “positive sum” thinking and “friendliness” is used to disarm the inexperienced, so that seasoned players can then take advantage. Startups shouldn’t drink too much of the kool-aid. Smile and be “friendly,” but CYA.

An underlying theme of much of my writing on SHL is that first-time founders and employees of startups, being completely new to the highly complex “game” of building high-growth companies and raising funding, are heavily exposed to manipulation by sophisticated repeat players who’ve been playing the same game for years or even decades. There are many important tactical topics in that game – around funding, recruiting, sales, exits – all of which merit different conversations, but the point of this post is really a more “meta” issue. I’m going to talk about the perspective that should be brought to the table in navigating this environment.

A concept you often hear in startup ecosystems is the distinction between zero-sum and positive-sum games. The former are where there’s a fixed/scarce resource (like $), and so people behave more competitively/aggressively to get a larger share, and there’s less cooperation between players. In positive-sum games, the thinking goes, acting competitively is destructive and everyone wins by being more cooperative and sharing the larger pie. Sports are the quintessential zero-sum game. Someone wins, and someone loses. Capitalism is, broadly, a positive-sum game because in a business deal, both sides generally make more money than if the deal had never happened.

The reality – and its a reality that clever players try to obscure from the naive – is that business relationships (including startup ecosystems) are full of both positive and zero-sum games, many of which are unavoidably linked. It is, therefore, a false dichotomy. In many cases, there are zero-sum games within positive sum games. In fact, rhetoric about “positive-sum” thinking, friendliness, trust, and “win-win” is a common tactic used by powerful players to keep their status from being threatened.

For a better understanding of how this plays out in broader society (not startup ecosystems), I’d recommend reading “Winners Take All: The Elite Charade of Changing the World” by Anand Giridharadas, who deep-dives into how, in many cases, very wealthy and powerful people (i) on the one hand, fund politicians/legislation that cut taxes and funding for democratically solving social problems while (ii) simultaneously, spending a smaller portion of the saved money on “philanthropic” or “social enterprise” initiatives aimed at addressing those same social problems, but in a privatized way where they are in more control. The latter of course comes with a hefty share of feel-good messaging about “giving back” and helping people.

The net outcome is that those powerful players direct discussion away from the full spectrum of solutions that may require addressing some unavoidable zero-sum realities, and instead get society to myopically focus on a narrower segment of purportedly “win-win” options that don’t actually threaten the power and status of the elite priesthood. There is much room to debate the degree to which Giridharadas’ perspective is an accurate representation of American philanthropy/social enterprise, but anyone with an ounce of honesty will acknowledge that it is definitely there, and large.

Sidenote: Anand is a clear hardcore socialist, and I’m not exactly a fan, but life is complicated and I’ll acknowledge when someone makes an accurate point. An enormous amount of “save the world” rhetoric is just kabuki theatre to maintain power and keep your money.

While the details are clearly different, this dynamic plays out all over startup ecosystems. They are full of influential market actors (accelerators, investors, executives) acting as agents for profit/returns driven principals, and in many cases legally obligated to maximize returns, and yet listen to much of the language they use on blogs, social media, events, etc. and an outsider might think they were all employees of UNICEF. This is especially the case in Silicon Valley, which seems to have gone all “namaste” over the past few years; with SV’s investor microphones full of messages about mindfulness, empathy, “positive sum” thinking, and whatever other type of virtue signaling is in vogue.  Come take our money, or join our accelerator, or both. We’re such nice people, you can just let your guard down as we hold hands and build wealth together.

Scratch the surface of the “kumbaya” narratives, and what becomes clear is that visible “friendliness” has become part of these startup players’ profit-driven marketing strategies. With enough competition, market actors look for ways of differentiating themselves, and “friendliness” (or at least the appearance of it) becomes one variable among many to offer some differentiation; but it doesn’t change any of the fundamentals of the relationship. Just like how “win-win” private social enterprise initiatives can be a clever strategy of the wealthy to distract society away from public initiatives that actually threaten oligarchic power, excessive “friendliness” is often used by startup money players to disarm and manipulate inexperienced companies into taking actions that are sub-optimal, because they lack the perspective and experience to understand the game in full context.

With enough inequality of experience and influence between players (which is absolutely the case between “one shot” entrepreneurs and sophisticated repeat player investors) you can play all kinds of hidden and obscure zero-sum games in the background and – as long you do a good enough job of ensuring no one calls them out in the open – still maintain a public facade of friendliness and selflessness. 

As startup lawyers, the way that we see this game played out is often in the selection of legal counsel and negotiation of financings/corporate governance. In most business contexts, there’s a clear, unambiguous understanding that the relationship between companies and their investors – and between “one shot” common stockholders v. repeat player investors – has numerous areas of unavoidable misalignment and zero-sum dynamics. Every cap table adds up to 100%. A Board of Directors, which has almost maximal power over the Company, has a finite number of directors. Every dollar in an exit goes either to common stock (founders/employees) or investors. Kind of hard to avoid “zero sum” dynamics here. As acknowledgement of all this misalignment, working with counsel (and other advisors) who are experienced but independent from the money is seen, by seasoned players, as a no-brainer.

But then the cotton candy “kumbaya” crowd of the startup world shows up. We’re all “aligned” here. Let’s just use this (air quotes) “standard” document (nevermind that I or another investor created it) and close quickly without negotiation, to “save money.” Go ahead and hire this executive that I (the VC) have known for 10 years, instead of following an objective recruiting process, because we all “trust” each other here. Go ahead and hire this law firm (that also works for us on 10x more deals) because they “know us” well and will help you (again) “save money.” Conflicts of interest? Come on. We’re all “friendly” here. Mindfulness, empathy, something something “positive sum” and save the whales, remember?

Call out the problems in this perspective, even as diplomatically as remotely possible, and some will accuse you of being overly “adversarial.” That’s the same zero-sum v. positive-sum false dichotomy rearing its head in the startup game. Are “adversarial” and “namaste” the only two options here? Of course not. You can be friendly without being a naive “sucker.” Countless successful business people know how to combine a cooperative positive-sum perspective generally with a smart skepticism that ensures they won’t be taken advantage of. That’s the mindset entrepreneurs should adopt in navigating startup ecosystems.

I’ve found myself in numerous discussions with startup ecosystem players where I’m forced to address this false dichotomy head on and, at times, bluntly. I’m known as a pretty friendly, relationship driven guy. But I will be the last person at the table, and on the planet, to accept some “mickey mouse club” bullshit suggesting that startups, accelerators, investors, etc. are all just going to hold hands and sing kumbaya as they build shareholder value together in a positive-sum nirvana. Please. Let’s talk about our business relationships like straight-shooting adults; and not mislead new entrepreneurs and employees with nonsensical platitudes that obscure how the game is really played.

Some of the most aggressive (money driven) startup players are the most aggressive in marketing themselves as “friendly” people. But experienced and honest observers can watch their moves and see what’s really happening. Relationships in startup ecosystems have numerous high-stakes zero-sum games intertwined with positive-sum ones; and the former make caution and trustworthy advisors a necessity. Yes, the broader relationship is win-win. You hand me money or advice/connections, and I hopefully use it to make more money, and we all “win” in the long run. But that doesn’t, in the slightest, mean that within the course of that relationship there aren’t countless areas of financial and power-driven misalignment; and therefore opportunities for seasoned players to take advantage of inexperienced ones, if they’re not well advised.

Be friendly, when it’s reciprocated. Build transparent relationships. There’s no need to be an asshole. Startups are definitely a long-term game where politeness and optimism are assets; and it’s not at all a bad thing that the money has started using “niceness” in order to make more money. But don’t drink anyone’s kool-aid suggesting that everything is smiles and rainbows, so just “trust” them to make high-stakes decisions for you, without independent oversight. Those players are the most dangerous of all.