Post Category → Accelerators

Startup Accelerators: Bundled and Unbundled

TL;DR: Elite accelerators have cemented themselves as the universities of the entrepreneurial world; offering a bundle of resources in exchange for a price (tuition in form of equity). The most elite absolutely deliver on their promise. But as with education, that bundle of resources can be unbundled, and that’s what’s happening among entrepreneurs who don’t need or want the “full package.”

Background / Related Reading:

What is the purpose of universities? It depends on whom you ask. Employers who are honest will tell you it’s mostly one thing: curation; various filters (admissions, testing, etc.) to help sort out who the good candidates are from the bad. If you ask students, you’ll likely get more varied responses. For some, it’s about preparing for a successful career, including building a network that you can leverage for your career. Those are the pragmatists.

Others will get a little more poetic and talk about how universities are a place to ‘find yourself,’ and be exposed to experiences and knowledge that stretch you beyond the narrowness of your upbringing.

The value and purpose of accelerators tracks almost exactly the above points about universities; just replace “students” with “entrepreneurs” and perhaps “employers” with “investors.” Pragmatically, accelerators offer entrepreneurs a curated bundle of resources (a network of entrepreneurs and advisors, faster access to investors, education, some initial money, etc.) in exchange for a price: usually 6-9% of equity, with (sometimes) heavy anti-dilution rights, and pro-rata rights.

Better curation leads to a better network and bundle, which leads to even higher quality, which further enhances the network, etc. It feeds on itself, at least when it works. And for a handful of top accelerators it works very well.

And of course there are certain accelerators who push beyond pragmatism and aim for loftier, more romantic goals than ‘just’ offering a set of resources: helping entrepreneurs build friendships, find greater meaning in their businesses, being part of ‘something greater,’ etc. It sounds very similar to how more liberal artsy universities pitch themselves to students. And you can verify from certain founders (not pragmatists) that the right accelerators do deliver on that kind of experience; that the accelerator was “life changing.”

Here are some thoughts, based on conversations I’ve had with founders and my own observations in the market, about the evolution of accelerators and how entrepreneurs are likely to engage them going forward.

1. Top accelerators have corrected an imbalance between the strength of founders’ networks and those of VCs.

In doing so, elite accelerators have ‘unbundled’ some of the ‘value add’ aspects of how venture capitalists, and other service providers (like law firms), traditionally used to sell themselves. First-time entrepreneurs often start out with virtually no network. VCs and law firms would pitch themselves to these entrepreneurs by emphasizing not just the core service they provide (capital, legal services), but that using them over someone else included access to their network. I’ve written before about law firms that pitch magical access to investors. 

A founder who gets into a top accelerator, however, gains access to a vast, well-curated network of other founders, mentors, potential hires, etc. When they shop for a law firm, they’re now much more interested in the actual service quality of the firm, rather than some lawyer’s half-baked ability to make investor intros. And having access to many resources that they once would’ve relied on VCs for, founders can focus on other variables in investor diligence; like how helpful they are on the Board.

In some ways, the resources that top accelerators give founders have upped the ante on what “value add” from institutional investors really means, and has put some traditional VCs in the same category as prominent angels or well-coordinated angel groups: checks, perhaps with a few intros, but not much more. Some VCs really do add value. Others mostly just provide large checks; which is perfectly fine – you want big checks – but some big checks are smarter.

2. However, there are still a lot of founders who don’t pursue traditional accelerators, and never will.

Traditional, fully bundled accelerators – the kind that involve months of full-time commitment, a demo day, and giving up a large amount of equity in exchange for the large “package” of resources described above – heavily slant toward young, first-time founders. As they should: those are the people who have the most to gain, and the least to lose, from the full accelerator experience.

As influential as accelerators have become, an enormous amount of our client base doesn’t go through them, and hasn’t tried to. The reasons vary:

(i) I’ve got a family and don’t want to move across the country for several months;

(ii) I’ve got my own professional network and don’t see the cost of the accelerator as worth what it can deliver to me; or maybe [and this last one is worth a discussion]

(iii) I can hustle my way to access the people I need – who are now easier to find thanks to the accelerator – without actually joining it.

3. Without tight integration, unbundling of non-elite accelerators is inevitable.

No matter how many MOOCs, Khan Academies, apprentice programs, degree-less job openings, Thiel Fellowships, etc. arise to eat away at the dominance of the 4-year university model, Stanford, Harvard, and MIT aren’t going anywhere. The exact same can be said for the most prestigious accelerator programs.

But outside of the true elite, the traditional format and cost of accelerator programs is likely not sustainable. Very little of what most accelerators offer founders (curated groups of people) is proprietary in any way; nor can it be viably cut off from the market to restrict access to only those who ‘pay’.  The content that is proprietary is *usually* not what draws founders into the program. I’ve seen some accelerators try to get control over ecosystem resources by playing gatekeeper. I’m sure you can predict how that ended for them. Don’t try to ‘gatekeep’ entrepreneurs.

If entrepreneurs are good at anything it’s being resourceful and gaining access to resources (including people) that are visible in the market. And accelerators, through a few years of curation and operation, have made those resources a lot more visible.

Yes, I know several entrepreneurs who are happily tapping into the networks of accelerators without actually going through them. And it’s not surprising, at all. They’re doing what entrepreneurs do. I’m sure the accelerators themselves aren’t even surprised. The networks of accelerators are effectively the compilation of smaller networks of individual people, very few of whom are beholden to any accelerator. And as is now common knowledge, modern tools have made networking 10x easier and more transparent than it was even 5 years ago.

So what does this mean? It means that outside of the very elite accelerators with the tightest integration and network effects, you’re probably going to see experimentation with smaller, more targeted, lower ‘cost’ alternatives. Some will still be called accelerators; others won’t. If the ‘price’ drops to 2% instead of 8%, a little boost in finding investors may be worth it. Maybe programs targeted toward educating founders in a Khan Academy way will pop up, perhaps just for cash.  Although YC appears to be building that, for free.

Prominent angels and advisors may band together to invest very early, and get a little extra equity for value-add advisory; their brand serving as a signal (via great curation) to larger, later-stage checks. Even certain targeted co-working spaces are playing a role, adding on some value add programming/events to sell their real estate.

I can’t predict where it will all go, but I can already see bits and pieces of the unbundling occurring.  My advice to new founders is always to approach accelerators just like they would approach any other resource or service provider in the market: (i) what is the cost, (ii) what do I get for that cost, and (iii) is it worth it, given alternatives available in the market. And always *always* ask the users.

Some founders will continue to pursue the very elite accelerators, and for good reason.  Others will over time find ways to access just the parts of the accelerator “bundle” that they need, and for the right price, all made easier by the foundation laid by the original accelerator boom. 

Even if most accelerators as we know them don’t survive, the people who built and ran them made enormous contributions to the market, and will surely find other ways to keep participating in their ecosystems. What’s definitely clear is that it’s never been a better time to be a tech entrepreneur.

Local v. Out-of-State VCs

Some things in life are certainties. The sun will rise tomorrow, you will be taxed for something… and startup ecosystem players across the world, outside of Silicon Valley and NYC, will complain about the lack of local VC capital, and the need for more foreign capital. Are they correct in complaining? I’m not going to answer that question. Too debatable, and the debate gets you nowhere.

What I am going to say, and I’m saying this as someone who manages a legal practice with visibility into a decent number of 2nd/3rd ‘tier’ ecosystems in the U.S., is that there are a lot of reasons to be optimistic about the overall trends in this area.

The Historical ‘Scarcity Culture’ of Local Venture Capital

Not just in Austin, but in many tech ecosystems that have a similar profile, there’s historically been a culture among the institutional investor community that directly reflected the scarcity of local capital, and of information about that capital. I will call this ‘scarcity culture.’ Trying not to come off as too judgmental, because all institutional capital plays a vital role in the business community, regardless of its approach, I would say that scarcity culture is largely summarized with the following statement:

“You don’t like our terms or our behavior? What can you do about it? What alternatives do you actually have?”

Does this mean that all local VCs outside of the densest markets think that way? Of course not. But it is definitely there, in a variety of ways.

Anyone with a broad enough visibility into American venture capital knows it is an absolute fact that California VCs are generally ‘friendlier’ than the VCs of any other ecosystem. By ‘friendlier,’ I mean that they are OK with higher valuations, they are more transparent in their intentions, and they tend to show significantly more deference to a founder team in terms of providing coaching/opportunities for growth as opposed to an early pink slip.  Why is that?

Is it something in the water? The weather? Have they achieved a new level of enlightenment? Hell no. California VCs have the same job as VCs anywhere else: to make money.  The answer lies in one very simple word: competition. And increasingly over the past few years it is magnified by one more factor: increased transparency through technology and decreased friction in networks. 

Competition and Reputation. 

Let’s use an analogy here.  Do you think that restaurant service is better or worse in dense urban environments relative to small rural areas? Obviously it’s better. There’s more competition.

Do you think the existence of Yelp, and the ability of restaurant goers to (i) easily find information on the past experiences of patrons of a specific restaurant and (ii) easily express their own experience about those restaurants, has improved or reduced the quality of restaurant service? It obviously has improved it. There’s a million times more transparency, which dramatically raises the reputational stakes.

In an environment where a quality founder team can, if they don’t like one particular set of VCs, walk almost literally across the street and talk to 10 more, investors have learned (rightly) that to be an asshole is to step right into a massive adverse selection problem. Combine a truly competitive market with inter-connected networks where reputational information flows freely, and you have a system that naturally corrects for bad behavior.  The really good companies, the one’s that everyone would want to invest in, don’t have to put up with anyone’s nonsense; and they do their homework. 

Contrast that with ecosystems where only a handful of investors, many of whom collude with one another, are available for companies that need serious funds, and you have a very clear explanation for why California capital is ‘sunnier.’  California VCs are more “founder friendly,’ because their circumstances make founder friendliness an almost essential requirement for deal flow. Most assholes can’t even survive in that environment, so it selects for ‘nicer’ people.

I am not saying that west coast money is all cotton candy and rainbows; nor am I saying that non-SV local VCs are all difficult to work with. But broadly and relatively speaking California VCs tend to be much easier for a founder/management team to get along with. It is also no surprise that the rise of industry/vertical-focused VC and VC ‘value-add services’ has come out of California. They’ve got to find a way of differentiating themselves in the noise.

Transparency and Friction.

A decade ago, if you needed to connect with X person for whatever reason – to diligence an investor, to connect to an investor, to find out some piece of information – you faced enormous opacity in finding a path to doing so. This opacity added friction not only to connecting with people far outside of your personal network, but also to obtaining information, including reputational information, about market players. Information is essential for separating marketing/branding from reality.

Blogging is marketing. Twitter is marketing. Talking on panels is marketing. Free office hours is marketing. That free beer at the ‘get to meet investors’ meet-up is marketing. This should be obvious to smart CEOs. Yes, this blog is marketing. Calling something marketing doesn’t mean it’s false; it just means you’re acknowledging the incentives behind it. And that you need a mechanism for verifying what you’re being told.

My method in biz dev is simple: “here’s a list of my clients. reach out to any of them, and don’t tell me which one. Ask them about our rates, and our responsiveness, and the independence of our counsel. I welcome diligence.”

Today, if I run into a set of founders who are talking to VCs, whether they are clients or not, I say “Here is a list of their past investments. Get connected to the founders of those companies, and start asking questions. And don’t tell anyone which ones you are talking to. Don’t treat any single ‘review’ as gospel, because it is a one-sided story. But look for patterns.” For a team that is even mildly good at networking, that is a fairly straightforward task. LinkedIn does 80% of the work for them by letting them know exactly who in their existing network, whether they’re local or not, can connect them to their target.

Tools like LinkedIn, AngelList, Facebook, and Twitter, and the way in which they eliminate huge amounts of friction and opacity in networking, have done two game-changing things for founders: (1) they’ve made expanding their networks beyond their local ecosystem 10x easier (I didn’t say easy, I said easier), and (2) in doing so, they have made finding accurate reputational information about market players 100x easier. That ease of accessing accurate information influences the behavior of investors in exactly the same way that Yelp influences the behavior of restaurants.

In an opaque market in which influencers can control access to people and information, you can reap the benefits of being an asshole without facing many of the costs. Today, the transparency brought about by modern tools and networks has made the costs of bad behavior 10x higher. Technology makes technology investors ‘nicer’ by opening up access to accurate information on market players. Knowledge is power. 

Improving Local VC. Accessing out-of-state VC. 

Thinking of this issue broadly with the above concepts: improving transparent access to accurate information, removing friction in expanding networks, increasing competition, I think we can arrive at some useful ideas for both improving the local investor environment in non-SV markets, and in increasing the flow of capital between markets; beyond the “great companies attract great capital” truism that rightfully causes eye-rolls among founders.

1. Founders/management need to talk to each other more, in places that aren’t controlled by the investor community. 

Information flows most freely when the consequences of sharing it are minimized. You better believe that in some markets where key players serve as gatekeepers (see: Gatekeepers and Ecosystems) the threat of being black-listed somehow for speaking honestly is real. You will never get accurate market information on blogs, on twitter, on panels, or in highly public events where anyone and everyone is watching.

To use Brad Feld’s categories: there are entrepreneurs, and then there are “feeders,” which sort of means everyone else. Events and communities where the whole ecosystem is invited are great. But that entrepreneur v. feeder divide is crucial, and there need to be ways for entrepreneurs to share information with each other, confidentially and alone.

That is the best way to create the following causal chain: (1) bad market behavior -> (2) information shared to broader entrepreneurial community -> (3) adverse selection for bad market player -> (4) correction to behavior.  You get along much better with the VC community when, instead of moralizing about their tactics and behavior, you try to understand their goals and their incentives; and find ways to align them with yours.

2. Outreach to foreign capital needs to come from people who don’t benefit from a scarcity/opacity environment.

Do not expect for a second that market players who benefit from scarcity of local capital and opacity of information will improve the environment for you. In a variety of ecosystems, I have seen circumstances in which local capital deliberately tries to keep out-of-state capital off of a cap table if it is not willing to enter on their terms. If a founder team builds local support and then themselves builds independent relationships with out-of-state capital (directly or via local relationships), that will create very different dynamics relative to a situation in which their local capital syndicates with its own existing out-of-state syndicate partners.

Is building those out-of-state relationship easy? Of course not. But it needs to start early. The companies that successfully receive out-of-state participation in their Series A round often were building those relationships at seed.  And the best intro to a particular investor is through a founder that they already invested in, so local founders who’ve accepted out-of-state capital are vital to encouraging that capital to engage more local companies. Once a foreign VC has made an investment in a city, it is a lot easier for them to look at others.

The angel v. institutional capital divide, highlighted somewhat in “Protect Your Angel Investors” is important here too. True angel investors – not the ones that behave essentially like micro-VCs, but the ones who are playing with their own money and who are really in it for more than just a return – typically behave very differently from institutional capital. They are usually more patient, more attached to the founder team, and usually aren’t laser-set on a “10x or bust” mindset that institutional investment often brings. Angel investors with broad networks can play a huge role in encouraging out-of-state capital to enter new ecosystems.

Just please for all things holy ignore any set of lawyers pretending to provide ‘special access’ to out-of-state investors. There is a hierarchy of paths to investors. If lawyers are even on it, they are near the bottom.

3. De-risk long-distance investment by improving communication.

If I’m an investor deciding whether to invest locally or make a bet on a team 1,000 miles away, I see substantial additional risk in the latter simply because of the added friction in communication. This is particularly important at seed/Series A, where feedback loops between investors and founders are more important. Think of ways to signal to long-distance investors that you will actively remove that friction.

Videoconferencing, well-done regular investor updates like through AngelSpan, committing to flying to meet-up in person regularly, are a few ways to do this. If entire companies can run with remote teams, leverage similar mechanics/tools to make long-distance startup investment seem natural and logical.

4. Reduce search costs. Successful curation is king. 

Finally, while communication issues often make long-distance investment at least seem difficult, you should never ignore the fact that to any investor, simply vetting out-of-state companies is much harder than vetting local ones. Most institutional investors build in various filters and qualification mechanisms into their pipeline/deal flow, and they often break down when looking at companies that are mostly outside of their usual network.

So creating credible, successful curation mechanisms to reduce the ‘search costs’ of institutional investors exploring non-local markets is essential. The obvious answer here is, and has been, accelerators; at least to the extent that accelerators aren’t beholden to particular local funds (in some markets, they are). The most prominent accelerators are playing extremely important roles in connecting companies in one market to investors in other markets, because those investors trust that the accelerator has done a significant amount of pre-qualifying for them. In fact, this curation dynamic is part of the core value proposition of accelerators in the first place.

Another obvious answer is angel investors with prominent personal brands. As angel investors develop broader reputations for selecting winners, out-of-state institutional capital can leverage them to reduce the search costs of exploring other markets.

So, is raising a Series A outside of Silicon Valley and NYC really hard? Absolutely. Then why the reason for optimism? Because every single variable/dynamic mentioned above is improving, and at an accelerated pace. Founders are finding each other and communicating directly, sharing accurate information about the investor community and other market players; aided by modern networking and communication tools. Local angels and entrepreneurs are actively using those same tools to expand their networks far beyond their local ecosystem. Tools for long-distance communication and investor relations are maturing. And accelerators and prominent angels are increasingly becoming curation mechanisms leveraged by institutional investors to reduce search costs and explore new markets.

We are certainly seeing all of this happening at an increasing rate in our work in the market. As additional funds that are more comfortable operating in the new environment pop up, and as geographic barriers are reduced for capital flows, the more established players are increasingly more concerned with their brands and reputation. Instead of a “scarcity culture,” an open, transparent market culture favors investors that deliver real value and build durable, authentic brands.

Raising local and out-of-state institutional capital, and ensuring you’re working with good people, is still extremely hard if you’re not in a top-tier ecosystem. And speaking as ‘just’ a lawyer, I don’t want to minimize that fact in any way.  But the truth is that it’s also never been easier, and the core trends suggest it will keep getting better. 

Protect Your Angel Investors

Background Reading:

A lot of writing, including my own, breaks the world of startup  funding “players” into 2 broad categories: founders and investors. While that is helpful, it’s also important for founders to understand that within the investor category, there’s an important distinction between angel investors and institutional investors; in terms of incentives, behavior, and their overall relationship with the company.

Institutional investors are sophisticated (… usually), repeat players who are working with large amounts of other people’s money; and those other people expect (demand) great returns. They have their own lawyers (and therefore usually negotiate harder), have much deeper pockets, and usually invest much later in the game than true angels; when the company is a much more attractive investment from a risk-adjusted perspective.

Angel Investment: faster, easier, but more exposed. 

Angel investors are investing their own money.  Seed funds / angel groups do work with a broader pool of money, but they are more accurately described as an organized group of angels than a true institutional fund.  Angels often do not utilize their own lawyers in executing deals (because the check sizes don’t justify it), which means they rely more on trust in the team, and on standardized, more lenient terms. Their money goes in much earlier in the stage of the company, so at a point where the company is much riskier. Angels are accurately described as betting as much on a founder team as they are on the business.  Prominent angels also regularly serve as “social proof” for gaining the interest of VC funds.

Because angels invest much earlier in a company (than VCs), usually without lawyers, and usually on standard documents with minimal investor protections, their relationship with founders/management is often much more informal and trusting, and less about “the numbers,” than the founder-VC fund relationship. Accelerators usually also fall in the same category. This is all very much a good thing. It’s what allows seed investments to move quickly, at a time where the company doesn’t need or want to spend a lot of hours going back and forth on deal nuances when they could be building the foundation of the business.  But it also means that angel investors are exposed to gaming by later investors (or, sometimes, bad actor founders) who take advantage of key inflection points to push the angels’ investment away from the “deal” they thought they were going to get. 

The broad context in which this happens is fairly simple: an angel round has been closed for a while – usually convertible notes or SAFEs, but sometimes seed equity – and the company is raising a Series A. After negotiation and modeling, the parties have not aligned on numbers. The VC doesn’t like the terms that the angels are ‘getting’ in the round (from their notes/SAFEs), because after accounting for his own share, too much of the cap table is taken.  So he makes his check contingent on the founders going back to their angels and convincing them to accept modified terms.

The angels, not happy about it, are exposed because their money is already sunk, and much worse things could happen if the deal dies. So they cave; accepting worse terms so that, effectively, the new money can get better ones.  Requiring earlier seed money to raise their valuation caps is a common way to make lower Series A valuations more swallowable.

But to be totally honest here, sometimes the gaming is not led by the VCs, but by the founders. They see what the angels are getting in the deal, and might collude with the new money to force a change. I’ve never had one of my personal clients play that sort of game, but I have seen it happen.

There are situations, of course, in which terms simply need to be re-negotiated; usually because the company’s path took a number of unexpected negative turns, and things just won’t work if a reset doesn’t happen. Those situations should be distinguished from the ones in which a deal really can close, but someone is just using the exposure of angels to get more of the pie.

Reputation is capital. Don’t waste it.

The job of company counsel is not to do whatever founders / management want; it’s to advise on what is best for the company and all of its stockholders long-term. On a whole host of issues, people who’ve seen the life cycles of companies play out over time (like VC lawyers) can bring a long-term perspective that a fresh team may not understand intuitively.

My advice to founders, which I put down in Burned Relationships Burn Down Companies, is that relationships matter. A lot. Especially with your early money, which often acts both as your cheerleaders in the market, and as a safety net if things get rough. Putting aside the purely ethical aspects of gaming angel investors (which are important, mind you), burning your early investors is bad for the company.  It’s also just bad for founders personally, whose relationships can mean a soft landing if their company fails, or support for their next venture. 

As a startup and new team, you don’t have buckets of money, or a rock-solid reputation, to insulate you from everything that can go wrong with a company. Your reputation and social capital are some of your most valuable assets; don’t waste them. If anyone is asking you to hurt your social capital, stand your ground. They’re asking you to incur a cost, but for their benefit.

In fact, real chess players sometimes want to burn your other relationships, because it reduces your optionality, which increases their leverage. Always think multiple steps ahead.

Pro-rata rights are core economics.

And on a final note, it’s important for founders to understand that when angel/seed funds request “pro rata rights” for future rounds, those rights are not a nice-to-have that is independent from the economics of their existing investment. Successful angel investment depends on the ability to double down on winners (put in additional investment), because the vast majority of an angel’s investments are losers. That’s the core economics of angel investment. If you deny angels their pro-rata in a Series A, you are taking away a part of their deal that allowed them to invest in you in the first place. The long-term consequences for a company and a founder team are usually not worth the near-term benefit.