Archive for January, 2011
Building an incubator is super-hard. To point to the success of TechStars and Y Combinator and think that this demonstrates that building an incubator is easy is simply a fallacy.
First, what is an incubator: An incubator is typically the earliest kind of investor involved in a business. Typically they invest a small amount of money and some amount of in-kind services in exchange for a small stake in the business. Typically these services will include providing office space, some small amount of legal, accounting, and business consulting, and some kind of “graduation party” that is designed to introduce their graduates to potential investors.
More important than the question of what an incubator is, is “What is the value that an incubator should deliver?”
I think the primary value that any investor can provide consists of three areas:
- Strategic advice/services that improve the viability of the business
- Helping the business exit
- Helping the business raise money
Now, that third category could theoretically be part of the first bullet, but I wanted to break it out due to the critical importance of that specific topic.
In my mind, the primary value that an incubator provides to a start-up is that it allows the start-up to raise money at a valuation that is a premium to the valuation that it would have raised money at prior to participating in the incubator – either through the pedigree of the program or the services provided by the incubator, the valuation has been increased significantly.
Why is Y Combinator the hottest thing going on today? Because 12 weeks after you start the program, you are virtually assured of being able to raise $1 million at a $4 million pre-money. The pre-money increases substantially and the odds of raising the money at that price increase. The result: You have to be in Y Combinator if they will accept you.
Is it possible for other incubator’s to replicate this value proposition? It is probably hard – in theory not too hard, but in practice quite hard. You need incubator leadership that is extraordinarily well-connected into the seed stage financing community.
Further, there is the concern that incubator’s model the VC community: The market is a “To the victor goes the spoils” where all of the good deals go to the top 20% of the incubator market, leaving bad deals for the rest of the market. This is not bad for the small businesses – any incubator may be better than no incubator for unsophisticated entrepreneurs, but it means that many of these incubators will discover that their business model is unsustainable. Deprived of “access to good deals” as good deals flee to the TechStars and Y Combinators that can assure them of financing, remaining incubators invest in companies far less likely to succeed, leaving them insolvent.
The first time I got to hear Josh Kopelman‘s pitch for FRC (probably four years ago), he described FRC’s value proposition as, “helping you raise your next round at a substantial premium”. If you don’t think you can do that, then your incubator will fail. It is that simple. The amount of money invested by an incubator typically necessitates raising money shortly after a start-up exits the program, therefore helping your investment raise money is the single core competency most crucial to an incubator. $25,000 does not go far.
Some incubator’s have touted that they will invest more money – in some cases six figures – as a tool for differentiating from programs like Y Combinator. This is probably an erroneous strategy. Funding companies at such an impossibly early stage without traction or the social proof of a round of investors makes placing big bets on relatively fewer companies a strategy that has a much higher beta than current incubation approaches. There is a reason people write smaller checks at an earlier stage.
I want to end this post with a few things that Y Combinator and TechStars have done that seem incredibly smart. While I have bashed the prospects of incubators in this post, if you think you can pull this off, there are some best practices that I would obviously rip off. (Caveat: If you didn’t already know this stuff, then you are probably not going to be able to do it. I have not been funded by these incubators, I do not know anyone who has participated as a company in these incubators, I know basically nothing, but I know this stuff.)
Here is the most important: They involve super angels early. Many different super angels are brought in as “consultants” to spend time with the incubatee’s. After spending a day with a variety of teams, many of these consultants invest in the one or two ideas that they like the best. The result is that the fund-raising begins with very warm meetings and by the time the team shows up for their demo day, they already have prominent investors that are leading their deal.
What are the other best practices of the incubator’s? Discuss.
Living Social raised $175 million from Amazon at the tail-end of 2010 and we saw thist week the benefit that could reap: A 50% off Amazon gift card offer sold more than 1.3 million copies, netting hundreds of thousands of new customers to Living Social and raising the profile of this Groupon competitor higher than it has ever been.
If you Groupon, you probably shop Amazon. The conversion rate for this deal must have been sky high. It was tweeted a ton. I saw it all over Facebook. Awesome deal, everyone bought it.
Even I bought it – my first daily deal purchase ever. Now I was on Living Social’s list and the next day I received my next offer: 50% off a pizza somewhere in the Penn Quarter of DC.
FAIL, FAIL, FAIL, FAIL.
You just added hundreds of thousands of new emails to your database and your first communication with them is a weak follow-up offer.
Here were a few of the other offers the day after Amazon:
- 15 weeks of kids dance classes
- Bikram Yoga classes
- A coupon to buy some mussels
They needed a big deal to follow it up. Something mass market that had broad appeal. Instead, probably half the subscribers immediately unsubscribed because this looked like a once in a lifetime deal.
A great deal drives retention, they just lost a lot of the benefit of adding new participants. Why treat this like strictly one-time PR? This could have turned into real long-term customers.
Or maybe those deals sound great to you.
One thing I noticed recently is that Root Markets generated a host of entrepreneurial activity. Root Markets was a failed start-up in the 2006-ish time frame. I think the conventional wisdom is that successful start-ups witness a host of people spun out that then start companies. Root is an instance of failure begetting a host of start-ups and that seems interesting.
Root alum include:
- Joshua Reich – founded BankSimple
- Greg Yardley – founded Pinch Media (merged with Flurry)
- Rob Leathern – founded XA.net
That is a lot of value for a company that didn’t really get too far. What was so unique about Root that enabled this entrepreneurial activity?
Here is my theory: One of the great things about a successful exit is that the founders become rich angels and everyone that didn’t get rich thinks that this adventure was easy. The result is a virtuous cycle of new entrepreneurial activity.
So Root had a few things that ended differently for them then your average start-up that doesn’t work out:
- I don’t think people at Root came to the conclusion that the idea was a bad one. I think most of them felt that investors screwed up the company.
- Several people came out of Root as prominent angel investors. Even though Root did not make them rich, Seth Goldstein and Jerry Neumann both were already wealthy and the credibility that people established at Root let to the opportunity to raise financing for their ideas.
I know Root people stumble across my blog all the time, tell me what have I missed here.
Does anyone know other companies outside Silicon Valley that saw such a prosperous cycle of innovation spring from the ashes of dead companies?
Great stuff ahead:
- The Dirty Secret of Small Ad Networks
- Customer Development Is Not A Breakthrough Idea
- Size Matters and Other Obfuscations by Ad Networks and Google
- Whither Ad Networks – Probably my favorite blog post ever.
- The Chaos of Second Price Auctions
- The Value of Vectors in Behavioral Targeting
- How To Build A Great Start-up Economy
And we are done. Happy Reading.
I get Startup Digest every week and at various points when I traveled a fair bit, I got it for many cities at the same time. One thing I realized was that, despite it’s popularity, quality varied widely and coverage tended to be lopsided. Dave Troy runs Startup Digest for Baltimore and the result is that it is filled with Rails events and the various things that Dave is involved in directly such as Bicycle Baltimore.
I thought that the lists that I saw felt very driven by the owners: either the types of events were slanted or a paucity of events implied that the list owner was not as wired into the community as one might like.
Here is a graph of the number of activities listed in Startup Digest. There are data problems here. Assume that empty weeks were, in every case, weeks that I lost the email as opposed to weeks with data points that were actually zero.
New York’s list tended to be not much bigger than Baltimore’s. That cannot possibly be right. Further, in DC, the list had virtually no items. What that says to me is that the volume of items in Startup Digest is really a proxy for how “at the epicenter” a given locations author is. Finding more events is not too hard: go on Meetup.
Everyone is moaning about the Wall Street Journal article/book coming out explaining why calling your kids “garbage” will make your kids better. Let’s share some excerpts:
Despite our squeamishness about cultural stereotypes, there are tons of studies out there showing marked and quantifiable differences between Chinese and Westerners when it comes to parenting. In one study of 50 Western American mothers and 48 Chinese immigrant mothers, almost 70% of the Western mothers said either that “stressing academic success is not good for children” or that “parents need to foster the idea that learning is fun.” By contrast, roughly 0% of the Chinese mothers felt the same way. Instead, the vast majority of the Chinese mothers said that they believe their children can be “the best” students, that “academic achievement reflects successful parenting,” and that if children did not excel at school then there was “a problem” and parents “were not doing their job.” Other studies indicate that compared to Western parents, Chinese parents spend approximately 10 times as long every day drilling academic activities with their children. By contrast, Western kids are more likely to participate in sports teams.
I have to say, and obviously a key part of a her argument is, this all sounds hard to disagree with. For my value system, I would say:
- Academics is good, therefore stressing the value of academics does not sound bad.
- Learning can be fun or not fun, but it must be done. There are classes and subjects that are hard. It is nice if it is fun. If is more pleasant if you have a good attitude towards it.
- Academic achievement is related to successful parenting. I think you can’t take all the credit for it, but study after study shows that better parenting situations drive better academic outcomes.
Here is another great quote:
What Chinese parents understand is that nothing is fun until you’re good at it. To get good at anything you have to work, and children on their own never want to work, which is why it is crucial to override their preferences. This often requires fortitude on the part of the parents because the child will resist; things are always hardest at the beginning, which is where Western parents tend to give up.
That is a good point. Hard work is required to become good at things. Things you are good at are more fun.
But that last area is a critical area where I diverge.
Here is my leap: Teaching your children the value of working hard – and that they must work hard on things they do – is critical. The “Chinese Mother” approach she takes is implying correlation where there is only the tiniest bit.
Before I start down my winding road of parenting tips, allow me to caveat: My wife is Chinese. Her parents are Chinese. My wife turned out great and our kids are working hard to become great (!). My wife and I have a shared value system on this stuff and that is what I am discussing. The concept of “Chinese Mothers” as discussed here is an extremely broad stereotype and we are all reasonable people that understand the context of this discussion.
When I became a parent, I became a connoisseur of the literature, as do many parents. The study I homed in on was a study published in Scientific American that indicated, in short, that teaching your child the value of working hard is critical for success in life. Allow me to quote:
…our studies show that teaching people to have a “growth mind-set,” which encourages a focus on effort rather than on intelligence or talent, helps make them into high achievers in school and in life.
The classic study looked at in this article was so simple that a child could do it. Longer quote:
In studies involving several hundred fifth graders published in 1998, for example, Columbia psychologist Claudia M. Mueller and I gave children questions from a nonverbal IQ test. After the first 10 problems, on which most children did fairly well, we praised them. We praised some of them for their intelligence: “Wow … that’s a really good score. You must be smart at this.” We commended others for their effort: “Wow … that’s a really good score. You must have worked really hard.”We found that intelligence praise encouraged a fixed mind-set more often than did pats on the back for effort. Those congratulated for their intelligence, for example, shied away from a challenging assignment—they wanted an easy one instead—far moreoften than the kids applauded for their effort. (Most of those lauded for their hard work wanted the difficult problem set from which they would learn.) When we gave everyone hard problems anyway, those praised for being smart became discouraged, doubting their ability. And their scores, even on an easier problem set we gave them afterward, declined as compared with their previous results on equivalent problems. In contrast, students praised for their effort did not lose confidence when faced with the harder questions, and their performance improved markedly on the easier problems that followed.
- FMyLife zips towards the top
- MySpace Data Makes Me Worry For Our Youth
- There is no remnant, there is only optimized and non-optimized
- Can Ad Networks and Premier Inventory Co-exist?
- Managing Product Overload and Your Sales Force
- Daisy Chains For Fun and Profit
- Types of Powerpoint Presentations – A 4 part series that was magnificent!
2010 is next!
Many people have done retrospectives on their blog, I am no different. I always thought some of my best work went unnoticed because this blog is not super high traffic. With that in mind, let me review a few highlights from years past that I wanted to share with you. If you are a new or relatively new reader and never sifted through the 300-odd posts on this blog, this is the post for you.
2007 Best Blog Posts
- How To Name Your Start-up
- Marketing and Sales in a Web 2.0 World – Interestingly, I think I was talking about an unrecognized trend that today, in a world of consumer web apps and the iPhone, is fairly well recognized.
- Cogmap and the Web 2.0 Business Model – Like many bloggers, I came out of the gate with a slew of great posts. Another oldie, but goodie.
- When Fewer Clicks Are A Good Thing – An interview I did that I pointed to from my blog
2008 Best Blog Posts
- NDAs Are Not Documents I Agree To
- Does Paying For Comments Work
- How Do You Manage Your Email? – I am a nut for email management processes and a believer that my process is the best.
- Reviewing Business Plans Before You Show Anyone
- Publishers Love People That Pay Them
- “Too Big To Fail”
Actually, I recognize this is information overload. I will break this into two posts and bring you 2009 and 2010 tomorrow.
Etacts should send me some schwag for all the good love I gave them that they did not give back.
After my post lauding their service, within days Salesforce.com acquired them. As always, we are on the bleeding edge of technology here at Cogblog. The comments in the TechCrunch post lead one to believe that Etacts was acquired for $6m. Nice exit for Y Combinator and Ron Conway and further proof regarding my long standing theory that raising a lot of money makes it hard to do a small exit. It is nice that a company with great products and poor traction can find a way out that leaves investors “not unhappy” and is ok for the employees as well.
Congratulations to Etacts, now I have to find a new technology to use since I didn’t like the others.