Start-up accelerators need driving

September 6, 2012

On March 11 2005, Paul Graham, an entrepreneur and angel investor, gave a talk to the undergraduate computer club at Harvard about building start-ups. While few heard about this talk in advance, its outcome is well known and drives one of the emerging trends in today's start-up industry. The lecture resulted in the establishment of Cambridge Seed, better known as Y-Combinator (YC), one of today's most successful business accelerators.

Seven years on, thousands of private business accelerators replicating YC are emerging. But there is one difference: poor results. Over 90 per cent of business accelerators are cash negative.

To understand why, one needs to understand the fundamentals of a start-up accelerator. An accelerator admits early stage start-ups to a short-term program that provides mentorship, capital and other resources, in exchange for partial ownership, with the goal of accelerating their growth and increasing their valuation.

Accelerators are key to any healthy start-up ecosystem. They can scale across many start-ups and provide early screening. They also develop an alumni network that helps future entrepreneurs scale forward.

Two key ingredients drove YC's success in Silicon Valley and Boston: the pool of talent, which allowed them to screen hundreds if not thousands of high quality applicants, and a healthy ecosystem of VCs that supported the start-ups upon their graduation.

The following ingredients exist in hubs in Silicon Valley, New York, Tel-Aviv, London and Berlin but many accelerators exist outside of these hubs. Mardid, Amsterdam, Santiago, Singapore, Hong Kong, Dublin and Taipei are just a few of the locations where accelerators have emerged.

Most of these still lack the required qualities and quantities. Some of these markets are still missing key ingredients such as access to follow-on investment. I believe accelerators in those geographies should focus on market education versus high returns.

The government of Taiwan has recognised the potential contribution of start-ups and small businesses to its economy and has set up an incubation program inside the Institute for Information Industry (III).

The goal of the program is not to generate returns but rather educate the market, generate a certain buzz together with other parties. In a similar way, the Chilean minister of Economic Development has established Start-up Chile, an incubator providing $40,000 to 300 startups who are admitted to the program. The goal is to educate the market and build awareness.

A final example is MEST, an incubator based in Ghana that supports the development of software companies in Africa. MeltWater, a SAAS based company, operates MEST and my guess is that they are not doing that for the financial returns.

In summary, in most geographies, a for-profit accelerator will not be able to generate the expected returns, mainly due to lack of high volume deal-flow. Long-term parties such as corporations, the public sector and some wealthy (philanthropic) individuals should step in and use the accelerators as a platform for market education and awareness. Doing so will drive start-up volume and quality in the long-run that will justify investments for the sake of financial returns.

Shani Shoham is an entrepreneur, VC and a board member of four incubators

Last updated: 2:46pm, September 6 2012