December 2013 - Beta version
Abstract
Business accelerators are playing an
increasing role in the creation and growth of innovative companies. Y
Combinator, since its creation in 2005, emerged as the most successful
accelerator and launched billion-dollar valuation companies such as Dropbox or
Airbnb. The business history of Y
Combinator highlights the role of the surrounding ecosystem and the marked need
that was addressed by this typology of investor. Different accelerator models
are tailored to the maturity of the surrounding environment and the network
effects between local venture capital funds, angel investors, startups, public
and private R&D programs, universities, incubators and corporate
development policies. The paper explores Y Combinator’s history, specific
strategies and, from the evolutionary point of view, what components of its
model can be replicated in other innovation ecosystems.
JEL Classification: L26, M13, G24, O31
Keywords: business accelerators, venture capital, innovation ecosystems.
Contents
1 - Introduction
2 - Business case
3 - Y Combinator
and the Silicon Valley ecosystem
3.1 History and Structure
3.2 The role of the ecosystem and
the success factors
4 – Entrepreneurship
Policy, Incubators and Ecosystems
5- Conclusion
References
Appendix
-Databases
- Tables and Figures
* Empedocle Maffia Fellow and MPA candidate at the Harvard Kennedy School, 79 JFK St., Cambridge MA 02139. Email: raffaele_mauro@hks14.harvard.edu. I thank Professor Calestous Juma for advice and support.
1- Introduction
The aim of
this work is to show Y Combinator's business case and its relation with the surrounding ecosystem. This is intended as policy paper, with the objective of
informing public decision makers about the options to improve entrepreneurship
and innovation in their areas of operation. The methodological lens are the
ones of business history, structuring facts and narratives to make them
understandable with the contemporary theoretical debate. Y Combinator was
chosen because it is the most successful among the existing accelerators, the
model is therefore analyzed in its structure and evolution. Then, the findings
are applied to a broader context of other acceleration programs and policy
experiments.
After the
burst of the dot-com bubble, and especially after the following years of
recovery, there was a new wave of accelerator programs in both advanced
economies and emerging markets. Business accelerators took advantage of the
reduced costs to create technology companies and approached the “lean startup”
model, with a focus on fast learning cycles and the quick delivery of minimum
viable products[1]. The most
effective programs addressed the specific difficulties of their economic
environments and innovation ecosystems.
According to
the literature (Miller and Bound, 2011), accelerator programs are now a
fundamental part of developed innovation ecosystems. This is occurring because
the declining costs for building a startup, especially in the internet
industry, pressures investors to grasp market cycles that are faster in
comparison with the past. Most of the
incubators that were developed after 2005 have some key element in common with
the Y Combinator model (Gilani and Dettori, 2011), with average deals of $ 35k
to $ 50k, 6-10% equity stakes, 3 to 6 months programs, demo days and hands-on
support. It is now estimated the existence of 200 seed accelerators program worldwide
(Gilani and Dettori, 2011), including some of the traditional incubation
programs, but only 38 true and relevant acceleration programs.
Y Combinator
qualifies as a "Model 2" incubator (Grimaldi and Grandi, 2005), with
a strong emphasis on mentorship and networking: this is an approach that it is
different in comparison with traditional incubations benefits related to real
estate and business services. “Model 1” incubators are aimed to strengthen the
perspectives for businesses focused on the local economy and with moderate
growth potential. This typology of incubators provide many forms of cost
reduction and the solution of logistical problems. On the contrary, “Model 2”
incubators are focused on high growth companies and are aimed at attracting
significant venture investments in a fast way. The latter typology, as Y
Combinator does, prepares the companies to deal with significant capital
injections and to solve scalability issues. More generally, there was a debate
related to the significance of the distinction between “incubators” and
“accelerators”, and the findings tend to go in the direction of a real
differentiation (Van Huijgevoort, 2012).
The
literature related to incubation programs is vast but the number of studies
specifically related to accelerator programs is not yet at this level. After
the classical papers (Cooper, 1985; Merrifield, 1987; Mian, 1996) and the work
made in the wake of new economy during the late ‘90s (Sherman 1999; Hansen et
al, 2000) a new wave of academic interest rose from 2009-10 onward. On the other hand, the fact that the majority
of the programs are focused on high potential startups allowed major news
coverage; some of the information is now aggregated in databases such as Crunch
Base, Seed-DB and CB Insights.
2 - Business case
Y Combinator
is one of the most successful acceleration programs in the world: it has the
most robust metrics in terms of funding, exits and company valuations (Table 4 and
Table 6 in the Appendix show respectively the YC’s aggregate performance and
the compared performance with other accelerators). In 2012 Forbes placed it first in its ranking of business
acceleration and incubation programs[2]. The initiative was created in 2005 by Paul
Graham, Jessica Livingston, Robert Morris and Trevor Blackwell. Since then Y
Combinator invested in 566 companies in the very early stage of their lifecycle
(Table 10 in the Appendix shows the complete list of YC companies from 2005
onward). The accelerator invested since 2005 over 9 million dollars in 17
semi-annual rounds; the target companies are mainly internet and mobile
companies, with over 40 sub-industries covered, with occasional investments in
other areas such as robotics, health and life sciences[3].
The aggregate portfolio reached, according to the information disclosed by the
accelerator, a total valuation of $13.7 billion at the end of October 2013. The
estimates are calculated for the 306 companies with an assigned valuation, with
a $2 billion increase since June 2013. The growth in aggregate valuation is
mainly due to late stage fundraising of the most mature companies, with a
limited impact from the eight acquisitions that happened in same time range.
The $13.7 billion figure is almost doubled in comparison with the 2012 total
valuation of $7.78 billion.
The average
valuation of Y Combinator startups is close to $45 million per company, but the
information is distorted by the “black swans” such as Airbnb. It is estimated
that 37 of over 500 start ups have a valuation of over $40 million. According to the online accelerator database Seed-DB, Y Combinator
companies have collected over $1.65 billion in venture capital funding and
realized 73 exits, with a total cash value of $1.2 billion. In fact, according
to the own words of YC founder Pual Graham, their intention is to scale a
“black swan farming”, identifying teams with the potential for hyper-growth
when they have no metrics and are in the very early stage.
As shown in Table
4 and Table 6 in the Appendix, this performance is remarkable and uncommon among
incubation programs, even considering the fact that the number is distorted by
the top two cases, Dropbox and Airbnb. Dropbox raised $250 million in venture
capital funding at a $4 billion valuation and Airbnb raised $113 million at a
$1.3 billion valuation (Table 8 in the Appendix lists the top 25 Y Combinator
companies in term of subsequent funding). In November 2013 the former was close
to a new valuation of $8 billion for his late stage round and also Airbnb is
now valued in the $2.5 billion range, with potential for future increase over
$10 billion in case of IPO. In comparison with other business accelerators and
incubators, Y Combinator demonstrated a unique capacity to generate “black
swans”, companies that generate extremely high returns in comparison with the
industry average, and what in the jargon are called “unicorns”, companies with
a valuation higher than $1 billion. Other companies are less popular but
successful, such as Stripe, Scribid, Posterious and Reddit, and some of them
had interesting exits such as Heroku, acquired by Saleforce for $212 million (Table
9 in the Appendix lists the top 25 Y Combinator companies in term of exit
value).
3 - Y Combinator and the Silicon Valley
ecosystem
3.1 History and Structure
Y Combinator
had different phases in its development and was itself a startup. As shown in
Table 1, YC evolved over time and aligned itself with the changes of the
surrounding ecosystem.
Table 1: Y Combinator’s growth phases and pivots, 2005-13.
Phase 1:
Startup
|
2005
|
Creation
of the program and first batch in Cambridge, MA.
|
Phase 2:
Proof
of concept,
first
growth curve
|
2005-2008
|
Expansion
to Silicon Valley and growth, first successful exits.
|
Phase 3:
First
pivoting
|
2009-2010
|
Partnership
with Sequoia Capital and restriction of the program only at the Silicon
Valley.
|
Phase 4:
Second
growth curve
|
2011-12
|
The
Start Fund, led by Ron Conway and Yuri Milner, allowed in 2011 all of the
admitted companies to access $150,000 in convertible note at favorable
conditions.
|
Phase 5:
Second
pivoting
|
2012-onward
|
Increased
selectivity and reduction of the additional funding to $80,000.
|
Source:
Personal elaboration based on Y Combinator historical data, bibliography and YC
partners official communications.
The actual
form of Y Combinator is deeply rooted in the resources and constraints of the
Silicon Valley. That was not always case: the program started in Cambridge, one
of the initial labels was "Cambridge Seed", but then moved
permanently to Mountain View, California, with a greater focus on Silicon
Valley.
Y
Combinator's ability to enable startups to grow very fast is a mixture of
several elements: personal reputation of the founders, serendipity
opportunities during the program, deep relations with top venture capital firms
such as Sequoia Capital, creation of an "hacker friendly" culture[4],
proximity with all the resources of the Silicon Valley such as corporations
ready to make acquisitions, VC funds, specialized law firms and early adopters.
These elements increased in effectiveness over time and the accelerator
accumulated credibility with both entrepreneurs and investors. When there was a
manifestation of scalability problems, Y Combinator partners were effective in
resetting the direction and maintained the sustainability of the organization.
During Phase
1, in 2005, the first batch consisted in only 8 startups, while in summer 2012
only the summer batch consisted in 80 startups. Up until 2012 Y Combinator was
funding 100+ startups per year, with a track record of 395 teams accepted in
the program since its inception. To address the growth in scale the original
partners, Paul Graham, Trevor Blackwell, Robert Morris and Jessica Livingston,
accepted new collaborators and extended the partnership to Geoff Ralston, Harj
Taggar and Paul Buchheit. When the accelerator reached a robust maturity stage,
in the 2011-12 phase, the biggest issue was the scalability of the program. Then,
in Phase 5, it was recognized an over-growth phenomenon, with decreased effectiveness
in supporting deals; therefore in 2012 the additional funding level was reduced from $150,000 to $80,000. Moreover,
the partners pushed for and increased selectivity rate: 47 companies were
accepted in the Summer 2013 batch in comparison with the 75 of the Winter 2013
batch. The selectivity rate has now
settled t at 2% level.
In October
2013 Y Combinator opened a second office in San Francisco and added new part-time
partners to its structure, reaching a total of 10 full time partners and 8
part-time partners. The partnership structure differentiates Y Combinator from
other institutions and generate a network of “employed mentors”. There was also
a change in the composition of the admitted companies: in the summer of 2013 Y
Combinator started backing no-profits, with an initial investment in Watsi, a
crowdfunding platform for medical are, and opening a specific application for
no-profit projects in Winter 2013. In
the same period, the accelerator replaced the Start Fund with a new vehicle,
the YC VC, backed by investors such as Yuri Milner and Andreesen Horowitz.
From the
point of view of the acceleration package, Y Combinator offers to the founders
strong networking and mentoring resources, optimizing the program with standard
contractual terms, acceleration lifecycle and "graduation" with the Demo Day. The initiative is
structured as a three months program, with a seed investment of $5,000 plus an
average additional $5,000 per founder, generally with an equity request from 2%
to 10%. The total investment is typically from $14,000 to $20,000 in exchange
for 6% of equity.
The
admission process at Y Combinator it is structured in two phases. The first one
is an application form with traditional questions about the startup project,
such as the description of the underlying customer pain and the existing
solutions, and some non-traditional ones focused on understanding team member’s
personalities and cultural fit. Emphasis is given to the "hacking"
mentality of the founders and their strength as a group. The second phase is an
interview: only 4% of the applicants reach this stage and then only half of the
respondents are admitted to the accelerator program. The interviews are short
in time, only 15 minutes, and are organized as a test of "fluid
intelligence", with the aim to understand if the entrepreneurial team will
be resilient when facing the frequent pivots that are likely in the first
phases of a startup life.
After the
admission, the Y Combinator experience is organized around weekly meetings with
entrepreneurs, office hours with the partners and a constant pressure to
deliver the best presentations and products, with strong user growth metrics,
at the Demo Day[5]. The
latter occurrence is now one of the most important events in the Silicon Valley
and all major investors
and observers of the Internet startup scene attend it.
3.2 The role of the ecosystem and the success
factors
Y Combinator
is part of the Silicon Valley's ecosystem, a "rain forest" that
provides fertile ground for company formation and scaling[6].
The concept of ecosystem is fundamental to understand the positive
externalities that are available to investment firms and incubators. Several
operations of the venture investment cycle are easier within an highly
effective ecosystem: from due diligence to fundraising, from knowledge gathering
to exiting investments. For instance, research shows (Hochberg et al.,
2007) that there is a
significant network effect among investors and that better networked firms
perform syndicate investments with a superior performance.
The role of
an accelerator within an ecosystem is twofold: first, from the investor side,
it provides a pipeline of high quality projects to venture capital funds,
reducing their due diligence costs and creating new opportunities for
investment. Second, from the entrepreneur side, it is a way to reduce the risk
of starting a business and turning an idea into a company. Moreover, the
"class experience" of the accelerator reduces both the transaction
costs, with the pre-structured deals, and reduces the risk in the case of the
startup failure, because the teams have not yet fully committed their careers
to the new venture. In the specific case of Y Combinator some of the biggest
venture capital funds, such as Sequoia Capital, integrated their dealflow
process with the accelerator and invested on a regular basis in the startups
presented in each batch. Moreover, Sequoia invested $2 million in 2009 in Y
Combinator itself, allowing the accelerator to increase significantly the
number of funded companies for each year. In 2010 the accelerator raised a
second $ 8.25 million from other partners with Sequoia Capital as lead
investor.
There are
several reasons that are related to Y.C. outcomes and successes, some of them
are schematized in Table 2.
Table 2: Y Combinator’s success factors
Reputation of the partners
|
Most of the founders and partners of Y Combinator
have remarkable backgrounds and are on a recognizable position in their
domain of activity. Graham, Blackwell and Morris founded in the past Viaweb,
a company that was acquired by Yahoo in 1998. Graham was a reputed scholar in
the programming language Lisp, Morris crated the first Internet
"worm" and was the founder of the low cost robotics firm Anybot.
|
Selection focused on high-scalability startups
|
Most of the project accepted on Y Combinator have in
common a strong scalability potential, with the aim to reach big markets and
high growth rates. This qualifies Y Combinator as an extreme version of
"Model 2" incubators, according to the classification of Grimaldi
and Grandi[7].
|
Proximity to Silicon Valley
|
Y Combinator cannotbe conceived without the Silicon
Valley and the close relationship with universities, angel investors, venture
capitalists and specialized professional service firms. All the enablers are
in close proximity, for instance many Y.C. startups were acquired by Google,
which has the headquarter only 3.5 miles away.
|
Power of the alumni network
|
Former Y Combinator attendees created a powerful
network that acts as a mentorship hub and, in some cases, supports new
companies with angel investments. The entrepreneurship cycle is therefore
accelerated with both knowledge transfer and a reduction of both cost and
time constraints to raise seed capital.
|
Engineered serendipity
|
One of the key elements of the innovation processes
is the random exchange and recombination of perspectives that occurs in
special places. The Y Combinator program is set to maximize the productivity
of the three months, creating an environment where the team are encouraged to
exchange ideas and change radically their projects during the work in
progress.
|
Hacker friendly environment
|
The focus of Y Combinator is placed in building
products and there is a culture that is appealing to engineers, where part of
the company creation has external help and it is heavily coached. The average
age of the founders is lower in comparison with other programs and the
interaction style is direct and informal.
|
One relevant
element from the ecosystem is that big players such as Google and Apple are
acquiring an increasing number of companies both for technology and talent
acquisition. They have now an open innovation strategy and are aware that most
of the technical talent and potential for disruption is located outside the
walls of their organizations. Some of them are pursuing aggressively these
opportunities: for instance Google acquired 131 companies from February 2001 to
November 2013. The process significantly increased during the last years and 73
out of 131 companies were acquired from 2010 onward.
Y Combinator
responded to a clear marked need from both venture capital firms and IT
companies involved in corporate development trough acquisitions. As shown in Table 5 in the Appendix, between
the companies funded by Y Combinator, 9 startups were acquired by Google, 7 by
Facebook, 4 by Twitter, 2 by Motorola, 2 by Apple and several other by the
other big players of the information technology industry such as Amazon,
Likedin, Zynga, Groupon and Yahoo. In fact, often the high growth layer of Y
Combinator-backed companies served as acquirer for the younger ones in the deal
pipeline, with companies such as Dropbox and Reddit beginning to acquire new
startups such as Snapjoy and TapEngage, in the case of the former, or Infogami,
in the case of the latter. Sometimes big companies outside the tech industry
acquired Y Combinator companies in order to be better positioned in the digital
industry, one example is the Reddit acquisition from the media group Condé
Nast. The large number of acquisitions
and the limited role for IPO’s is a long standing inheritance of the dotcom
bubble, according to some observers Silicon Valley has not yet completely
recovered and the investor community remains cautious in front of new public
offerings (Beltramini, 2013).
4 - Entrepreneurship Policy, Incubators and
Ecosystems
There is a growing
interest in entrepreneurship policy and the creation of accelerators as a tool
to foster innovation and economic growth. Technological innovation and entrepreneurship
are now largely considered as crucial elements for the competitiveness and
prosperity of nations. Since the Schumpeter’s early reflections on economic
cycles, high potential ventures and the underlying process of marked disruption
were placed at the center of the economic growth in modern economies.
Venture investments
impact both the macro scale, in terms of job creation and economic growth, and
the micro-economic level, increasing the profitability of backed companies.
Moreover, a mature venture capital industry has significant spill over in terms
of increasing the skill premium and helping to create incentives for
technological innovation.
In the US, from 1970 to
2008, each dollar invested in venture capital created 6.36$ of revenue, venture
backed companies generated 21% of US GDP and contributed to 11% of the total
employment in the private sector (NVCA – HIS Global Insight, 2009). The
Kauffman Foundation studies show that the top 1% high growth companies created
40% of the new jobs in the American economy (Stangler, 2010). Before the global financial crisis, 6-7
billion Euros were invested in VC each year in Europe. It is estimated that in
Europe more than one million people were employed in venture backed companies
and the compounded growth of employment, from 1997 to 2004, in European
VC-backed companies reached 2.4%,
compared to 0.7% in other companies (EVCA, 2005 and 2002). Even if the effect of VC funds on company
innovation levels on the post-investment stage is questioned (Caselli, Gatti
and Perrini, 2009), the impact on performance is robust and measured in several
markets.
These scenarios
attracted the interest of policy makers and created the case for governmental
intervention. Past cases of positive public programs that created successful
innovation ecosystems were, in different time phases and with different
industry specialization, the Silicon Valley, Singapore, Tel Aviv-Wadi cluster
in Israel, Bangalore and the Zhongguancun cluster. Nevertheless, most of the attempts to replicate the success
of the Silicon Valley had limited performance. There are several cases with mixed evidence there are “horror stories”,
such as Kansas Investment Fund and the KPERS (Kansas Public Employees
Retirement Fund) activities, where public or citizen’s money was wasted and
there was a clear misallocation of capital.
From the
policy side, in order to replicate the success of accelerator programs such as
Y Combinator, the major challenge is the absence or immaturity of some
components of the surrounding ecosystem. As pointed in the literature[8],
the vast majority of public efforts to promote venture capital and
entrepreneurship had poor results: the most common error is the combination of
a lack of acknowledgement of the specific characteristics of the target regions
and an excessive distortion of market mechanisms, for instance with geographic
restrictions in fundraising an hiring. Another significant element is the need to develop the whole financial
systems, empowering all the financial institutions needed in the company
lifecycle[9]. One
of the most successful models of government intervention, designed to develop
the capitalization of venture capital funds without distorting market
incentives, is the creation of “hybrid funds”, government backed funds of funds
(FoFs) that invest in venture capital funds[10].
An
additional challenge is the fact that the availability of technical talent,
capital, tacit knowledge and potential buyers in Silicon Valley is not common
in other parts of the world, even within the United States. Therefore policy
challenges will be different for each innovation ecosystem and the Y Combinator
model cannot be copied in its original form. On the other hand, from the point
of view of human capital, the "war for talent" in the second part of
the 2000's decade expanded significantly for software engineering roles. Even
with a weak macroeconomic context, due to the financial crisis and the
following slow recovery, the compensation for these positions is driven up by
the very high demand from technology companies and the expanded number of
Internet startups. Therefore, high
quality talent is often wiped out of the market and some of the best people, in
terms of a combination of up to date technical talent and pro-active mindset,
are “acqui-hired” trough the acquisition of startups. This is also an
opportunity for other areas of the world where technical talent can be involved
at low cost.
There are
several cases of acceleration programs that are trying to model part of Y
Combinator success and some example are discussed here. The cases presented in
Table 3 are not reflective of the whole accelerator/incubator landscape in
general, but they have in common the focus on startups with high-scalability
potential and are considered among the most successful ones.
Table 3: Examples of successful accelerators
Techstars
|
Acceleration program with multiple locations:
Boulder, New York, San Antonio, Seattle, Boston. The essential elements are
the mentorship support and a $ 100,000 convertible note given to each startup
from a syndicate of VCs. The initiative is very selective, with 1% acceptance
rate, and in comparison with other incubators publish publicly its metrics:
among the 137 companies admitted to the program from 2007 to 2012, 90%
received funding, 16 failed, 18 were acquired and 98 are alive.
|
Seedcamp
|
It is considered the major European accelerator
program, based in London but with a strong international focus. It has a
structure more suited to less developed ecosystems, it has a rolling
application process and provides €50,000, office space and mentoring in
exchange for 8-10% equity stakes. From 2007 to 2012 73 companies were
accepted and 80% received funding after the program,
|
Startup
Chile
|
Six-month program created by the Chilean government
that provides funding to approximately 100 startups each year. It is aimed to
attract foreign entrepreneurs; the teams that pass the selection are awarded
with $40,000 of funding, a networking program and a one-year visa. The
program is based on a strong connection with the Silicon Valley ecosystem and
has both the objective to promote innovation internally and build links with
the world markets.
|
Sources:
Techstars, Seedcamp and Startup Chile datasets.
The top business
accelerators add value to their companies in a measurable way (Hoffman, Radojevich-Kelley,
2012): accelerator-backed
companies tend to acquire subsequent funding rounds much earlier than other
companies and, on the same time, have an higher risk/return profile with an
higher probability of a successful exit. On the other hand, the same companies
have concurrently an higher probability of failure (Smith t al, 2013), putting
the accelerated startups in a “high success or failure” track. One of the most common criticism is also
that accelerator programs had often poor performance in their aggregate
portfolios and only few, such as Y Combinator, fulfilled the promise of
building companies with valuations greater than $1 billion. None of them was
able to generate, up until now and including Y Combinator, “super-unicorns"[11],
technology companies with valuations greater than $100 billion such as Google,
Facebook, Apple and Microsoft.
One of the reasons for
the success of the Y Combinator model is shown in historical structure based
subsequent pivots and adaptations: the constant evolution of the incubator
helped its performance and was aligned with the rapid changing structure of the
Silicon Valley ecosystem. For instance, in the most recent pivots in 2012 and
2013 involved the adaptation of the program to the new Silicon Valley landscape:
the new context is characterized by a limited number of series A rounds in
comparison with the number of companies funded per year, especially in the
consumer internet area, with on the same time an increase of the average
valuations that doubled from 2010 to 2013[12].
As shown in
Table 7 and Figure 1 in the Appendix, from 2003 to 2013, in the USA 39
companies reached a $1 billion dollar valuation. The figure could be larger,
given the fact that recently founded companies will often need a five year
window in order to develop fully their potential[13].
Y Combinator produced 2 out of these 39 companies: Dorpbox, from the summer
2007 batch, and Airbnb, from the Winter 2009 batch. Other companies, such as Stripe, from the
Summer 2010 batch, are likely to join the club of the companies valued over $1
billion (Table 7 and Figure 1 in the Appendix list the US software companies
founded between 2003 and 2013 with valuation higher than $1 billion).
The
performance of the Y Combinator model does not imply that it must be copied
completely. Incubators in aggregate demonstrated the skewed return distribution
and time consistency that is typical of VC funds (Kaplan, Schoar 2005), leaving
space for new players mainly if specialized in market niches or if associated with
highly differentiated investment strategies. Moreover, new experiments such as
funding platform like AngelList and the crowdfunding regulation related to the
JOBS Act in 2012-13 are changing the landscape and will potentially disrupt
low-tier investors.
On one hand, most of the
modern accelerators were born after 2005 and it is still to early to drive
conclusions, on the other hand there is enough empirical evidence to say that most of these structures
will not generate big hits. The first element is that several highly successful
companies, such as Square, Quora, Palantir, Zynga and Evernote, were created by
serial entrepreneurs. These actors have
a higher probability to build successful companies (Gompers et al., 2006) and,
by definition, they do not need the help of an accelerator. Moreover, the
network effects and the location effects are extremely powerful factors in the
growth of technology companies.
In the accelerator space there are the same Paretian distributions
and power law typical of the venture capital industry: the top 1% incubators,
such as TechStars and Y Combinator, are attracting most of the high-quality
dealflow, leveraging their capacity to attract the best entrepreneurs (Isabelle
D. 2013) and letting few space for the new incubators. The latter tend do be successful when they
specialize in industry verticals, such as medical technology in the case of
RockHealth or hardware in the case of Lemnos Labs, of for specific
underrepresented demographics, such as women or minorities such as NewME. A new
wave of accelerators related to social business and impact investing is also
confirming some of the key characteristics of the YC model, such as the key
role of partner selection and selectivity (Barn et al, 2013). It is also shown from most of the datasets
that top accelerators are generating most of the new job positions, and also
for this metric Y Combinator is placed at the first position among similar
programs[14].
Public sponsored
programs often demonstrated difficulties in their implementation and promoted
distorted incentives: one of the most common errors is to replicate practices
that worked in other areas without taking account the local market needs. One of the best cases of public funded acceleration programs is Startup
Chile. One of the key ideas of the program is related to the creation of hubs
of talented entrepreneurs with a global mind set, an approach aimed to create
the minimum critical mass for the creation of a private innovation ecosystem.
Therefore, the Startup Chile attempted to attract 1,000 high-tech startups in
four years with an overall cost of $40 million. The impact was significant: a
country that was known for traditional industries or for its troublesome
political history is now considered one of the hubs of global entrepreneurship.
It is too early to wholly assess the performance of the program, we know that
from the first year batch 55% of the startups are now profitable or were able
to raise funding. If this performance will be consistent in the future, it will
be a remarkable result for a government sponsored program, even if the outcomes
will be lower in comparison with the top private incubators.
Startup
Chile is an interesting example of global talent pooling, a mechanism were a
country was able to attract people that otherwise would have been
under-utilized in their respective countries or would have migrated to the
traditional innovation hubs. Startup Chile attracted human capital and build an
investment hub, something very similar to the Y Combinator key elements, but
generated a longer and more structured program that was tailored to the
specific characteristics of the local business environment.
5 - Conclusion
From the
business history perspective, the Y Combinator model succeeded thanks to its
capacity to evolve rapidly and change its strategic direction in at least two
phases of its development. Moreover, Y Combinator integrated effectively with
the surrounding environment because not only leveraged its existing strengths
but compensated the scarce elements in its ecosystem. In particular, the
market, in this case VC funds and corporate development offices of big IT
players, needed an high quality dealflow of small companies with proven metrics
and robust growth rates. These elements
are easy to build in the Silicon Valley ecosystem, but in other environments
there are additional challenges to be addressed. The policy maker must accept
the fact that longer programs, different acceleration packages and training are
fundamental elements in less mature ecosystems.
Successful
examples around the world, such as Techstars, Seedcamp and Startup Chile have
elements in common with the YC model but they are structured with their own
DNA. In particular, the key similarity
between Startup Chile and Y Combinator is the extreme focus on attracting the
best human capital on a global scale and the design of the program, structured
to combine the best elements of the local ecosystem and supplying the missing
ones externally. It is too early to see if Startup Chile, as a government
program, will show the same evolutionary properties of Y Combinator. The dynamic
approach should be a key element of the structure of future incubator programs:
the ability to pivot and to maintain complementarity with the surrounding
ecosystem are fundamental aspects to
reach success.
It is
debated if the role of public policy should be to create “black swans” with
disproportionate returns in comparison with average deals. The alternative view
stands for the public as the catalyzer to the creation for average, but
sustainable, companies. From this point of view, the search for
disproportionate returns should be left to private investors. Moreover, the
chances for the creation of very high growth companies are higher in the
ecosystems where the hubs of technical talent and capital are already formed.
There are
also other limitations to the startup enhancing programs: they can accelerate
investments bubbles and distort incentives, for instance deviating resources
from other industries were a specific country can benefit most. But, on the
other hand, the positive externalities for the creation of entrepreneurial hubs
are significant and seed accelerators are increasingly considered part of mature
innovation systems. Moreover, even if most of the accelerators are unable to
systematically build $1 billion companies, they can became the focal point for
the evolution of local innovation ecosystems and add significant value.
Successful
entrepreneurship policies should acknowledge that the most successful startup
and teams are "born global" and that there is the need to compensate
the specific limitations of the target region of the program. The experience of
private accelerators such as Y Combinator and public seed programs such as
Startup Chile tells us that it is possible to create new institutions to
promote innovation in a relatively fast way. They are experiments, some of them
will fail, but this exploration process will provide guidance for the evolution
of innovation ecosystems in other geographical areas.
[1] The popularization of the lean start-up concept has its most significant example with Reis Eric, The Lean Startup: How Today's Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses, Crown Business, 2011.
[2] VV.AA., "The Mida's List - 2012" Top Tech Investors, Forbes, May 2012.
[3] Data are available from Y Combinator, CrunchBase, YC Universe, CB Insights and Seed-DB.
[4] Meaning that YC partners pushed for a culture focused on engineering and experimentation, with the aim to build product and services with strong growth metrics and fast iteration cycles.
[5] There are very good narrative accounts of the YC experience, such as Randall's Inside Y Combinator, Silicon Valley's Most Exclusive School for Startups, and some attempts to systematize the fragmented sources of information, as Jed Christiansen work. The founders of Y Combinator are themselves prolific bloggers and many of the companies that participated at the program released accounts of their experience.
[6] Hwang Victor W., Horowitt Greg, The Rainforest: The Secret to Building the Next Silicon Valley, Regenwald, 2012, pp.31-33.
[7] Grimaldi Rosa, Grandi Alessandro, "Business Incubation and New Venture Creation", Technovation, n°25, 2005, pp. 111-121.
[8] Lerner Josh, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed--and What to Do About It, Princeton University Press, 2009.
[9] For a description of the Italian Case, see Gervasoni Anna, Bollazzi Francesco, “Developing venture capital activity to promote entrepreneurial competitiveness: Italy’s case history”, Sinergie Nr. 87, January-April 2012.
[10] For a comprehensive assessment, Murray G., Cowling M, Liu W., Kalinowska-Beszcynska O., Government co-financed ‘Hybrid’ Venture Capital programmes: generalizing developed economy experience and its relevance to emerging nations, Kauffman International Research and Policy Roundtable, Liverpool, 11-12 March 2012. Look also Feola Rosangela, I fondi misti di venture capital, Convegno Aidea Giovani - “L’Innovazione nella Pubblica Amministrazione: Teoria e Prassi”, Università di Roma Tor Vergata, 15 July 2005. For a discussion of the recent Italian experiment with the Fondo Italiano di Investimento, look at Montanino Andrea, Sattin Fabio, Il nuovo Fondo Italiano di Investimento per le PMI: una riflessione generale, EntER - Centre for research on Entrepreneurship and Entrepreneurs, Università Bocconi, WP n°1, 2010.
[11] The expression was coined by Lee Ailen, Welcome To The Unicorn Club: Learning From A-Dollar Startups, TechCrunch, 2 November 2013.
[12] PitchBook, Venture Capital Database.
[13] Wilson Fred, The Billion Dollar Valuation Club, AVC blog, 3 November 2013.
[14] Seed-DB collects information on start-up employment, but data related to the workforce levels in new companies are hard to collect and often not reliable.
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Appendix
Databases
AngelList https://angel.co/
CB Insights http://www.cbinsights.com/
CrunchBase: The Free Tech Company
Database http://www.crunchbase.com/
Statwing Blog, A Statistical Portrait of a Y Combinator Batch, August 2012.
http://blog.statwing.com/a-statistical-portrait-of-a-y-combinator-batch/
PitchBook –
http://pitchbook.com/Venture_Capital_Database.html
Seed-DB http://www.seed-db.com/
Y Combinator Universe http://ycuniverse.com/ycombinator-companies
Tables and Figures
Table 4: Y Combinator
investments, exits and returns organized by batch, 2005-13.
Source: Personal elaboration,
data from Y Combinator CrunchBase, TechCrunch, Y Combinator Universe and
Seed-DB.com.
Table 5: Major
acquirers of Y Combinator companies
Source: Personal elaboration,
data from Y Combinator CrunchBase, TechCrunch, Y Combinator Universe and
Seed-DB.com.
Table
6: Comparison of the top 30 business accelerators worldwide.
Source: Personal elaboration on Seed-DB
data.
Table 7: Valuations of software companies founded
between 2003 and 2013 with at least $ 1 billion in valuation. YC companies are highlighted.
Source: Personal elaboration from NYSE, NASDAQ, CrunchBase and Cowboy Ventures dataset.
Table
8: Top 25 Y Combinator companies by subsequent funding.
Source: Personal elaboration on Seed-DB
data.
Table
9: Top 25 Y Combinator companies by exit value.
Source: Personal elaboration on Seed-DB
data.
Table
10: Complete list of Y Combinator’s investments, 2005-13.
Source: Personal elaboration on Seed-DB data.
Figure
1: Valuations of software companies founded between
2003 and 2013 with at least $ 1 billion in valuation.
Source: Personal elaboration from NYSE, NASDAQ, CrunchBase and Cowboy Ventures dataset.
