The renewed opportunity for incubators

Image: Wikipedia

It’s not all about accelerators.

Post by Stefano Bernardi. You should follow me on Twitter here.

We live in the age of the accelerator.

It seems like the 10-12 week “batch” model has completely taken over the pre-seed market.

And it’s all Y Combinator’s “fault”. They launched their Summer Program in 2005 and immediately started spurring copycats.

But was YC’s success attributable to the summer batch model or just to their hustle, product insights, marketing and connections?

I think the accelerator model doesn’t make too much sense outside of YC or a couple of other example. Aside from being really hard to self sustain financially, the reality is that most accelerators can’t quite accelerate a company like PG and YC’s current partners.

It’s time to face that YC is in a league of its own.

The death of the incubator

Before accelerators were all the rage, there were a number of traditional incubators, oftentimes sponsored or run by big corporates or universities, where companies were actually “incubated”. Companies would be accepted on a rolling basis and would be offered office space as well as general help and services.

Starting companies today has become much cheaper and easier than before, and this factors have led to a slow but steady decline for incubators. Why give away 20%+ more of your equity if you can just go out and raise a million dollar round for the same amount?

But the reality is that getting to product market fit and scaling a company are much harder than it seems. Everyone can get started, but getting started right is fairly hard.

When incubators make more sense than accelerators

In my opinion though, incubators can actually be better structures for some type of businesses and entrepreneurs.

Complementary skills

To make sense, the founder and the incubator each need to have very strong complementary knowledge and skills, just like in any traditional co-founder relationship.

For example, the incubator could be vertically focused on e-commerce and the founder extremely knowledgeable about and connected in the outdoors community.

Or the incubator could be vertically focused on fashion, and could accept teams with experience in data, logistics, marketing, e-commerce and so on.

The incubator I’m envisioning becomes really close to some foundry models, but those usually don’t accept external ideas for a variety of reasons. In my opinion, accepting external ideas, and most specifically founders who are really passionate and knowledgeable about a space and an idea is instead one of the great opportunities for incubators.

Strong, aggregate knowledge

The incubator needs to aggregate the most possible knowledge from all of its companies and redeploy it on all of them.

Being able to see patterns of errors and best practices amongst many companies is a privilege usually left to VCs. An incubator should do the same.

Remove complexity

A shared HR practice, as well as accounting, legal, EA, recruiting, etc. can help the companies focus on product market fit in the early days and reduce premature scaling problems.

Remove risk

Starting a company, even if less riskier than it once was, is still a bold and risky decision for most.

People have families and other commitments which in my opinion are preventing great companies to be created.

Incubators can target this specific niche of entrepreneurs and remove their risk by hiring them, while getting compensated in equity.

TL;DR — this is what a modern incubator should look like in my opinion:

  • Vertically focused on a specific business model or vertical.
  • Accept founders with complementary skills and knowledge.
  • Aggregate the most possible knowledge, best practices and connections.
  • Aggregate and provide basic company functions such as bookkeeping, tax, lawyers, HR, EA, etc.
  • Only accept founders/ideas where the incubator’s knowledge and services will have a positive impact.
  • Work with 2-10 companies at any given time.
  • Act as a full cofounder for at least 12 months.
  • Provide office space.
  • Aim for 10-40% equity stakes.
  • Hold a board seat, but without weird vetos or controlling provisions.


It’s not so simple.

Incubators are hard. Some of the biggest challenges in my opinion are:

  • Getting to financial sustainability. I’d treat an incubator almost as a traditional VC fund. The capital required to start something like this is non negligible, if you want to really help the companies and attract the best teams.
  • Attracting the best talent. The best people usually have no trouble in raising capital for their companies, and may not be interested in the additional services if it means giving away a huge chunk of equity.
  • Transitioning out the business. Not super easy to cut loose all ties with the incubator, but if done gradually can be sorted out.
  • Follow on investments. Getting VCs to invest in businesses spun out of incubators is a bigger challenge than clean cap tables.

I might write a post on these challenges in the near future, but I think they’re all solvable.

In the meantime I remain a big believer in nicely executed foundries and incubators.

You should follow me on Twitter here.

The rise of the thematic VC 

Photo credit: casualeye37

The reasons more and more funds are focusing on single verticals

Every VC firm claims to have a specific focus, but most of the time it’s so broad that it becomes useless.

Most firms would say: we focus on internet, mobile, consumer and enterprise. Well thanks.

The reality is that most firms will invest in anything that has the chance of scaling to a multi-billion dollar valuation, from coffee and liquid meals to spaceships and Facebook.

That’s totally fine, and a great diversification approach. There are just a number of companies that will go public or get acquired for $1b+ every year, and they’re in different verticals. Sprinkling bets around gives you more chances to actually be in one of those.

Some firms think otherwise though.

  1. Many have developed specific focuses for different reasons, but are still very horizontal. For example, Founders Fund and DFJ are known for investing in world-changing, crazy-sounding ideas in energy, space and advanced sciences, but they will still invest in consumer internet companies.
  2. Side funds are also not new, famously fbFund from Founders Fund and Accel, managed by Dave McClure and focused on apps built on top of the then emerging Facebook platform. Accel also recently launched two Big Data funds.
  3. Corporate venture funds are also traditionally focused on the mothership’s market (Citi -> fintech, Vodafone -> mobile and infrastructure, Rakuten -> ecommerce).
  4. Some industries, like life science and med-tech, have traditionally seen very focused funds, given the different life-cycles of those companies.

But then there are some new, truly vertical VC firms.

These firms believe that by concentrating all of their bets in a specific vertical, which they believe will either massively grow in the coming years or is ripe for disruption, they can produce better returns for their LPs.

The most successful example in my opinion is Ribbit Capital. It was founded in 2012 by Micky Malka and focuses exclusively on Fintech. It raised a first $100M fund and is now closing a second one.

Micky was the founder of Lemon, a mobile wallet app and firmly believed that there are more opportunities in fintech than he could pursue by himself.

In less than 2 years, he was able to get into the most interesting and hot fintech deals, including Wealthfront, Credit Karma, Coinbase, Funding Circle, Fuze Network, etc.

That would probably have been impossible should they not have a very specific focus.

Here are the thematic funds I’m aware of:

(I might be forgetting a bunch, please add notes and I’ll add them).

So why do thematic funds make so much sense?

Much clearer and easier marketing of the firm

By appearing in an industry’s specific publications and events, it’s much easier to build brand awareness for a new firm in a niche or vertical.

Partners will soon be regarded as experts in the field and the exposure compounds.

Much easier to get into deals

Getting into really hot deals will be much easier for a vertical fund, as every company in the space will want to get that firm even if for a small amount thanks to the connections and expertise it can bring.

Lighter dealflow, less bullshit

Big firms spend A TON of time looking at really crappy deals. By shrinking the firm’s focus the team will have much more time to evaluate deals.

Specific value add

Generally the partners will have had some previous success in the field, gaining very focused expertise and a huge network.

That’s immensely valuable for founders who haven’t been exposed to a specific industry before.

Partnerships and knowledge sharing between portfolio companies is also much more valuable than in a horizontal firm.

But by investing in a single specific niche, some problems tend to arise:

Portfolio theory problem

Modern portfolio theory states that diversifying a portfolio into multiple assets, geographies, currencies, sectors, etc. produces the best risk-adjusted expected returns.

MPT has been challenged by behavioral finance recently, but even before that, venture firms need to produce the highest returns, and sometimes that means assuming the most risk. If a VC firmly believes in a specific vertical, it might make sense to put all its eggs in that basket.

Competing investments

If you only invest in a specific vertical, there will be high chances that you’ll end up investing in competing companies.

If you don’t take board seats these might be fine, but it will be really hard in the value-add phase.

Small company pool

As I said previously, the pool of companies to look at will obviously be much smaller than other VCs.

This might be a good thing but might also limit the ability to deploy capital at the ideal pace.

In general, I think the opportunities outweigh the risks, and that we’ll see stellar results from current vertical firms as well as a lot of new ones launched in the coming months and years.

You should follow me on Twitter here.