This post originally appeared on Entrepreneur.com - #StartingABusiness
Entrepreneurs think they’ll provide that extra “oomph” to their business. The opposite may often be true.
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Shortly after I first moved to San Francisco, I was sitting outside Peet’s Coffee in Palo Alto and speaking with my then-co-founder about accelerator programs. We were eager to get into one of the most prolific accelerators in Silicon Valley because of the instant brand recognition and investor connections it would provide.
“If we can get into 500 Startups, it can really take us to the next level,” he said. “We can raise at least $1 million at a valuation over $6 million. We just have to give away 7 percent of the company.”
I responded bluntly: “Is it worth it?”
“If we get the results, then yes,” he said, before lobbing one more comment, somewhat anticipating my reaction: “It’s going to be worth it. It’s going to work. I think it’s going to work.”
I could not help but investigate further and started to discover that there’s a lot more to accelerator programs than meets the eye.
In the years since, accelerator programs have proliferated around the country and the world. Offering capital investment, crucial connections, advisory services, discounted resources and investor “Demo Days” where you can pitch your business to a group of investors all at once, accelerator programs continue to be in high demand. At last count, more than 1,000 such programs were in existence in the United States. Corporations like Nike and Disney have partnered with Techstars to create their own accelerator programs. Universities and even the Dubai government have done the same.
And yet, it still may not be the right move for every company. Yes, accelerators offer advantages, but they also come with some significant drawbacks, and it’s important to weigh the tradeoffs. These include both the cost of the equity you usually have to give away and the distraction created for your team and demands on their time.
The Valuation Increase May Not Be Worth the Equity
Accelerator programs like Y Combinator are world-renowned for launching companies like Airbnb, Dropbox and Stripe. There are thousands of other programs similar to Y Combinator around the world. Usually, each one takes between 3 and 7 percent of equity in a business in exchange for an investment sometimes no greater than $200,000. Founders will trade off what is usually an extremely low or discounted initial valuation for a premium from investors when they graduate.
The data backs this up to a point. For companies that progress through Y Combinator’s program, for instance, they can command a significant valuation increase over similar companies in the market or even those that went through other accelerator programs. Often, investors engage in pattern-matching, and the “rubber stamp” of having gone through a prestigious accelerator is viewed as a marker of potential success, even though the data doesn’t necessarily support this.
And yet, what about other accelerators that are not as prestigious as Y Combinator or even 500 Startups? The data gets a lot murkier as many of the companies graduating from those other programs struggle to raise capital, and when they do, have to do it at market rates.
Therefore, if you’re considering the “valuation bump” that may come with an accelerator program, please do detailed diligence. Understand the data from previous cohorts and founders — what they raised, how long it took them to do so and whether they would go through the program again. You may well find that the 3-to-7 percent equity isn’t worth what they provide in return.
Accelerator Programs Can Be Massively Distracting
A few years ago, I was speaking to another founder who had just entered an accelerator in Colorado. Despite its status as a nationally recognized program, the founder became exasperated at having to spend days in classes learning about subjects as elementary as incorporation, human resources and business development.
“They really go over the basics,” he recalled to me on the phone. “If I didn’t know many of these things, I wouldn’t be anywhere near where I am in my current business. They totally think we don’t get it, and it’s a massive distraction.”
Many accelerator mandate in-office time, attendance at programming and mentor sessions and days of meetings in order to graduate and complete their programs. While beneficial to some founders who may be just starting out, a large percentage likewise find this programming to be distraction.
In the early stages of a startup, founders need to be “heads down” and laser-focused on execution in shipping their product and testing their minimum viable product (MVP). Before entering an accelerator, please be aware of the time commitments required and the level of distraction the program may entail. Make the decision that’s right for your business.
Do What’s Right for You
Accelerator programs have fundamentally altered the entrepreneurship world over the past decade. Although many founders believe that they are extraordinary helpful or even necessary to launching their business, they should be aware of some important tradeoffs. Namely, that the valuation increase promised by accelerators may not be worth the required equity and the potential for distraction from core business functions.