Tuesday, June 21, 2011

The Great Incubator Debate

Today at the Computer History Museum, Chris Yeh moderated a panel of entrepreneurial thinkers, including Jonathan Abrams, Dave McClure, Adeo Ressi, Kindra Tatarsky, and Cameron Teitelman. The panel was part of the Orrick Total Access series, focused on Startup Incubators.  

After listening to the panel and taking some time to consider what I heard, here are my observations and thoughts on the session. I'm unable to squeeze in all the topics here - in particular, addressing the gaps in gender and race of founders needs further discussion.

What is an Incubator
I cannot remember an event where within the first five minutes, everyone on the panel made a concerted effort to distance themselves from the term "incubator".  To be fair, Dave McClure did exclaim “we’re an incubator, we embrace the term” after one pass through the panel with everyone explaining why they were not an incubator.

With an unfortunate run of failed experiments in the 1990's, the term incubator takes on a lot of different meanings to people. If you were in Silicon Valley for the "first bubble", you probably wince a bit when you hear the term. If you're under twenty-five, you probably don't care. In either case, it was interesting that each panelist pointed out they are not an incubator, and did so using definitional design of "what is an incubator."

In the end,  the debate on definition came down to three main topics - space, funding, and mentor networks. Only one of the participants offered all three of these attributes, although there was great debate if some, or any of them, are requirements to be called an “Incubator”.

Jonathan and Dave provide some of the most amazing space in the Valley in FoundersDen and 500Startups (read the 500Startups blog entry on space). Adeo, Cameron (StartX), and Kindra (Astia) do not provide space.
There was not much debate on the value of co-working or co-location. Having lots of smart, passionate people with different backgrounds, skills and experiences in close proximity creates better startups. Everyone from Mark Suster to Fred Wilson has chimed in on the topic in the past, and great environments like PariSoma, Dogpatch, exist, along with so many others, even if if you are not in an incubator.  

For me, space is important. When it’s time to move out of your home office and local Peets, its important to get into  high productivity, high-community Co-Working spaces. Jonathan had a lot to share about this point, and how it shaped FoundersDen.

The discussion of space also let to debates of "services", a term I believe that was  misunderstood by the audience, and even the panel. In today’s startup world, services are not accounting, legal, and front desk support - which you can get at Plug and Play or Regus rental offices - but having SEO, Marketing, Design, Mobile, and UX experts around, able to help with tough problems; these are the startup services of today.

I think this is one of the fundamental differences between today and the 90's incubator market. Legal, accounting, and other services are important, but to be successful today, it's less about payroll and more about customer aqusistion. I think this is directly attributable to the state of funding. I don't need to worry about payroll services when I raise $25k. I need to worry about getting revenue. In the 1990s, incubated companies were raising $5-10M rounds on ideas (or without ideas!) - so they needed legal and accounting services just to manage the intake. 

Frankly, the "support" industry for startups in the late 1990s - from legal to Solaris servers - was also tilted towards funneling big money back into the coffers of established businesses. As the Lean Startup and other movements that value execution over idea have taken hold, and server infrastructure become commodity (Rackspace, Amazon), the needs of the companies are laser focused on execution, revenue, and customers. This is a very good thing.
In the end, I think these market trends lead to the importance of community and mentor networks as the most critical asset that a Incubator can bring a potential applicant. The beauty of FoundersDen is not only an amazing physical space, but a curated community of people interested in helping others. I/O ventures, although not on the panel today, has a similar concept linking amazing co-working spaces, mentorship and incubator models.

It does not mean you cannot be successful without a great space - the mentor network and community is the most important aspect, which you can hear when Adeo explains that he ensures that all founders and mentors in his program have an equity stake in the other program participants. Any effort to keep incentives aligned is a good effort.

So the question to the entrepreneurs in the community is, would you give 5% of your company for amazing space and people, but no funding? I would. I’m lucky to have had an nice exit so money is not the critical aspect, but having an extended team of people, mentors and friends with aligned interests in an amazing space? Priceless.

Metrics and Scale
One of the biggest considerations you can hear, both in their words and in their voices, is the struggle of how to understand and scale the incubator process. In particular, Adeo Ressi and Dave McClure, in very different ways, are quite humble in admitting that they are still trying to figure out the metrics, values, data, and systems to filter the enormous deal-flow, and a process that is providing little repeatability in the process.

Dave often talks about Billy Beane and the Moneyball movement as one of his inspirations (if you have not read his blog post on Moneyball for Startups, please stop reading this and go do it. Now. I'll wait). If that sports reference does not translate well, I'll try to summarize a the entire book in one sentence: Billy Beane is a General Manager who figured out new models and approaches to talent aquisiton in baseball, which let small-market teams compete and excel with big market teams with less revenue.

This is the foundation for 500Startups, the Oakland A's to Sequoia's New York Yankees, but it also goes a bit deeper. What Billy Beane figured out, influenced by brilliant statisticians like Bill James, was how to break down common myths and apply a statistical model to find the best value. The subtitle for the book was "the art of winning an unfair game". That should give you the best idea yet of the fit and strategy of 500Startups.

A startup example - maybe Dave cannot afford Bill Nyguen and the Color team at $41M, but he's betting with the right system he can find the next Bill...before they are "Bill". Remember, the A's found and nurtured Jason Giambi, and later the Yankees overpaid him (Three times as much as Color, to be specific) a few years later. It's not a static state - some today's 500Startups companies will raise gigantic (and in some cases, overvalued) rounds. Dave will have participated in seed, and A rounds, and will let the Yankees take up B and futures.

This is the idea, to find a model, method, or some predictability in what seems to be a very unpredictable market. Specifically, Dave mentioned female founders, the international market, and husband and wife teams that are undervalued today, so he invests in those places. As he said - “I’m not doing this to be nice. It’s good business”.

Adeo is taking a much more scientific method with a testing and review process that he believes will lead to a data-driven approach to finding the best entrepreneurs. Although their methods, process, and outcomes have been challenged, the Startup Genome project and even Y-Combinator have been attempting similar, albeit less rigorous methods, of reviewing and synthesis of data.Cameron has created a filter by requiring you to be part of the Stanford Community, and Kindra requires at least on woman co-founder. These are all filters and methods to try to narrow down overwhelming opportunity.

It shouldn't be any surprise that many of 500Startups companies are in the area of metrics, process optimization (usually email), and related fields. Although he does not embrace it as publically as Adeo, Dave is circling the same topic. What's the signal to help identify great entrepreneurs in all the noise?

The current market, and the forseeable future, past success, market space, concept/execution, networking, and social proof (a reference is a requirement of 500Startups) will still make up the lionshare of successful applicants. It's never been easier to test out your ideas, get customer feedback, blog, execute, and network. As Mark Suster said at the Founders Showcase just a few days ago, in the age of social networking if you can't make a connection, you're probably already in trouble. So while it’s a fine process, it does lead to overwhelming in-flow. There was a time when execution set a high-enough bar as to filter out a large majority of companies that should not be funded. That bar has dropped a bit.

Personally, I'm leery of the purely data-driven approach. I added a Cognitive Psychology degree to Computer Science because I believe in the ideas of social science, but still find the process to be too malleable to believe in it as a sole input. As a startup community, we need to continue to collect and analyze success and failure.

We're currently devoid of a enough data in enough markets, and still struggling with issues of  cultural/gender/race bias. Adeo is onto something, and combining his data-driven approach with social proof, execution, and hustle found in the 500Startups methods will be the best filter for another five or ten years, as we gather actionable data we can use to have a more predictable model.

 In the end this is still a hits business, be it baseball, music, or startups. There will be misses. 

The most important thing for you to do as an entrepreneur is to know the incubator you are applying to, do the research to understand their values, process, and interests, and be sure there is a match with your values and interests. You have a responsibility to contribute to the community, to give back, and to be bigger than something you can be on your own. There are a number of great incubators (or whatever they want to call themselves!) - go make it happen!