Sat, Jan 26, 2013

The Price of Joining an Incubator

It’s funny to see how hot & hip incubators are these days. Everybody and their dog either wants to join or run one.

It’s kinda sad to realize that most startups don’t seem to do the math.

Let’s take your run of the mill incubator (and please note that I am explicitly not speaking about the likes of Y Combinator, Tech Stars, 500 Startups, Seedcamp or some of the newer kids on the block like H/C Co-op — they are essentially black swans in a sea of white).

What you get from your incubator is usually (with an estimated dollar value):

  • A little bit of money (hard to argue with that) = $10,000
  • One or two desks in a co-working space for 3 months = $3,000
  • Office hours with mentors (I would always argue that you can get the same or even deeper mentor relationships if you just put yourself out there; I mentor a bunch of startups outside of any engagement with an incubator — simply by them reaching out to me) = $0
  • Training and advice (Do yourself a favor and buy the following books — they cover pretty everything and then some of the stuff you will learn in an incubator: Guy Kawasaki’s Art of the Start, Eric Ries’ Lean Startup, Steve Blank’s Startup Owner’s Manual and Cennydd Bowles’ Undercover User Experience Design) = $77.63
  • Ongoing support from the incubator team (I guess you get the drill by now — this is again something you can get equally as well and better from peers, friends, etc) = $0
  • Some goodies such as free legal services or hosting (Guess what — you get that stuff for free if you just ask) = $0
  • Demo Day (yeah, the big one, eh? Also free if you just make an effort; networks such as AngelList make this incredibly easy today) = $0
  • Camaraderie from fellow teams (you know what I am going to say, right?) = $0

So it comes down to a bit of money, a desk in a co-working space and some books. For that you happily fork over 7% (and often more) equity.

Now lets do the math in reverse.

Say you go through the incubator and pay your 7% club membership fee. You go on and raise a seed round which will dilute your company by 25%. You’re awesome, work hard and get lucky — you raise a series A. Your stock goes down another 25%. And then you exit. Hooray — you sell the company for a neat little $10M. Let’s see how much you paid for that help your incubator gave you, shall we?

Assuming simple dilution in each round your incubators 7% are diluted down to about 4% (3.9375% to be precise). That’s $400,000 in hard cash for a little more than $13,000 they put into you. 30x their investment. Not bad for them. But is it really that good a deal for you?

Note that reality often looks much messier and you (as the founding team) will end up with significantly less stock than in the simple example above. And suddenly 4% becomes an awful lot of stock.

With that being said — here’s my two cents: Incubators can be worth the money (heck — if I would get a spot in YC I would take it!) but do the math. And think hard about giving away your equity — these are the bargaining chips in your startup. Guard them carefully.

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