Y Combinator and the rise of ‘incubator’ companies

3rd May 2012

Budding entrepreneurs can take their ideas from first concept to commerciality thanks to a growing number of "incubators" – specialist firms which provide advice and practical training on technical, business and fundraising issues to help turn that idea into marketable reality. Incubators typically take a smallish slice of equity in exchange – some charge fees additionally or as an alternative.

United States is well ahead

The incubator concept is more advanced in the United States – one is so advanced that it takes on prospective entrepreneurs who don't have any idea of what they want to do other than they want to do something.

United States based Y Combinator regards its activities as alternatives to MBAs, sometimes accepting applicants who don't even have a startup idea. It has come top of a Forbes analysis which measures some $7bn worth of US companies created via incubators.

Incubators have become an increasingly important part of the tech startup scene in recent years. David Cohen, head of TechStars – it provides seed funding from over 75 US venture capital firms and angel investors –  says "A number of hot startups have emerged from these programmes, encouraging more new entrepreneurs to apply. They've become so popular that about one accelerator project launches a day, popping up in many cities."

Learning from an incubator company

Most incubator ideas are based on technology although this is more than gadgets or software. One field which is filling fast is the for-profit application of computerisation to education.

Cohen foresees "a high-tech wave sweeping through the educational world largely driven by technology entrepreneurship – if entrepreneurs can get funds."

He cites US group K-12 which believes that "infrastructure, hardware, software, and platforms are either available or being developed that will change the nature of how we teach our children in profound and far-reaching ways."

Class Dojo, a classroom-management tool for teachers, which has grown significantly in schools since it was launched,  started last year when entrepreneurs Sam Chaudhary and Liam Don met at Cambridge University during a so-called startup weekend, an event where would-be entrepreneurs, Web designers, and software developers gathered to brainstorm for 54 hours straight.

The two had coffee in London about a month later and hatched an idea. Within days, they had applied to an American business-incubator program for education entrepreneurs, and by last August, they had launched.

But unlike the US, there seems to be little interest in educational projects  if this article is a typical experience.

According to the Forbes survey of the top U.S. incubators and accelerators, Y Combinator comes out top based on factors including the exit prices or the last priced equity valuation of the companies that have gone through each programme.

Taking into account Y Combinator's 172 companies that have been acquired, shut down or raised funding, the total value is $7.78 billion, for an average of $45.2 million per company. The Mountain View, California based firm has been in existence for just seven years. There are some big-hitting "graduates" including phone and video share site Dropbox, accommodation network Airbnb and news link site Reddit.

Incubating incubators

Techstars, set up in 2007, comes in second in the incubator championships – it's in five major US cities and helps incubate other incubators.

Forbes comments: "Y Combinator has a natural perhaps unfair advantage over others because it has been around longer than many others. Therefore, its companies have had more time to grow. Y Combinator has also been popular among investors, judging by the types of deals that are getting done for its companies. For its most recent batch of companies that pitched to investors in March, a select few startups were trying to raise convertible notes at caps of $10 million, $12 million or even $15 million. Y Combinator established itself by bringing in talented technical founders and encouraging them to build a startup and launch it in three months."

"The best way to find out if a product will work is to launch it," Y Combinator co-founder Paul Graham tells entrepreneurs.

Starting up in the UK

In the UK, the Institute for Small Business and Entrepreneurship is a good place to start. It has links to universities and to organisations for start-ups. It describes itself as "The UK's principal and successful authority on incubation, incubation development and good practice since 1999.

It adds: "We have has helped the UK government and regional development agencies to build a thriving business incubation infrastructure that will make increasingly significant contributions to local, regional and national economic growth, as thousands of incubated clients move out of incubation environments and achieve sustainable commercial success in their own right."

Its focus on "high quality, professional incubation" has, it claims, "helped a wide range of organisations to create the right environment for nurtured and supported growth, including universities, science parks, research and development laboratories, commercial clusters and social regeneration projects."

For those willing to take on the risks of investing in start-ups – some little more than plans on a sheet of A4 – this thread is a good start. But investors should not forget that stakes in these companies are not covered by any Financial Services Authority protection.


More from Mindful Money:

Facebook: The IP arms race

What Mark Zuckerberg could learn from the demise of the Murdoch dynasty

Is Larry Page the new Kim Dotcom?

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