For many would-be entrepreneurs there are two basic routes open to achieve their goals. The first is to bootstrap, to figuratively pull yourself up by your own shoelaces and slug it out in a decade (or longer) march to achievement. Possibly, along the way, funding can be obtained through business Angels or other forms of participation.
The second is to hook up with one of several start-up incubators.
So. Much. Tech.
Some of the biggest names in tech are coming to TNW Conference in Amsterdam this May.
The differences between these two ways of running your business are significant and it would help to be aware of those differences before making a decision. It seems as though many people view the ‘bootstrap’ route as an alternative or last resort but in my opinion both alternatives have significant pros and significant cons.
In this article I’ll try to list those pros and cons as objectively as possible. To quote a dutch soccer legend: “Every downside has an upside”, and this holds true for most of the incubator vs bootstrapping debate. Almost every ‘pro’ for an incubator translates in to a ‘con’ as well, and the same holds for the ‘pros’ of bootstrapping. Which factors weigh heavily for you is highly dependent on your situation, your personality and your comfort zone, so you will have to assign your own weights to these items in order to be able to help you in reaching a decision which route is the right one for you.
Just in case you’re unaware of what a start-up incubator is, let me give you a quick recap: A start-up incubator is a group of people operating through an investment vehicle that enables would-be entrepreneurs to attempt to reach their goals by abstracting out many of the common elements in launching a new business and to facilitate those elements. Typically a start-up incubator is run by very seasoned, successful and wealthy entrepreneurs. Start-up incubators usually – but not always – have cycles during which they announce funding is available for new companies with an application procedure where the would-be entrepreneurs present their projects to the incubators. Typical examples of (very visible) incubators are Y Combinator and TechStars, but there are many more.
Working with an incubator means that you have immediate access to all their facilities, including lots of experience setting up corporate legal structures, shareholder agreements and possibly even things like office space and other down to earth needs of a fledgling company. Typically they’ve done this sort of thing lots of times before you came around and you get the benefit of all that experience. Do remember during the negotiation phase that you are on opposite sides of the table and it is typically a negative to let the other party arrange all the contractual work, so make sure you get any contracts reviewed by your own legal representative. If you are going to use office space, a reception desk and so on, make sure that these are charged at a rate that is at or below market value, if this is not the case consider going elsewhere for your needs.
One of the great advantages of working with an incubator is that since they’re (supposedly) all experienced business people and will be able to mentor you to help you grow in your capacity of being a business person yourself. You have to keep in mind though that a typical incubator will have 10’s or even more than a hundred other companies that are ‘live’. Each and every one of them is competing for the attention of the available mentors.
If an incubator has a well connected network of alumni this can help offset some of the disadvantages here, but typically the attention of the operators of the incubator can be (logically) expected to go to those that are most likely to succeed. If you plan on signing up for an incubator try to get an idea of how much time there is allocated by the various partners in the incubator for this mentoring and maybe talk to some alumni to see how well that worked out in practice.
Low hanging fruit
Incubators tend to focus on the ‘low hanging fruits’, the companies that are either very easy to make profitable or very easy to ‘flip’ to a larger party in a tech acquisition or a team acquisition. Various incubator operators are on the record stating that they are ‘in for the long haul’ but the statistics do not bear this out and incubators tend to stay away from companies that really intend to ‘change the world’. The ‘change the world’ companies are typically not launched from incubators, though there is no reason why that should continue to be the case.
However, if you are planning on a project that has a long runway, that requires large amounts of capital or that requires the development of completely new technology then you are probably not going to find many open doors with incubators. Incubators revolve around the ‘team’, not around the ‘product’ and if your vision of the product is a rigid one and you think in terms of years to market rather than a ‘minimum viable product’ in three months time then trying to get in to an incubator may well be wasted time. Hardware based companies, a new pharmaceutical company, biotechnology, energy start-ups and so on are better off trying to hook up with specialized investment vehicles serving those markets.
Network of alumni
Probably one of the bigger advantages of being in an incubator is that you have immediate access to a large network of former incubator bred entrepreneurs. The combined wealth of experience here is something that is hard to quantify but it is probably safe to say that if you’re faced with some kind of immediate problem that the network of alumni will have at least a reasonable idea of how to solve it. You’ll still need to do the solving yourself, but that’s still several points ahead to being out there on your own. It’s hard to see any downsides to this, other than maybe that it may lead to a feeling of seeing everything through an incubator tinted glass and forgetting that there is a whole world outside of the companies started through incubators that may have a valid (and sometimes conflicting) opinion as well.
Having a network of alumni factors big in one other aspect, to have respected peers to review your ideas, products and demos. Constructive criticism is hard to come by and to have ready access to a large number of individuals that are willing to provide this service to you at no cost other than reciprocity is a huge advantage. Again, the combined experience is likely to be substantial and most of the tuition fees in terms of mistakes made and accidents survived have already been paid, so this can help substantially in improving your product before you demo it in public or hit the market.
Network of contacts
If the incubator partners are the first circle, and the network of alumni is the second then the combined Rolodex of all these people acts as a third, a vast resource. The network of contacts of an incubator that has been operating for a while is likely extremely large and most of the people you’d ever want to talk with about your product, some collaboration or other business arrangement is likely no further than a one step personal introduction away.
Relatively easy access to follow up funding
Because incubators typically have a large number of companies in their portfolio that survived their first public demonstrations and have gone on to public success and have found significant backing (in the form of an A series VC round for instance) they have ready access to the capital market. Some incubators have a public demonstration where they try to create a market for capital (where venture capital partners are invited to come and look at the products of the next batch) which may lead to higher valuations than you’d be able to effect when working as a bootstrapped company. The downside of this is that if there are no takers in that round that there likely will be none later on either because you’ve already been exposed to the majority of available parties and they’ve got a collective negative impression. On the other hand, if you should find that you are ‘hot’ then likely there will be some competition to be allowed to participate.
One incubator (YC) now has a deal with a wealthy individual that basically guarantees follow up funding to the tune of $150K in a convertible loan format for *every accepted applicant*. Finding follow up funding for a seed round will probably never get easier than that.
Getting significant exposure for your bootstrapped venture can be very hard. Unless one of your trial balloons goes viral or if there is some reason why the tech press loves you and / or your product this will be an uphill battle. An incubator backed venture will have the advantage that simply being backed by the incubator will validate the venture in the eyes of a lot of people and plenty of those people work for the press. They’ll more or less automatically write about your start-up, because it is associated with a well known and respected industry name.
Some people think this is ‘unfair’ and that the tech press should write without looking at the pedigree of the company but that they should look objectively at the products. Personally I think that this is indeed ‘out of balance’ but I don’t fault the press for playing it safe and dedicating their limited attention to those subjects that people are likely to recognize and therefore are more likely to read in the first place.
Access to potential exits
As a bootstrapped entrepreneur it can be hard to gain access to the right people that guard the doors to potential acquirers, and opening those doors can consume a significant amount of time. Incubators on the other hand usually have the eyes of a number of larger companies on them in the hope of snapping up a promising new company before they become too expensive. Having ready access to parties able to acquire successful start-ups certainly won’t hurt. A potential downside is that many of these so-called exits are really team acquisitions and that the actual product that you built your company around will be left to die or flounder post acquisition.
Because of all these combined advantages typically incubator backed ventures have a slightly higher chance of success than those that are bootstrapped. That does not mean that bootstrapped ventures should be abandoned in favor of funneling all start-ups through incubators. What it means is that if you are on to a ‘sure hit’ that you will probably succeed whether or not you’re in an incubator. And if you are ‘likely to fail’ and you somehow manage to get in to an incubator you are still ‘likely to fail’. The problem here is that you can’t apply statistics to any individual, you can only make a statement about a larger population and that statement is that given a large number of start-ups the likelihood of success for start-ups launched from an incubator versus start-ups launched from bootstrapped situations, that the number of successes (for some definition of success) will be a bit larger in the incubator backed scenario.
Should you fail
Even though everybody goes in to the founding stage with a clear vision and hopes of good fortune the cold hard fact is that – even in an incubator setting – a very large fraction of all new ventures fail, for a large variety of reasons. And if that happens as a bootstrapped entrepreneur you are possibly in a difficult position to extract yourself from. But when you have an incubator as a partner then you will have ready access to lots of other start-ups that might want to take you on board as a co-founder or as a salaried employee, and they may even be able to bend your ‘failure’ in to an acquisition-cum-signing-bonus.
Incubators have a ‘track record’ and some of this track record will rub off on the start-ups launched from the incubator. If an incubator has a long series of failure behind it this effect will likely be a negative, if they have a long history of above average performance then the effect will likely be positive.
Cookie cutter corporate structure
Typically incubators will try very hard to keep the various companies they invest in as similar as possible in corporate structure, it is not unusual to see them demand that they set it up using their lawyers, in their chosen jurisdiction and so on. Chances are that this puts a group of founders at a disadvantage compared to how they would have structured the business if it were bootstrapped. For instance, choices of venue for lawsuits, vesting, taxation, residence etc may all flow from these documents and if an incubator is not willing to move on these it may leave the founders at a disadvantage.
Requirements about location
Some – but not all – incubators place strict requirements on the founders with respect to their location for some period of time. The goal here is to have all the founders close to each other to encourage the forming of bonds and to increase the ‘contact surface’ between the various founders and the incubator partners and the alumni network. If you’re bound to a certain location (family, VISA, current job, mortgage, etc) then your chances of making it in to an incubator are significantly reduced.
This closes the doors on a very large number of potential applicants, the ‘incubator’ formula works best in close proximity, in spite of this being the ‘networked age’ it still does not appear to be possible to get this kind of interaction going without physical presence. If moving is not an option then going the incubator route is a lot harder.
Working with an incubator is very high pressure. Even after the initial ‘to MVP’ stage is behind you there is a strongly competitive element between the various people in a given batch of companies and there are a lot of eyes on you. If you don’t work well under pressure and/or have a problem with a constant stream of (hopefully constructive) criticism then this may be problematic. On the other hand, if you don’t work well under pressure, maybe you should reconsider your desire of being an entrepreneur in the first place.
Incubators tend to favor the younger people
The older you are, the more likely that you have significant obligations to the world directly around you and the smaller the chances that you will be able to set aside everything and anything for a period of time in order to join an incubator. In practice this means that incubator entrepreneurs tend to skew towards the younger end of the scale. Other potential reasons for this are that older people typically are more affluent than younger ones, that they have an extensive network around them already and possibly that they are interested in starting companies that require longer runways and/or capital.
Taking on an outside investor is an immediate increase in your responsibilities. You are now not only working with your own money, but also with the money of others and this is a difficult hurdle to take for some. There is obviously no difference in the buying power of a dollar provided by your or by a financing institution, but if you should lose that dollar it will feel completely different and not everybody has it in them to manage funds contributed by outsiders.
Even though ‘changing the world’ is trotted out as the reason why starter-uppers do what they do, in reality most of them are in it for the money. That’s probably not going to make me many friends but it is something that I’ve observed over the years. The incubators themselves are no different, if they weren’t in it for the money they would not be doing these convertible loans and stock deals, they’d make donations. So, once it has been established that all parties that are at the table are in it for the money it becomes a lot easier to chart the way forward.
If you have any illusions about ‘changing the world for the better’ or ‘doing the right thing’ then you will find that as a bootstrapped entity you will have increased freedom, no exit pressure and no other ‘hands on the wheel’ while you are doing your thing. There are specialist funds that exist for the sole reason of really trying to change the world for the better, likely your big plans ™ will find a better home there than in an incubator.
The people that work well in incubators are best described as team players, maybe green in business but technically competent and ‘people wise’. If you’re in introverted person, have difficulty interacting with others and with speaking in public then an incubator will likely improve your skills in these areas tremendously.
Ability to respond to criticism
Being in an incubator almost guarantees a constant stream of constructive criticism and even though it is all well meant and no doubt with the best of intentions it will take a lot of patience and resources to deal with all this. Not everybody responds equally well if their ‘baby’ is the constant subject of deconstruction.
Stage of application (when started already)
Applying to an incubator works best if you’re not already operational but you do have a demoable product (or something that can give the general flavor of what it is that you envision). That way you’re not too early (nothing but an idea) and not too late (incorporated, having (significant?) turnover). In the first case you’re up against possibly hundreds (or even thousands) of other applicants and having a somewhat demoable product will make you stand out and so will improve your chances. But if you move further than that you are suddenly much harder to put a value on and there is a lot of stuff that would need to be researched to justify your increased valuation (due diligence).
They take a stake in your company
An easy to overlook downside of an incubator is that they will be shareholders (or the holders of a convertible note, so potential shareholders) to your company. If the various upsides to having them on board are outweighed by the dilution and the other downsides then this is a net loss to the founders. Typically incubators will take between 2 and 10% of the stock of the companies they fund for several tens of thousands of dollars which means they value those companies at a few hundred thousand dollars.
Working with an incubator takes time away that you could be spending working on your project
Don’t underestimate the amount of time that working with any third party as an investor / shareholder will take away from you doing your thing. There is a return-on-investment at work here and you have to weigh carefully the pros and cons of going this route versus the alternatives. If the ROI is a net positive then by all means, go for it. If you feel that you’ll be spending a lot of time and effort satisfying the reporting requirements and other overhead of working with an incubator due to all the factors mentioned above then you are better off as a bootstrapped business.
In closing, both ‘bootstrapping’ and working with an incubator are independently valid routes to starting a new company, there are advantages and disadvantages to both, and even though it may seem that bootstrapping is an alternative after the other one has been exhausted there are valid reasons to bootstrap even if you would be accepted in to an incubator.