Accelerator fundraising: Backing the batch

"Essentially we are farmers," explains Meng Weng Wong, co-founder of Singapore-based accelerator Joyful Frog Digital Incubator (JFDI). "For most of venture capital's history we have been hunters, but what we are doing with accelerators now is agriculture and we are growing our own opportunities."

For Wong, having investors understand the difference between the two was essential when it came to JFDI's latest fundraise. In March, the group managed to pull in S$2.7 million ($2.1 million) from a mix of individuals and institutions. Infocomm Investments led the round, with Russia's SpinUp Partners and Silicon Valley's Fenox Venture Capital also participating. There were also contributions from several angel investors and some unnamed backers in the Philippines.

JDFI - which hopes to raise S$6 million over the next two years - is using half the capital to scale up its operations and the other half to invest in start-ups participating in its accelerator bootcamp, now in its fourth iteration. Meng explains that, just as farmers need land, tools and fertilizer, accelerators require significant capital to cover their operating costs.

Fundraising - and how best to go about it - is therefore a major issue for those looking to expand.

JFDI is just one of a continuously expanding ecosystem of accelerators in Asia seeking capital with which to nurture region's start-ups. Yet the model is still very much in its infancy. The idea is that accelerators will take on a bigger role in the early-stage venture capital landscape, but with an investment approach that is so different to that of venture capital, who will back them?

Given that accelerators are new to Asia and the term itself covers broad range of businesses, there is little data available. However, numbers released by Crunchbase - a start-up-focused database operated by TechCrunch - reveals a rapid proliferation of accelerators globally. They have increased seven-fold from 27 to 170 between 2006 and 2013.

AVCJ Research's records show a parallel rise in the number of seed stage investments, classified as deals under $1 million in size, over same period. Last year $83 million was deployed across 257 transactions last year, nearly double the $48 million that went into 116 deals in 2006.

"The increase in the number of accelerators is really part of a mega trend where we are seeing more start-ups being launched globally," Rajesh Sawhney, founder of India accelerator GSF Super Angels. "It is an attractive opportunity but it works to different of economics to venture capital."

Pick your model

Accelerators broadly follow three types of business model. The first is the real estate model, which can be likened to traditional incubation. The approach tends to be more passive in nature; start-ups are offered office space in exchange for a fee or equity in the company.

The second is the development model, which comprises accelerators run by non-profit and governmental organizations with a view to growing a start-up ecosystem and stimulating the economy. The third category is the return on investment (ROI) model, where investors pool capital to back start-up accelerators and try to add-value through mentorship, networking and support services. They hope for a lucrative exit multiple at the other end.

It is this latest model that has proliferated. US accelerator Y-Combinator, set up in 2005, is widely credited with being the pioneer of this type of accelerator, although several variations have emerged in Asia in response to particular local conditions. However, the high cost of running a program ia a consistent theme.

"With most accelerators being based in city centers, there are a lot of costs related to things like office space," explains Bernard Moon, co-founder of Korean Start-up accelerator SparkLabs. "Typically, operating expenses can be anywhere up to 50-60% of the capital invested. It is not like venture capital, the money doesn't go to high salaries. Most of it just goes to the space, programming, and demo days, and the rest is for investments."

Most accelerator cycles are built around a 2-3 month program attended by batch of start-ups selected following an open application period. There are usually 2-4 programs a year.

Start-ups receive an initial five-figure injection of capital for a stake of 5-10%. The winning applications, of which there will be around 20, will normally have some kind of finished product and be between six months and one year old. After spending several weeks honing their ideas and business plans, they present to potential investors in a demo day. The most successful accelerators report that 70% of their investees go on to receive funding.

When it comes to raising capital to run the program and invest in start-ups, angel investors have historically accounted for much of the LPs base. In many cases, these will be the CEOs of VC-backed companies. In addition to providing capital, these angels usually serve as mentors to start-ups in the program, leveraging their experience and networks.

A common trade-off is that the angel, in exchange for capital and mentorship, will get early access to the company founders, a better understanding of the business, and therefore a chance to the lead on early funding rounds.

"Sometimes you a have company that - even before the demo day - has three term sheets and it ends up raising over $1 million and is massively over-subscribed ," says JFDI's Wong. "Lots of the investors want to get in but often the only investors who can get in where those that invested in accelerator."

In many cases there is no formal agreement that underpins preferential treatment for these early backers. Angel investors may simply develop such a close working relationship with the founders during the three-month incubation period that when it comes to demo day, they already know they are going to invest, and founders are comfortable with their participation.

Further afield

But the pool of investors behind an accelerator is not limited to angels. Increasingly, institutional investors are showing an interest in backing accelerators and, in turn, accelerators have been looking to broaden their LP bases.

Venture capital firms have become regular backers. One or more firms will sponsor the accelerator and, in addition, investing in seed rounds for individual start-ups. There are also situations in which the accelerator is tied to a single VC, operating more like an affiliate.

This is the case with Australian accelerator Startmate which started as an independent program launched by Niki Scevak 2010 before joining with Blackbird Ventures - where Scevak is now managing director. Rick Baker, Blackbird's founder and managing director, explains that Startmate was primarily intended to support local business rather than generate returns, so it didn't make any money in the first two years before being brought under the Blackbird umbrella. The relationship has benefited both.

"It is hard for those sorts of accelerators, founded for love of it, to keep going unless they find a home within a larger fund," says Baker. "It makes it easier to keep the costs low and it is an important part of what Blackbird does and for our deal flow. It is a way to make sure we are seeing new trends and new technologies as they evolve."

Under the arrangement, Blackbird contributes around one third of the capital for each program with a group of angels - all of whom are mentors - investing the rest. Around A$50,000 ($46,000) is given to each start-up. Startmate differs from other accelerators in that overheads are kept low. Blackbird shares it resources with the accelerator, and extra expenses are shared by the VC firm and mentors when needed. When demo day comes the comes Blackbird takes part in follow-on rounds on a case-by-case basis.

Chinacceleratror has similar relationship with SOS Ventures. The program was co-founded by Sean O'Sullivan and Cyril Ebersweiler, managing director and Asia investment partner, respectively, at SOS. Ebersweiler explains that Chinaccelerator had only one LP - SOS - which financed the program like a regular investment, on a per program basis. Only recently has it opened up to angels.

While a relationship with a VC firm can mean the difference between life and death for an accelerator, particularly in markets where the model is less established, it can also create problems.

Last month, Y Combinator decided change the way in which its VC partners contribute to accelerator rounds. Under the old structure, Y Combinator would invest $17,000 in every start-up accepted into the accelerator in return for a 7%. Four VC firms - Andreessen Horowitz, Khosla Ventures, General Catalyst and Maverick Capital - would then contribute another $80,000, structured as a convertible note, through a vehicle called the YC Fund. Now Y Combinator will still invest 7% but contribute $120,000. A portion of the additional capital comes from a new fund that does not include the four VC firms.

The issue with the former approach was it created a perception problem for entrepreneurs. If backers of the YC Fund didn't invest in follow-up rounds, the concern was that it would be seen as a signal that the startup in question might have problems.

VCs are not the only potential partners, though. Many accelerators have earned backing by forming partnerships with large corporates. Again, the relationship is mutually beneficial: corporates will provide capital and give start-ups access to their own resources and networks; in return they get access to talent, technology and potential acquisition targets.

"Corporates are getting into the game not so much as an ROI function but as a scouting function for new technology and innovation," explains SparkLabs' Moon. "It is an early look at what is coming through the pipeline. That is why you see these corporate accelerators programs proliferate in the US."

TechStars has launched a number of accelerators off the back of partnerships with corporates. Its partners include the likes of Nike, Microsoft, Sprint and even Barclays for a financial technology-focused program. Corporates have been equally active in Asia. JFDI - which claims to model itself on TechStars - launched the JFDI-Innov8 Bootcamp in 2012 alongside SingTel Innov8, the corporate investment arm of Singapore telecoms giant SingTel.

On the other hand, many corporates have launched their own programs without teaming up with an existing accelerator. Japanese telecoms giant KDDI is a case in point. It created KDDI Mugen Labo, which focuses on mobile app start-ups that not only provide a return but can also be a source of innovation, talent, and value-add services for KDDI to offer to mobile customers.

A new asset class

The longstanding question is whether accelerators can complete the journey from start-up to institutional platform by drawing support from pension funds and financial groups. It comes down to issues of risk and the investor's perception of what accelerators are.

"The way we put it is that accelerators are fundamentally a different animal to venture capital, we are different asset class," says JFDI's Wong. "It has been difficult for us because we run at such an early stage that two out of three investors we talk to say they are interested in dabbling in early stage but think investing in an unproven team with unproven ideas and giving them only 100 days to get their act together is way too risky."

If accelerators do manage to achieve broader acceptance among investors it will be a long time coming. In the short- to medium-term, many in the industry expect a cull of smaller accelerators, much like what has been seen in the broader the venture capital space as larger, more proven accelerators come to the fore, attracting more commitments and landing more investments.

"A lot of accelerators will likely die in the next several years. If you are working with an ROI model it is all about deal flow," says SparkLabs' Moon. "Like VC firms - where only the top ones do really well - in the US maybe the top three or five will get the best deal flow. Those are ones that will survive."

Some anticipate a similar scenario in Asia, with a handful accelerators dominating deal flow in each jurisdiction while smaller players close or restrict themselves to niche areas. Akash Bhavsar - a mentor and managing director of SkyQuest, an intellectual property-focused advisory firm that invests in accelerator-backed start-ups - believes the accelerators that are able to attract investors will be those with an international focus. The country specialists will struggle.

"It will l be difficult for them to get good deals," he says. "There have to be multinational accelerators that can help start-ups act like multinational corporations and take advantages of market access within a shorter time frame."

GSF's Sawhney is equally enthusiastic about the global approach. One of his firm's highest-profile exits came recently when Facebook acquired Little Eye Labs, which provides developers with software that allows them to monitor mobile app performance, for around $15 million. It was the US giant's first-ever India investment.

GSF is also unique in that it is held across several countries. The most recent program saw start-ups spend just one month in India, followed by a month in Silicon Valley, 15 days in New York and the final 10 days in Singapore.

Not everyone shares this view. After all, Asia is economically and culturally different to the US and Europe, while the large consumer bases in countries like China and India provide plenty of room for growth.

"Asia has several cultures which lead to the massive differences across the region and will complicate the task of having a pan-Asian accelerator dominate every country," says Chinacclerator's Ebersweiler. "Focusing on a growing market they understand is critical for entrepreneurs, and as such entering another Asian market early on is unlikely."

Either way, many in the industry observe that while some smaller accelerators may cease to exist, interest among investors looking beyond the ROI model will persist. For example, state-backed programs adhering to an economic development model will continue as long there is the government money to support them. JFDI's Meng notes there is already government interest in Singapore, with state-controlled giants Temasek Holdings and GIC Private attending demo days.

Again, Meng evokes the agricultural analogy. "Governments are interested in acceleration because - like agriculture - it is more predictable and defensible. It is not like venture capital, where you are basically just sending out a group of hunters."

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• Topics
• Venture
• Early-stage
• Fundraising
• Greater China
• South Asia
• North Asia
• Southeast Asia
• Australasia
• GSF Accelerator
• JFDI
• Venture
• seed
• China
• India
• Australia
• South Korea
• Singapore
• Fundraising
• Blackbird Ventures