Xconomist of the Week: Michael Greeley Dissects the VC Data

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coming back, a wave of them, saying “If you squint, I kind of hit my milestones, and now I need $5 million.” And the funds just don’t have that collective capacity to support all of them.

X: But at the very same time, you have the first-generation accelerators scaling up—you have 130 companies a year coming out of Y Combinator alone, not to mention TechStars and 500 Startups. And you’ve got new incubators popping up in verticals like cleantech and media and healthcare. So there are even more startups in the pipeline. Is it a reality for these companies that not all of them will make it past the seed stage?

MG: Absolutely. The way we think about our portfolio construction is that we expect half of them not to graduate. Our orientation around a seed is, it’s an experiment. Experiments can be successful or they can fail. You should be perfectly willing to walk away. Our Series A’s and B’s are real investments. We are building a company.

You started by talking about the proliferation of all these incubators. Groups like Y Combinator have become such a beacon for the better seed talent that they will probably have better success rates for their graduates. In New York now, somebody told me this week that there are 25 incubators in Manhattan alone. Three years ago there were none. There is a little bit of adverse selection. My sense is that those guys are seeing lower quality commercial opportunities. Y Combinator has a three- or four-year head start, has a record of success, has incredible sponsorship. Those cohorts that graduate there will be on average, much stronger companies.

X: Now you’re even seeing some specialized, vertical accelerators like Rock Health and Greenstart and Turner MediaCamp.

MG: And Blueprint Health in New York. I have met with all of their companies, and they are all smart people, but even in that small group they start to look like derivatives of one another. And what’s hard, I think, for any of us in our position, is when you look at those and ask “Can that be a $100 million business?” More often than, you conclude that it’s just not going after a massive market opportunity.

X: There are only a certain number of $100 million markets out there.

MG: Right. Some of these are very compelling—you can see that they could quite comfortably build a $10 million or $20 million business and be marginally profitable. But that’s probably worth $20 million. If it doesn’t have the explosive, uncapped market opportunity you just never make a [venture] return on it.

X: Do you think there will be some kind of correction in the number of accelerators?

MG: Oh, absolutely. New York can’t sustain 25 accelerators. The truism is that every year a couple of dozen great companies get created. If you explode the top of the funnel you still have your couple dozen at the bottom. So maybe it’s a more vibrant process, but it just means greater failure to get that same couple of dozen companies.

X: That’s a sad way to look at it. There are so many talented people pouring their hearts into these startups.

MG: There will be pain and disruption. But it’s really temporary. Getting people into the system and giving them a taste of that is incredibly powerful for society. They will go off and do it again or join others that are consolidating, and at least that way we have retained the best minds in the innovation economy.

The only thing that may mitigate against some of the dramatic contraction of some of these incubators is if they are state-sponsored. You have states trying to build these ecosystems and put in uneconomic dollars to sustain it. For example, Bloomberg has made a huge push in Manhattan. If it becomes clear in the next two years that many of these companies are not going to be viable, I don’t think he turns that off. It’s part of a larger agenda for what he’s trying to do in Manhattan. So you may see them sustained a little bit longer than their useful lives because of the state support. But any of them that are sponsored by business or private sector, I think they will back off pretty quickly like they did in 2000-2001. Think of all the incubators that burst on the scene and disappeared very quickly.

X: It was a different style of incubator then.

MG: Yeah, you brought legal and accounting—you brought in services that were, frankly, less value-add. We fixed that model. Having free legal advice didn’t make a company. You needed great product vision and technical skills. Incubators now are much more focused on those elements. You don’t even see a general counsel or an accounting firm in these places.

X: So there’s a place for incubators—just not as many.

MG: Yeah. I think the other observation is that as the tide goes out—and the tide is clearly going out—the secondary and tertiary markets suffer disproportionately. So incubator in…these cities with great intellectual bases but not great venture bases, I think those get washed out very quickly. So it may be more sustained in the Valley or Boston or New York because there is a history there. But other cities that put up their obligatory incubator space, that could wash out pretty quickly.

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Wade Roush is the producer and host of the podcast Soonish and a contributing editor at Xconomy. Follow @soonishpodcast

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