StartupNorth

  • Holy Schmoly – iLoveRewards Rumoured to Raise $25mm Round

    As you know, something like 10 of the past 12 articles on startupnorth have been grumblings either in the article or in the comments about lack of Canadian startups trying to go big and how the ecosystem here can’t really support it.

    Well check out this hot rumour we’ve heard. Apparently, Razor Suleman and the folks at iLoveRewards are doing a MONSTER round from Sequoia sized at $25mm… with none other than Alfred Lin of Zappos fame stepping on to their board. Is that big enough to settle the anti-early-exit crowd? That’s a first class round for any company anywhere.

    More good news – apparently Canada gets to keep a big chunk of the company. Razor and the sales and marketing team are heading down to San Francisco, while our beloved Canadian engineering brains will not get drained.

    Seriously, it had been a while since we last talked about iLoveRewards in 2008 with their also very impressive $4.7m series A round led by JLA . They are one of those companies that have silently dominated their industry, picked up lots of awards but stayed out of the mainstream startup spotlight. Kind of the classic 5 years later you’ve got an overnight success story, like this one.

    I want to ask “Why didn’t iLoveRewards raise this round in Canada?” but really, they just got took a big round from one of the most renowned, deepest pocketed VCs in the world. I just don’t think most Canadian late stage investors are going to beat Sequoia money, so I’m not sure its even a relevant question.

    But it is a perfect example to ask a far more relevant question “should we care about our companies raising money locally?” – shouldn’t CEOs care far more about value than about where it comes from and live with the resultant potential location issues. I’d love to hear the inside story one day on what the bidding looked like on this deal.

  • The Upside Of Canada’s Startup Buying Binge

    Editor’s note: This is a cross post from StartupCFO written by Mark MacLeod, it is a response to Mark Evans’ post The Downside of Canada’s Startup Buying Binge. Mark MacLeod is a Partner at Real Ventures, Canada’s largest seed VC fund. He is also an advisor to some of Canada’s leading startups including Shopify and others. Follow him on Twitter @startupcfo or StartupCFO.ca. This post was originally published on September 14, 2011 on StartupCFO.ca.

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    Mark Evans posted recently about the downside of Canada’s recent startup buying binge. Year-to-date, we have had 22 exits in Canada. But save for outliers like Radian6 and Algorithmics, most have been relatively small. Mark correctly argues that there are long term negative implications to these early exits: losing talent to the US and not building mid to large scale companies that can really bolster our tech scene.

    Can’t argue with that and I have posted in the past about the importance of large tech companies to our ecosystem. But, exits are like pizza, even when they’re bad (small) they’re good. Why?

    Returns to LPs: Returns in the Canadian venture industry since inception are negative. Some funds have delivered returns, but the industry as a whole has not. That won’t work if we want to attract non-government LPs who are motivated by returns vs. policy, job creation. So, any exit that contributes towards fund performance is good.

    Generating repeat entrepreneurs: The reason (I believe) why many of our exits are relatively small is that the founders behind those companies have not had a positive exit before. As an investor, you should not bet against human nature. And I think it’s perfectly natural for an entrepreneur that has the opportunity to sell early and pocket a few million to do that. The trick is to keep that entrepreneur in the system and working on the next company. The next time, that same entrepreneur will set his or her sights much higher.

    Eliminating borders: It used to be an uphill battle to convince US investors to come up here. Now with the elimination of witholding taxes on exit and with our companies doing great things US investors are coming up here more often and earlier in the startup lifecycle.

    So when you think about what’s happening now, my hope is that we are setting the stage for long term success and the creation of some tech giants right here in Canada. To enable that, investors need to do more of the following:

    Give Canadian Startups more capital: This might be ironic coming from a guy at a seed fund, but it’s a well known fact that Canadian startups raise less than their US counterparts. I think it’s fine to operate with small $ before product/ market fit but as soon as you are ready for goto market acceleration you need serious fuel. Canadian investors and entrepreneurs need to continue building strong syndicates that include US investors that can write big cheques.

    We did that at Shopify. The investor group there includes two large tier 1 funds that can help Shopify become a giant in its industry.

    Enable founders to take cash off the table: As a founder you’re more likely to “go for it” if you can sell some shares and not have to worry about cash. This is common practice in the US. We need to do it more up here. It does not make sense early on but series B and up, I think it makes sense.

    Surround our CEOs with mentorship: When you look at the truly giant tech companies, they are almost always founder-led. So that tells me that we have to surround our founders with peers, mentors, coaches, advisors to help them make that transition from founder to CEO.

    We also need tech companies going public here in Canada, but that’s another topic for another time. So, I say bring on these early exits and realize they are setting the stage for great things to come.

    Editor’s note: This is a cross post from StartupCFO written by Mark MacLeod, it is a response to Mark Evans’ post The Downside of Canada’s Startup Buying Binge. Mark MacLeod is a Partner at Real Ventures, Canada’s largest seed VC fund. He is also an advisor to some of Canada’s leading startups including Shopify and others. Follow him on Twitter @startupcfo or StartupCFO.ca. This post was originally published on September 14, 2011 on StartupCFO.ca.

  • GoInstant launching tonight at TechCrunch Disrupt

    You haven’t seen many posts recently from my StartupNorth Cofounder Jevon MacDonald for a very good reason… he has been working on a startup.

    Customers can’t wait to get their hands on it. Robert Scoble had this to say: “It is one of those companies, when you see it, you say wow that is so cool. It should be bought by Facebook or Salesforce.”

    GoInstant has raised seed funding from an impressive syndicate including: Josh Felser (Freestyle Capital), Reid Hoffman (Greylock Partners), Howard Lindzon (Social Leverage), Steve Anderson (Baseline Ventures), Chamath Palihapitiya (Embarcadero Ventures), Patrick Keefe (Innovacorp), Boris Wertz (W Media Ventures), Ed Sim (BOLDstart Ventures), Yuri Milner, Matt Wyndowe, Daniel Debow, and myself.

    The Halifax based company has been in stealth mode for 9 months. By now you are probably wondering… what is GoInstant?

  • The Downside of Canada’s Start-up Buying Binge

    Editor’s note: This is a cross post from Mark Evans Tech written by Mark Evans of ME Consulting. Follow him on Twitter @markevans or MarkEvansTech.com. This post was originally published in September 12, 2011 on MarkEvansTech.com.

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    There has been a lot of euphoria and happy dances recently about the flurry of Canadian start-ups being acquired. The list includes Zite (CNN), Five Mobile (Zynga), PostRank (Google), PushLife (Google) and BackType (Twitter).

    The positive news is that the flurry of deals (22 and counting, according to TechVibes) provide a huge boost to Canada’s start-up ecosystem, which needs all the support it can get. Acquisitions reward start-up founders, encourage venture capitalists and angel investors, embolden entrepreneurs, and provide a healthier landscape for people like myself who provide services to start-ups.

    In short, Canada’s start-up ecosystem is on a roll and, hopefully, these deals will make things even better and more active.

    But there is a downside to these start-ups being snapped up. Many of them are early-stage companies with interesting technology but perhaps not a lot of customers or revenue. Rather than a business being acquired, it is the ideas, intellectual capital and, as important, the people that are being purchased. Many acquisitions are fuelled by the need to add strong talent to jump-start the growth of a business or service. Zynga, for example, was looking to boost its mobile development capabilities so buying Five Mobile was a quick way to do it.

    The problems with many of these deals are two-fold:

    1. Many start-ups are snapped up before they get a chance to gain real traction and evolve into small or medium-size businesses that employ dozens or hundreds of employees. It means the loss of an opportunity to build a high-tech community that features a “middle-class” between start-ups and large players (most of them U.S.-owned) such as Microsoft and IBM. In an ideal world, some of these start-ups would grow into an Open Text or, heck, a RIM.
    2. Many of these deals involve some or all of the start-ups’ employees moving out of Canada. PostRank’s employees, for example, moved to the Mountain View, CA. after the Waterloo-based company was acquired by Google. It’s an M&A-driven brain drain when the best and bright entrepreneurs, developers, etc. get sucked south of the border. Granted, many of them will likely return to Canada with more experience and some dollars in their jeans but, in the short-term, it’s a loss for Canada’s high-tech and start-up community.

    I recognize that, in the scheme of things, these are nice “problems” to have. After all, it is better that start-ups are being acquired and investors rewarded as opposed to no M&A activity, which afflicted the start-up landscape for far too long. My point is it is also important to recognize there is a downside, even though it is something we can happily accept.

  • Quota is not a dirty word

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    “We are ALL in sales” – Dale Carnegie

    I used to think that quota was a dirty word. It struck me as restricting freedom and potentially forced the exploitation of trusted customers and prospects to drive the bottom line results. But I was wrong. In reality, a quota is a number that is useful to incent certain behaviours. The trick is to incent the appropriate behaviours. It is a contract between a sales person and an organization about how to compensate behaviours based on outcomes.

    “Quota is a direct path to clarity and accountability.” – Shawn Yeager

    So many entrepreneurs can benefit from contracts with defined outcomes. I was chatting with a startup last week about the numbers he agreed to with his VC to unlock the next tranche of funding. He mentioned that he wasn’t going to meet the numbers, but he still expected the VC to unlock the funding. My advice to him was very straight forward, it was to figure out how to achieve the agreed to numbers, or immediately open a conversation with the VC about missing the numbers due to changing market conditions and see if the tranche can be renegotiated. In the case of this entrepreneur, the numbers were in the funding contract, and I fully expected the VC to hold the entrepreneur to deliver on these numbers. The numbers and metrics exist to help assess the risk and the ability of an entrepreneur to deliver.

    The secret with an early stage company is to set appropriate metrics, quotas and growth numbers that incent the correct behaviours out of entrepreneurs. The good news is that there are a lot of examples of SaaS, B2B and consumer metrics that can be used.

    There are a lot of different sources of metrics and numbers. Each of the numbers needs to be considered in corporate revenue goals, past historical performance, current product development stage, market share, budget, etc. The targets and growth numbers need to be established.

    I’ve taken to requiring all of the startups I mentor, to establish 3 metrics that we discuss in our mentorship meetings. Each of the metrics must be clear enough for me to understand, for example:

    • Number of paying customers
    • Number of registered users
    • Churn rate
    • Number of pageviews or unique visitors

    And each metric should have the current measurement, the predicted growth rate and the actual target number. I try to start each conversation around the metrics. And any issues related to the market conditions, learnings, corrections, etc. Then together we set the targets as part of the planning for the next meeting. This may include a redefinition of the metrics. The trick for me as a mentor is to try to help identify what metrics I think are most useful for the startup and founder to focus on next.

    What are the metrics other entrepreneurs track? How do you set your targets and quotas?

    What are the metrics and growth rates that investors like ExtremeVP, Real Ventures, iNovia Capital, GrowthWorks, Rho and others want to see from prospective early-stage companies?

  • Startup Offspring

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    We’ve been focusing a lot on exits recently. Some folks have asked “why celebrate”? So many are $30-$50mm exits, who cares? $30-$50mm exits = VCs dying = ecosystem dying… or so goes the logic.

    Let me tell the story of Redknee. Redknee creates billing software for telecos. Started in the late 90s by 4 mid-20s, Waterloo grads who had worked at Telus & Nortel – Lucas Skoczkowski, Vishal Kothari, Dan Macdonald, and Rubens Rahim. Without taking any VC money, they IPO’d in 2007, raised something like $30-40mm out of the IPO, and now have a market cap of about $70mm. I.e. modest success, not great success.

    Here is the list of who is where now from the early days at Redknee:

    • Shailesh Lakhani – was director of operations, now VP at Sequoia India
    • Shyam Sheth – product manager, then product manager at Google, now co-founder of Fixmo
    • Tony Mak – was a sales engineer, moved on to VC side at OATV, now founder of Everpic (SF-based startup)
    • Kristin McClement – was product management, now heads up product and super early employee at Payfone (hot New York startup)
    • Bohdan Zabawskyj – was CTO, now CTO of a hot Toronto startup that I think I can’t name yet, and also advisor & investor to several other startups
    • Jeff Zakrezewski – was a dev team lead, then was managing partner at 5-Mobile (acquired by Zynga), now Chief Architect Zynga Toronto
    • Brian Glick – was a product manager, early guy and now lead product manager at YouTube
    • Dalia Asterbadi – was marketing, now founder of RealSociable
    • Jason Tham, Jason Yuen, Sean Kirby – product & development, now founding team at Nulogy
    • Karthik Ramakrishnan – was a product manager & sales engineer, now heads up product at BluTrumpet and at HatchLabs/IAC/Xtreme

    So let’s tally that up – 1 modestly successful startup equals roughly 6 new companies founded and 2 new startup investors and some other people in influential places. I am forgetting people as well.

    Success begats success. Probably more than money begats success. And that is why we need to celebrate even the modest victories.

  • Did we hit a billion?

    Dr. Evil "One Billion Dollars"Today IBM just announced the $387MM acquisition of Toronto-based Algorithmics. It begs a couple of open questions. Is Algorithmics after being sold to Fitch for $174MM in 2004 still a Canadian startup? Can a 30 year old company like MKS be considered a startup? Is Eloqua who’s HQ moved to Virginia still a Canadian company?

    If you imagine that Algorithmics is the second Canadian software startup acquired for more than $300MM in the past 6 months. Then to answer Dan Morel’s question,  if this was “The One Billion Dollar Year” for Canadian startup acquisitions, yes it is.  Only if you consider Algorithmics still a Canadian startup and 30 year old MKS a startup, then combined with Radian6 the acquisitions total just over $1B, everything else is icing on the proverbial cake.

    Congratulations to the Algorithmics team and alumni.

    Adding to the TechVibes list of Canadian Acquisitions:

    1/5/2011 – Victoria’s Flock acquired by Zynga

    1/6/2011 – Edmonton’s Attassa acquired by YouSendIt

    1/31/2011 – Toronto’s Adenyo acquired by Motricity for $100 Million

    2/8/2011 – Toronto’s MyThum acquired by OLSON

    3/3/2011 – Toronto’s CoverItLive acquired by Demand Media

    3/11/2011 – Vancouver’s Sayvee acquired by Bandzoogle

    3/26/2011 –  Waterloo’s Tiny Hippos acquired by RIM

    3/30/2011 – New Brunswick’s Radian6 acquired by Salesforce for $326 Million

    4/7/2011 – Waterloo’s MKS acquired by Parametric Technology for $292 Million

    4/8/2011 – Toronto’s PushLife acquired by Google for $25 Million

    4/27/2011 – Montreal’s Tungle acquired by RIM

    4/28/2011 – Montreal’s Coradiant acquired by BMC

    5/10/2011 – Toronto’s Conversition acquired by e-Rewards

    6/3/2011 – Waterloo’s PostRank acquired by Google

    6/7/2011 – Toronto’s DealFrenzy acquired by Intertainment Media

    7/8/2011 – Toronto’s FiveMobile acquired by Zynga

    8/30/2011 – Vancouver’s Zite acquired by CNN for an estimated $25MM

    9/1/2011 – Toronto’s Algorithmics acquired by IBM for $387MM

     

  • Lean Startup Tools

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    Back in May, Nat Friedman wrote about the tools used in setting up Xamarin. They include a great set of basic tools for getting a startup off the ground with very little investment. We have seen a lot of startups using a similar set of tools and I thought that we’d compile a list of the tools that we’re actively using (and some of the others we evaluated). There are the tools and blogs listed by Steve Blank that include many

    Landing Pages

    We’re big fans of WordPress at StartupNorth. We’ve powered StartupNorth on WP since the beginning. The combination of WordPress, Premise, and the WordPress MU Domain Mapping plugin is a pretty powerful combination for creating mutliple sites and landing pages to test your landing pages. But we’ve also developed a sweet spot for Vancouver’s Unbounce, it took us less than 5 minutes to have 2 landing pages and a domain set up. We’re big believers that you can use Adwords and Facebook Ads to quickly create a landing page to test ideas before writing a single line of code.

    Analytics

    We primarily use Google Analytics and WordPress Stats for StartupNorth. We’ve been working with startups and using a KISSmetrics and Mixpanel to measure activity on their web properties and applications. Make sure you read Ash Maurya’s 3 Rules to Actionable Metrics to understand how the analytics can be used in combination with split testing and/or cohort analysis to better track your optimization before product/market fit (What do you measure before product/market fit? – check out Ash’s conversion funnel and metrics).

    Mailing Lists

    We haven’t been as proactive in building a mailing list for the StartupNorth community as we probably should have been. I’ve used have started using MailChimp because of the quick integration to GravityForms and WooFoo, but have had very positive experiences using both Campaign Monitor and Constant Contact.

    Billing and Accounting

    What is amazing is that both of these companies are local to Toronto. We use WaveAccounting integrated with our bank account and PayPal for tracking expenses, billing, and financial operations. And we use Freshbooks to bill for sponsorships. They are a must have in our back office. What we’re missing is a really easy to use and integrated payroll system (I hear that it might be coming).

    Human Resources

    For full disclosure, I’m an advisor to TribeHR. It doesn’t change the fact that they rock. It is the easiest way to get an HR system in place. And there is no better way to get feedback and help employees improve than Rypple.

    Surveys and Feedback

    We are actively using Survey.IO to gather feedback from users about the state of StartupNorth. It helps us figure out the state of our product market-fit, if there is such a thing for a blog about Canadian startups, fill it out and help us be better.

    Project Tracking

    We use Pivotal Tracker. We like them so much, we actively recruited them as a sponsor for StartupNorth. There are lots of other tools from project tools to issue tracking. Curious at what others are using.

    Source Control

    We use Github Bronze for our project hosting. Most of the code we work on is PHP against MySQL (see WordPress), though we have additional apps in development like the StartupNorth Index (which will be moving to startupnorth.ca/index shortly) but all are LAMP.

    Hosting

    Full disclosure: VMFarms is a sponsor of StartupNorth. However, their hosted VMs that are backed up and hot mirrored coupled with the outrageous “white glove” makes them a dead simple choice. We also use Rackspace Startups and EC2 for access to easy Linux and Windows VMs for development and testing environments.

    Customer Relationship Management

    We don’t have any strong recommendations. There are platforms like Salesforce that are fantastic and sales teams are used to. There is Highrise which is broadly supported with a lot of 3rd party tools. But so far, neither of these has been the clear winner for us. There is a great Quora question about “What is the best CRM for startups” that lists SFDC, SugarCRM and Highrise. There are a lot of choices for CRM including Nimble, Insightly, Woosabi, Capsule, Solve360,AppPlane, Batchbook, PipelineDeals, TactileCRM, ZohoCRM and many others.

    Conferencing, Screen Sharing & Telecommunications

    I’ve been using Calliflower for conference calling. It’s $5/call for up-to 5 callers, or for $30/month unlimited minutes and >70 participants, it’s a great solution. It is not a replacement for a office phone system.

    Google Voice and Skype have been the least expensive way as a Canadian startup to get a US phone number. This is great for me as an individual. However, this does not scale to an enterprise or an organization. I’ve been looking at Grasshopper, RingCentral and Toktumi, but I have yet to settle on a solution.

    SEO & SEM Tools

    This part of the list is pretty much cribbed from Steve Blank’s list of tools for entrepreneurs. Go read it for a more comprehensive list of tools beyond the SEO/SEM listing included below.

    What are we missing?

    I’m going to cover in the next post: discounted travel, conferences, business cards, design services, and other tricks for being relentless resourceful as a founder.

    There are a lot of online tools that startups are using to make or break their business. And there is a lot missing, monitoring like NewRelic, PagerDuty, Pingdom and Blame Stella for example. But I’m curious what are the indispensable tools being used at iStopOver.com, HighScoreHouse, CommunityLend, Idee/Tineye, Massive Damage, Empire Avenue, Indochino, Lymbix, Hootsuite, AdParlor, Locationary, Chango and others. What are you using? What gives you the edge in quickly and effectively gathering feedback to test your hypotheses?

  • The Mentor Manifesto by David Cohen

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    I am continually amazed at the horror stories I hear from entrepreneurs about finding mentors. About mentors taking large pieces of the company and not providing any value in return. It was great to see David Cohen’s The Mentor Manifesto this morning. It is great to see David take the time from his 11 cohorts at TechStars and try to explain “What does it mean to be a great mentor?”. This is an extension of his tips for entrepreneurs that includes how to Find and Engage Great Mentors as part of his top twelve startup tips.

    The Mentor Manifesto

    • Be socratic.
    • Expect nothing in return (you’ll be delighted with what you do get back).
    • Be authentic / practice what you preach.
    • Be direct. Tell the truth, however hard.
    • Listen too.
    • The best mentor relationships eventually become two-way.
    • Be responsive.
    • Adopt at least one company every single year. Experience counts.
    • Clearly separate opinion from fact.
    • Hold information in confidence.
    • Clearly commit to mentor or do not. Either is fine.
    • Know what you don’t know. Say I don’t know when you don’t know. “I don’t know” is preferable to bravado.
    • Guide, don’t control. Teams must make their own decisions. Guide but never tell them what to do. Understand that it’s their company, not yours.
    • Accept and communicate with other mentors that get involved.
    • Be optimistic.
    • Provide specific actionable advice, don’t be vague.
    • Be challenging/robust but never destructive.
    • Have empathy. Remember that startups are hard.

    I hope that I can live up to the manifesto for the companies I mentor at UW VeloCity, FounderFuel and those I’ve been working with in Toronto and Waterloo.

  • Trying to understand incubator math

    Editor’s note: This is a guest post by Jesse Rodgers who is currently the Director of Student Innovation at the University of Waterloo responsible for the VeloCity Residence & he is also the cofounder of TribeHR. Jesse specializes in product design, web application development and emerging web technologies in higher education. He has been a key member of the Waterloo startup community hosting StartupCampWaterloo and other events to bring together and engage local entrepreneurs. Follow him on Twitter @jrodgers or WhoYouCallingAJesse.com.

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    Incubators are not a new addition to the financing and support for startups and entrepreneurs. On the surface, incubators and accelerators seem like a low cost way for VCs and government support organizations to cluster entrepreneurs and determine the top-notch talent out the accepted cohort. The opportunity to investing in real estate and services that enable companies where the winners are chosen by the merits of the businesses being built. It feels like a straight-forward, relatively safe bet to ensure a crop of companies that are set to require additional growth capital where part of the products and personalities have been derisked through process.

    However, its not as simple as putting small amounts of investment into a high potential company. An incubator is a business and it’s sole purpose should be to make money.

    What are the basics of an incubator?

    The basic variables in setting up an incubator business are:

    • Cost of the expertise, facilities, services and other overhead
    • Amount of $ to be invested/deployed
    • Number of startups
    • Equity being given in exchange for cash
    • Return on the total investment

    There are cost of operations: real estate, connectivity, marketing, programs and services for the entrepreneurs, and the salaries of the individuals to find the startups, provide the services and build successes. These costs are often covered by governments, in exchange for the impact in job creation and taxation base. We’ve seen a rise in incubators that are funded on an investment thesis, where an individual or a set of “limited partners” provide the initial investment in exchange for an investment in the companies being incubated.

    How much do incubators cost?

    The goal is to efficiently deploy capital to produce successful investments. I’m going to explore how incubators make money by making a few assumptions based on the incubator/accelerator models we’ve seen in Toronto, Montreal, Palo Alto and New York.

    Basic assumptions:

    • Capital Investments: 10 startups x 20k = 200k invested with an assumed ‘post-money valuation’ of $2.2MM
      • This means you now own 9.1% in 10 startups each with a post-money valuation of $220k
    • Support Costs: 10 startups x $10k = $100k
      • This is the cost of real estate, furniture, telecommunications, internet connectivity, etc.

    Alright, we’re planning to deploy $200k and it need to provide approximately $100k in services just to provide the basics for the startups. We’ve spent $300k for the first cohort and and that is before you pay any salaries, host an event, etc.

    Additional costs:

    • People:
      • $100k per year salary for one person to rule them all. Call them executive director or dean or something.
      • Assuming you’re not doing this to deploy your own capital, the person or people in charge probably need to collect a salary to pay their mortgages, food, etc.
    • Events – Following the model set forth by YCombinator or TechStars we have 2 main types of events. Mentoring events where the cohort is exposed to the mentors and other industry luminaries to help them make connections and learn from the experience of others. The other event is a Demo Day, designed to bring outside investors and press together to drive investment and attention in the current cohort, plus attract the next cohort of startups.
      • Mentoring event: $1k for food costs with 25 founders
      • Demo Day: approximately $5k
      • Assumption: 10 mentoring events plus a demo day per cohort adds $40k.

    The estimated costs are approximately $340,000/cohort. Assuming 2 cohorts/year plus the staffing salary costs, an incubator is looking at $780,000 that includes 40 investments and a total of $4.4MM post-money valuation. If we assume that I’m a little off on the total capital outlay, and we build in a 30% margin of error this brings the annual budget to appromimately $1MM/year to operate.

    How do incubators make money?

    Incubators make money when the startups they take an equity stake in get big and successful. The best exits for an incubator come when one of their startups is acquired. Why acquired? Because the path to getting acquired path is shorter than the path to going public which would also allow the incubator to divest of their investment.

    Let’s do the math. If your running an incubator hoping to get respectable returns on the $1,000,000 you’ve laid out above, let’s say it’s not the mythical 10 bagger but a more conservative 3x, the incubator needs one of the companies to exit at near $30,000,000. It can be one at $30MM or any combination smaller than that totalling $30MM. This needs to happen before any dilution and follow-on funding for your cadre of companies. You have to assuming that they can make it to acquisition on the $10,000 and services you’ve provided. For more on incubator math, check out there’s an incubator bubble and it will pop.

    The bad news is that it isn’t as simple as that. Startups are not just something that exist in a vacum. There are a lot of unknown variables that can make or break an incubator.

    • percentage of startups that fail (or turn into zombies) in the first two years after investment
    • time frame return is expected
    • how many startups currently produce that kind of return annually
    • total number of startups that receive investment in any given year
    • total number of acquisitions in any given year
    • avg. number of years a startup takes to get to acquisition (because they aren’t going public)
    • avg. price a startup sells for (I bet those talent acquisitions drag the average way down)
    • what do VC’s currently spend on their deal pipeline?

    It is the unknowns that are where the gamble exists. You can tweak the numbers all you would like but assume startups have a no better fail rate then any small business. The common thinking on that is 25% of businesses fail in the first year, 70% in the  first five years? If just more than half of those companies are alive in one year you are doing well. If one out of those 20 is acquired in 5 years and you get 3x return do you succeed? Do you have to run the incubator for the 5 years at $1MM/year to be able to play the odds?

    Maybe this is why so many incubators focus on office space, it’s easy to show LPs what they are getting for their $5MM for 5 year investment, plus an impressive number of “new” startups that have been touched by the program (often without an exit, you know the way incubators make money).

    What am I missing?

    Editor’s note: This is a guest post by Jesse Rodgers who is currently the Director of Student Innovation at the University of Waterloo responsible for the VeloCity Residence & he is also the cofounder of TribeHR. Jesse specializes in product design, web application development and emerging web technologies in higher education. He has been a key member of the Waterloo startup community hosting StartupCampWaterloo and other events to bring together and engage local entrepreneurs. Follow him on Twitter @jrodgers or WhoYouCallingAJesse.com.