AngelList, an online platform that matches high potential startups with investors and employees currently indicates that 578 accelerators are in operation, up from one in 2005. Why the enormous increase in the number of accelerators in the United States over the past decade?
What’s Behind the Growing Number of Business Accelerators in the U.S.?
Accelerators — organizations that provide early stage companies with mentoring, capital and access to investors in return for an equity investment — are an organizational innovation. They provide a better way to manage the financing of high potential early stage businesses than previous alternatives.
This innovation solves several problems with the process of investing in early stage companies. First, business accelerators facilitate investor diversification. Many investors want to put smaller amounts of money in a large number of companies. However, many investors do not have the means to identify and evaluate potential investments in a large number of small start-ups. By investing in accelerator funds, which, in turn, own shares in the startup companies themselves, early stage investors can invest in a wide variety of early stage companies at relatively low cost.
Accelerators also make it possible to structure investments in startup companies as real options. Real options provide the right, but not the obligation, to make future investments. Because no one knows ahead of time which start-up companies will succeed and which will fail, investors would like to make small investments in many companies to see how they develop. For those whose future seems most promising, the investors would like to have the right, but not the obligation, to make additional investments. Accelerators provide that opportunity to early stage investors.
Accelerators make it easier and cheaper for investors to identify businesses in a wide variety of locations. Because business accelerators accept applications from companies from anywhere who then relocate to the accelerator for a few months, accelerators provide their limited partners with the opportunity to find promising companies in places where they do not have a network of contacts.
These organizations also make it easier for investors to learn about companies. Accelerators provide the opportunity for early stage investors to meet with and talk to the founders of the early stage companies that join their organizations. They also allow their investors to serve as mentors to the accelerator’s portfolio companies. By serving as startup company mentors, investors can gather hard-to-get, fine-grained, information about which startup businesses have the greatest potential and so are worthy of further investment.
Accelerators help young companies develop faster. Accelerator directors are experts at working through the problems that companies face in their early stages. Entrepreneurs are co-located with the accelerator directors. Together these two attributes mean that companies in accelerators can get more and better assistance overcoming the problems that early stage companies face than companies outside of accelerators are able to obtain.
The accelerator structure breeds both collaboration and friendly competition among start-up companies. Both of these forces accelerate the development of young companies, which benefits the investors who have put money into those businesses.
In short, accelerators are an organizational innovation that improves the start-up financing process. As a result, they are likely to be a lasting addition to the world of early stage venture finance, much like the development of venture capital funds were several decades ago.
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