Trying to understand incubator math

Trying to understand incubator math(startupnorth.ca)

41 points by jrodgers 14 years ago | 13 comments

pg 14 years ago |

As in startup investing generally, the expected value comes mainly from a small chance of a big hit, multiplied by lots of investments. You're hoping that if you invest in 100 startups, one will be a Dropbox or Airbnb.

For this to work, you have to (a) invest in a lot of startups and (b) they have to be drawn from a pool that could include big winners.

The latter could actually be a problem, if you're not founders' first choice. If you lose the big winners, your returns might be orders of magnitude smaller, even if you get everyone else.

Yes, you do have to invest for years before you end up in the black, even if things go well. That's also true for startup investing generally.

When we started YC, the returns seemed completely unpredictable. (They still do actually.) What allowed us to do it was that we didn't care if we made money.

jrodgers 14 years ago | |

My thought on why that works for YC is that you are an educator. This thought is influenced not by your credentials but by students that I have known go into YC and what they seem to get out of it from an observers point of view. I don't think it should be about making money... it should be about education first, it would be nice if it at least covered everyone's costs (plus a little bit).

A post on higher ed and incubators is what lead me down the incubator math question... I just need to finish up the original post.

pedalpete 14 years ago | |

Though the big hit makes the major returns, doesn't the one small hit per session cover the operating expenses? (Reddit, Zenter, 280North, etc. etc.)

I think this is what the original post might be missing. The top incubator(s) can patiently wait for the big hits, as long as they've got 1-in-20(ish) small hits to keep them in the black.

pg 14 years ago | | |

You can't count on that, because acquisitions are so unpredictable. In bad times they dry up entirely. YC was not in the black till December 2010, more than 5 years after we started.

JacobAldridge 14 years ago |

"it’s sole purpose should be to make money."

Wrong use of "it's". Wrong application of "sole".

Why would an incubator, or any business, only have a "sole" purpose? Certainly, it makes sense for them to have a purpose that is "to make money", but what requires that to be its sole purpose?

If a client every came to me and declared their sole purpose in business was "to make money" I would 1) not take them on as a client, but not before 2) strongly suggesting that there is something far deeper than money which needs to drive them and their business if they're to make that money. Maybe their underlying reason is still personal, like being able to holiday 11 months a year or have enough money to send their kids to a better school than they went to. Maybe their other purposes include changing peoples' lives or delivering health initiatives into a third world country. Both benefit enormously from a sustainable, profitable company. And it's a lot easier to recruit motivated staff, build clients, gain media attention etc when your authentic reason is more than money.

Trying to solely make money is like running a business solely to not make money - makes no sense, and I've not seen anything in incubators that indicates they're any different.

herTTTz 14 years ago | |

He does it a lot, even the other way around:

"However, its not as simple as putting small amounts [...]"

it's

akkartik 14 years ago | |

Also:

"If your running an incubator.."

Wrong use of 'your'.

JacobAldridge 14 years ago | | |

Possibly missing my main point, so I must refrain from nitpicking, especially when I'm making a more significant point.

nazgulnarsil 14 years ago |

what are you missing? the fact that the vast majority of your return will come from just one or two major exits after funding 50+ companies.

mathattack 14 years ago |

It certainly makes ycombinator's performance seem all the more impressive.

What is left out of the equation is the opportunity cost of Angel/VC time. And benefit too. The caliber of advice and strength of networking has a huge impact on fund performance. This comes at a large opportunity cost, as advisor time and attention could be deployed elsewhere. I believe this opportunity cost is higher than tangible dollars. Te benefit certainly is.

gallerytungsten 14 years ago |

re: "An incubator is a business and it’s sole purpose should be to make money."

Not necessarily. Some incubators are government organizations or non-profits, with the goal of improving the local economy.