Incubators Should Force Their Startups to Get Paying Customers

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(originally titled, "Forcing Incubator Companies to Get Paying Customers"...changed the title because it bugged me that it was unclear --DS)

I had the pleasure of helping out at the Stanford d.school's Launchpad class this last quarter. It was a graduate level class which was the first incubator class offered by the design school (a.k.a. d.school) whereas the "b school" (business school) and the "e school" (engineering school) both already had entrepreneurship classes involving creating new businesses.

The class was taught by Perry Klebahn, a classmate of mine from when I was in the product design master's program way back when, and Michael Dearing of Harrison Metal, an early stage venture fund. They interviewed about 60 applicants and accepted 12 into the class. The goal of this class was to teach entrepreneurship from the design school's perspective, and their major objective was to sign up paying customers by the end of the class in 10 weeks. Those that did were reported to get an instant A in the class!

Those entering the class mostly started from nothing. So imagine the pressure to develop an idea into a business model and a product that was good enough for customers to want to pay for in as little as 10 weeks!

Certainly Ycombinator drives its companies pretty hard over the 10 weeks or so during the time they are in the program. Every other incubator program does similarly to its crop of startups.

But they have a slightly different goal than what the Stanford Launchpad class had. There was no requirement that their startups develop a product AND get paying customers; the only objective was only to launch, and hopefully convincingly enough to raise a round of cash to keep going. There was no emphasis on racing to a proven business model in the allotted time.

I find this very compelling in this day of economic crises, and as an angel investor trying to find great companies to fund.

Too many startups come into being with no concept of a business model; they aim to get users and drive towards that and hope that a business model falls into their lap along the way. The problem with this approach is that, at early stage, you don't have enough runway to try a few things and see what can work. You are extremely time constrained given your bank account and you have to race to making revenue as soon as possible.

Granted, this could have worked pre-economic crisis. Many startups were raising their second rounds on the promise of a business model and a strong user base. Sadly, those days are gone; without revenue, it would be extremely hard to get another round today. Investors just think that either you and/or your idea have failed.

As an early stage angel investor, I invest in the riskiest time in a startup's life. After having seen a lot of my companies trying to employ the "race for users" model and then failing to raise more money, or not raising enough initially, I really like the fact that someone is forcing startups to find customers who will pay for their product or service. This at least proves that there is some validity to whatever business model they are pursuing and increases their survivability with incoming revenue.

How would this be implemented with an incubator program? I think there is one big hiccup which I have not completely solved, or more accurately, is solved only in the context of university setting. This is the reward for being successful in the task of finding paying customers.

For a class of students, their reward is only at the end of class when they successfully find paying customers: they get their A.

For an incubator program which typically invests a small sum of money for a small piece of the company, a big portion of the reward has already been given. How would we incent them to go for a lofty goal of finding paying customers if they already have their reward in hand?

Some ideas:

1. You give them the initial money and let them run. Then you commit to investing a second chunk only in your startups who find paying customers after the time period.

2. You could set loose the entrepreneur teams without funding for 10 weeks and then only fund those at the end who find paying customers. In many ways this parallels what happened in the Launchpad class with students.

3. You could give them their initial money and then only allow those who find paying customers to present to investors at the end. Those who failed are cut loose and left to fend for themselves.

Are there other ideas?

I would love to see some of the incubator programs incorporate this into their graduation criteria. I think it would strengthen the quality of the exiting startups immensely.

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This page contains a single entry by DShen published on June 5, 2010 5:13 PM.

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