This document discusses incubator 2.0 and lessons learned from previous incubators. It summarizes that incubators should focus on making many small investments and expecting a high failure rate (60-80%). Successful incubators provide mentoring support and focus on getting startups to build functional prototypes, test customer usage, and quickly iterate based on feedback. The goal is to identify the top 20% of startups that show traction after 6-12 months and double down the investment in those companies.

1. Incubator 2.0
Let’s Hope This Time We Don’t Suck.
Dave McClure
http://500.co
(@DaveMcClure)
Mountain View, January 2013
http://slideshare.net/dmc500hats

2. Dave McClure
Founding Partner & Troublemaker, 500 Startups
00’s & 10’s:
• Investor: Founders Fund, Facebook fbFund, 500 Startups
• Companies: Mint.com, SlideShare, Twilio, WildFire, SendGrid
• Marketing: PayPal, Simply Hired, Mint.com, O’Reilly
80’s & 90’s:
• Entrepreneur: Founder/CEO Aslan Computing (acq’d)
• Developer: Windows / SQL DB consultant (Intel, MSFT)
• Engineer: Johns Hopkins‘88, BS Eng / Applied Math

3. 500 Startups
Global Seed Fund & Startup Accelerator
• What is 500?
– $50M+ under management
– 20 people / 10 investing partners
– Silicon Valley HQ + Incubator
– SF, NY, MEX, BRZ, IND, CHN, SE Asia
– 800+ Founders / 200+ Mentors
– 20+ confs/events per year
– Focus: Design, Data, Distribution
• 400+ Portfolio Co’s / 30+ Countries
– Wildfire (acq GOOG, $350M)
– Twilio
– SendGrid
– TaskRabbit
– MakerBot
– 9GAG
– Viki

4. 70%
Capital
4
Quantitative Investing before Traction
250+ companies @ $50K avg. (1st check)
- Assume high failure rate (up to 80%)
Double-Down after Traction
50+ ‘winners’ @ $100K-$1M
(2nd + 3rd check)
- - Target 10+ exits @ $100M+
500 Strategy: “Lots of Little Bets”*
1) Make lots of little
bets pre-traction,
early-stage startups
30%
Capital
2) after 6-12 months, identify
top 20% performers and
double-down higher $$$
3) conservative model assumes
- 5-10% large exits @20X ($50-100M+)
- 10-20% small exits @5X ($5-50M)
*See Peter Sims book: “Little Bets”

5. 500 Startups: Global Seed Fund
startup investments in 30+ countries
• Q4/12 added: Germany, Korea, Peru; + Russia & Turkey in Q1/13
• Priorities In 2013: SE Asia, Middle East, Eastern Europe

6. Angel* List: It Rocks.
• Startups & Investors
• Activity & Metrics
• Platform & APIs
• *ps – not just for Angels, or USA

7. Early-Stage Risk Reduction
• 1st Mtg: Crazy, Idiots, Liars or Crooks?
• Product: does it work? (crappy, not perfect)
• Market: are people using it? (not their mom)
• Revenue: will people pay for it? (just a few)
• Growth: how will it/they scale? (online? offline?)
• Finance: what will it cost?
– Q1: cost to get a customer?
– Q2: how & when do you make money?

8. Early-Stage Startups:
Your “Due Diligence” Is An Illusion
(Better approach = write a quick, small check then wait ~6 mo’s)
• Problems in Early-Stage Due Diligence:
– You Might Be Able to Detect Idiots & Liars, but…
– Not much history, product, customers, or revenue (yet), so…
– You probably can’t figure out Winners (yet).
• The New Due Diligence = Incremental Achievements
– “Due Diligence”  Trusted Referrals + History
– “Great Team”  Functional Prototype + Usage
– “Size of Market”  Evidence = Customers, Revenue
• The Odds Are: They Suck, You’re Wrong
– You’ll Be Wrong 4x out of 5x. (If U Don’t Suck).
– In 6 Months, You’ll Know If They Don’t Suck.
– In 1-2 Years, You’ll Know If They’re Awesome.

9. Startup Incubators & Metrics
Lots of Little Bets. Most FAIL.
(but a few succeed :)

10. Incubator 2.0: Fast, Cheap, FAIL
• Incubators = supportive startup ecosystem (+ angels, VCs)
• Efficient use of investment capital ($0-100K)
• High fail rate (60-80%) => large initial sample size

11. Incubator 2.0:
Education, Collaboration, Iteration
• Success based on:
– MANY, small experiments
– common platforms, customers, problems & solutions
– physical proximity, open/collaborative environment
– Domain-specific mentors & expertise
– fast fail, iteration, metrics & feedback loop
• Incremental investment; high-risk, but high-reward

12. Education & Community
• Mentors, Investors
• Design, Data, Distribution
• Platform Partners
• Sponsors & Strategics
• Marketing & Visibility

13. Hacker, Hustler, Hipster
• Hacker: engineers & developers
• Hipster: design & UX
• Hustler: marketing & business
1. Build functional prototypes
2. Improve UX so people convert
3. Scale customer acq & distribution

14. Product, Market, Revenue
• Product: assess functional use, improve design/UX
• Market: test usage, distribution channels
• Revenue: test cust acq cost, revenue, *timing*
• Work on Pitch, Help Find Co-Investors, etc

15. Outlier Competition +
Modeling Success Behaviors
• You want min 3-5 “rockstars” to compete
• Rockstars to model success for others
• You can’t assume >20% rockstars
• Therefore, pick 5x5 = 25 teams
• 3-5 rockstar teams emerge, compete, win
• 5-10 *other* non-rockstars learn
• Identify losers quickly (but don’t be an ass)

16. Winners, Losers, Tweeners
• Winners #WIN (with or without you)
• Losers #LOSE (with or without you)
• Tweeners #TWEEN
– They might win with your help
– They might lose with your help
– Be helpful, but don’t dally
– Note: you might be wrong about the losers &
tweeners, so don’t be an arrogant a-hole.

17. fbFund REV
fbFund REV: Facebook “Social” Incubator: invest in startups, apps,
websites based on Facebook platform & Facebook Connect.
• 22 startups @ ~$35K each (< $1M total)
• 3 month program: Technology, Design, Marketing, Business topics
• Success: 8 startups raised $500K –> 5 Series A -> 3 Series B (+ 3 small exits)
• Wildfire Interactive acquired by GOOG for $350M (>50X) 

18. The Lean VC:
Lots of Little Bets, Incremental Investment
Method: Invest in lots of startups using incremental
investment, iterative development. Start with many
small experiments, filter out failures, and expand
investment in successes… (Rinse & Repeat).
• Incubator: $0-100K (“Build & Validate Product”)
• Seed: $100K-$1M (“Test & Grow Marketing Channels””)
• Venture: $1M-$10M (“Maximize Growth & Revenue”)

19. Investment Stage #1:
Product Validation + Customer Usage
• Structure
– 1-3 founders
– $25-$100K investment
– Incubator environment: multiple peers, mentors/advisors
• Test Functional Prototype / “Minimum Viable Product” (MVP):
– Prototype->Alpha, ~3-6 months
– Develop Minimal Critical Feature Set => Get to “It Works! Someone Uses It.”
– Improve Design & Usability, Setup Conversion Metrics
– Test Small-Scale Customer Adoption (10-1000 users)
• Demonstrate Concept, Reduce Product Risk, Test Functional Use
• Develop Metrics & Filter for Possible Future Investment

20. Investment Stage #2:
Market Validation + Revenue Testing
• Structure
– 2-10 person team
– $100K-$1M investment
– Syndicate of Angel Investors / Small VC Funds
• Improve Product, Expand Customers, Test Revenue:
– Alpha->Beta, ~6-12 months
– Scale Customer Adoption => “Many People Use It, & They Pay.”
– Test Marketing Campaigns, Customer Acquisition Channels + Cost
– Test Revenue Generation, Find Profitable Customer Segments
• Prove Solution/Benefit, Assess Market Size
• Test Channel Cost, Revenue Opportunity
• Determine Org Structure, Key Hires

21. Investment Stage #3:
Revenue Validation + Growth
• Structure
– 5-25 person team
– $1M-$10M investment
– Seed & Venture Investors
• Make Money (or Go Big), Get to Sustainability:
– Beta->Production, 12-24 months
– Revenue / Growth => “We Can Make (a lot of) Money!”
– Mktg Plan => Predictable Channels / Campaigns + Budget
– Scalability & Infrastructure, Customer Service & Operations
– Connect with Distribution Partners, Expand Growth
• Prove/Expand Market, Operationalize Business
• Future Milestones: Profitable/Sustainable, Exit Options

22. Thanks 
• Want more info? Go visit:
– http://500startups.com (our company)
– http://500hats.com (my blog)
– https://angel.co/500-startups-fund-ii (our fund)