Many investors think acceleration programs are cute. Playgrounds where inexperienced and hopeful founders go to learn basic stuff. And where real successful people generously share stories to “pay it forward”. Like charity for young people. Those investors are mistaken. Not always. But the ignorant consensus can cause some investors to overlook what can be the most effective and best performing vehicle for startup investing. This post will explain why insider trading is illegal and how that makes quality Accelerators a must for investors. In the end, you will know how to evaluate Accelerators, and management teams will gain inspiration.
In 1934 the rules of the game changed. In the ensuing years, hundreds of people would be jailed. Among them a beloved housewife and self-made celebrity named Martha Stewart.
The US Congress witnessed how certain investors benefited immensely from possessing unique information about publicly traded companies. Because these investors knew something others didn’t, they could make timely and informed decisions. Economists call it asymmetric information. The public called it unfair.
In response, the US Congress passed the Securities Exchange Act in 1934 making it illegal to trade securities on asymmetric information. Today, we know it as “insider trading”.
In 2001, Martha Stewart learned the value of asymmetric information. The celebrity housewife owned stocks in a company called ImClone Systems but her stockbroker knew something other people didn’t. He knew that ImClone Systems would receive a rejection of their new cancer drug. He urged Martha to sell immediately. She did and avoided a loss of about 200,000 dollars. To her horror, it would also cost her five months in prison.
Asymmetric information in startup investing
The rules surrounding publicly traded securities do not apply to startups. And because asymmetric information is generally the most valuable element in investing, startup investors are furiously seeking to obtain it. To this end, most Venture Capitalists require startups to sign ‘exclusive term sheets’, meaning that only they get to due diligence the company for a period of time. The VC wants to know something other investors don’t.
The problem with asymmetric information is that it’s hard to obtain. That is because it’s sticky. The information resides within a few key individuals and is often non-codified. If it wasn’t, the information would diffuse and thus become symmetric. In other words, everyone would know it.
Sticky information must be extracted and the process of extraction takes time and effort. The individuals holding the information must trust the entity that wants to extract it. Simply put, the startup founders must trust the investor before they share what they know.
Furthermore, sticky information tends to be unstructured. Maybe a startup founder recently got the impression that most of the customers will upgrade their subscription next year because of a new feature. This information is not just important but is also unstructured. To obtain this information the investor must spend time with the founder asking random questions until the topic might come up. Needless to say, this is expensive at scale.
How great Accelerators extract asymmetric information at scale
Interestingly, an acceleration program can be regarded as an institutionalized and methodical system for extracting information. And a well-run accelerator does this at scale.
Quality programs have lengthy and deep relations with hundreds of startups per year. During the program, the startups and the Accelerator enter into a mutually beneficial exchange. The Accelerator provides value in form of content, help, and resources. In exchange, the Startup provides information, such as in the application forms, office hours and workshops etc. Much of this information is asymmetric and can be called ‘Insight’.
Great Accelerators understand the value of Insight. And they design their program to obtain it. Less sophisticated programs will not.
To obtain Insight, the Accelerator must do two things. First, establish trust between the founders and the Accelerator. Second, provide content, help, and resources of high perceived value. If the founders trust the Accelerator AND believe the program will be valuable to them, the founders will be willing to provide Insight in exchange for benefiting from the Value of the program.
How Accelerators develop trust
Trust is an outcome of earlier beneficial interactions between the parties. If two people have engaged in numerous trades in the past and both parties feel they benefited from those exchanges, they most likely trust each other.
The speed at which trust develops seems to be a function of multiple factors. Such as the number of interactions, the depth of the interactions, and the environment the interactions take place in. This equation of Trust is depicted in the table below:
Fig 1: The equation of Trust. (Completely non-science based)
According to the equation above, Trust develops quickly if the parties have many rich interactions in unfamiliar environments. And that is exactly what marks great Accelerators. Many programs start with an intense kick off period. The founders fly in and spend long days in workshops, mentor sessions, and social activities. The result is trust, at scale.
How great Accelerators obtain insight
Data is the ingredient of Insight. Not all data is Insight, but all Insight is data. Because data and Insight can be hard to distinguish, the way to obtain Insight is simply to obtain large amounts of data. Consequently, the best Accelerators collect data at every possible instance.
In order to obtain data, the Accelerator must solve the biggest problem with data collection. The problem is that data collection often incurs significant costs on the side of the startup. This is because the data is rarely readily available.
Often, the founders must spend time and energy to clean and codify the data before it can be provided. An example would be a lengthy survey. Not only must the founders spend time and opportunity costs answering the questions, but must also look through documents, search for old e-mails, and make calculations to answer the questions. The cost of a lengthy survey can easily seem insurmountable to a startup founder.
That is why the best Accelerators are solving this problem in two ways.
One, they provide Value of such a high quality that it offsets the costs of the “intrusive” data collection. This enables the Accelerator to obtain insight through conversation, surveys, and participation in customer meetings etc.
Two, they implement systems that collect data non-intrusively. Like tracking the attendance rate of the founders, their KPI reporting, and development in team composition, etc.
The collection of data at scale is making great Accelerators the most knowledgeable entities for startup Insight. Period. No other entities have had deep trust-based interaction with thousands of startups over extended periods of time. While collecting valuable data.
If done right, an acceleration program is simply the most efficient system for obtaining Insight into a large number of startups. And for investors, the best programs represent a golden opportunity to benefit from true asymmetric information. Wall Street would be envious.