Acceleration - Innosight Strategy & Innovation ConsultingThe next generation startup ecosystem holds important lessons for big companies seeking to drive transformational growth.

Over the past few years, the pace of innovation in Silicon Valley has quickened. It’s not just the pace of new products and services produced by the entrepreneurs; it’s also the pace of innovation occurring within the entrepreneurial ecosystem itself: the way that new startups are being formed, the way they are operating, and the way in which they are being funded. The changes to the system are triggered by the lessons learned by entrepreneurs and investors – and these insights have real value for big companies seeking to build their own innovation capabilities.

The concept of the internal corporate incubator has come in and out of favor over the past two decades. The idea of an internal hatchery for startups has been dismissed by some as a flawed concept, but it has also been embraced by others who believe that large companies can (and must) launch new ventures in order to drive sustainable and repeatable growth. Just in the past few weeks, we’ve seen the launch of Samsung’s Innovation Center in Palo Alto, the latest of many corporations to open such centers.

Innosight has helped many clients conceive, build and strengthen their own innovation acceleration capabilities over the past decade—clients ranging from Medtronic to Citi to Procter & Gamble to Syngenta to Turner Broadcasting.Managing partner Scott Anthony chronicled three recent big company startups in the recent HBR article, The New Corporate Garage– which outlined the enormous opportunity facing big companies as they enter the “4th era of innovation.” This is an era in which global giants can adopt and adapt many of the tools developed in the entrepreneurial world to strengthen their own ability to drive growth.

We see six trends that corporations would do well to harness while building their own “innovation accelerators.” These accelerators can take different forms; some are dedicated centers while other are focused sets of capabilities. What they all have in common is that they leverage corporate assets in service of speeding ideas to market.

1. The rise of entrepreneurial social networks

A decade ago, entrepreneurs mostly walked a solitary path, surrounded by people who couldn’t understand what they were trying to do and unable to empathize or offer support. While college campuses, such as Stanford’s in Palo Alto, created early startup communities, the benefits of physical and virtual co-location were unavailable to the majority of aspiring entrepreneurs.

The entrepreneur of today is far from isolated. Now, he or she is a part of a growing community of kindred spirits who connect across both the online and offline worlds to share knowledge, best practices and stories, as well as to meet potential employees and investors.

Companies such as Meetup allow entrepreneurs of all backgrounds and interests to network on a daily basis in hundreds of cities and get real-time feedback on their latest idea or prototype. Similar groups include “Co-Founders Wanted” or “Investor speed-dating” (both held in my neighborhood last week). The rise of co-working spaces in many cities further supports this trend. Companies like AngelList allow investors to follow hot startups—as regular citizens might follow a celebrity on Twitter.

The implication for corporate innovators is clear: you must ensure that your innovation accelerator is networked. Your innovators must be plugged in to their local physical entrepreneurial ecosystem as well as the global virtual entrepreneurial community. They must have the freedom to learn from their peers, both inside and outside the organization, which might require sharing lessons learned as much as they learn from the lessons of others. They must have the freedom to identify and recruit talent from their networks, and quickly experiment with and embrace or discard new processes and tools as they become available. Navigating the fine line between an existing corporate culture that often leans towards secrecy and efficiency and creating a culture of innovation where these behaviors are the norm will be a critical component of setting up your accelerator for success.

2. The rapid growth of angel and pre-seed investments

Small investments have become big. Sometimes referred to as angel-funding or micro-VC to reflect the push by many traditional venture capital firms into this space, these funding rounds break the lower barrier of the traditional Series A investment, placing more speculative bets with smaller amounts of capital (ranging from $20,000 to $1 million). Many firms now play heavily in this space, which includes accelerators such as YCombinator and Techstars and the hundreds of industry/geography-specific investors who have replicated their approach. New investors like 500startups and storied firms such as Charles River Ventures now have nearly five years of experience playing in this space.

This new market has been fuelled in part by the ability of entrepreneurs to “do more” with less. Ten years ago, Bain Capital conducted an analysis to determine the optimal amount of capital that should be invested to help take a software company to scale, and found that VC’s planned on investing around $15 million. With the advent of cloud-based offerings and many other solutions, a company can now achieve scale on an investment of less than $1 million. Early stage funding is also more about the team than the idea. A great team with a mediocre idea is more likely to succeed than a mediocre team with a great idea. Thus, the angel funding round represents an opportunity for investors to understand whether a team has “what it takes” to succeed, whether they understand their proposed customer, and whether they can they pivot towards a scalable business model worthy of a follow-on investment.

The implications for corporate accelerators are clear: These funding rounds should also be appropriately sized so as to force the team to be creative and careful with their capital. Large companies often throw too much capital at early stage ventures, which actually hinders the ability of a team to step into test and learn mode. Worse, that mistake makes it easier to scale a poorly-conceived solution prematurely – the fastest route to failure for most startups.

Similarly, seed-investments should be treated as a useful tool not just to test the validity of an idea, but to test the capability of a team. Corporate rules often make it hard to quickly identify talented resources or to rotate existing talent into new positions, but an experienced entrepreneur or even a new entrepreneur with the right training and instincts will be 10 times more effective than someone without the right skills or experience. Our experience suggests that the best corporate accelerators heavily invest in recruiting and are willing to throw away the corporate rulebook on best practices in order to seek and bring on the best and most suitable talent.

3. The standardization and simplification of term sheets

As investors have moved upstream in search of earlier stage and smaller investments, the number of companies in which they have invested has risen commensurately. Indeed, some accelerators, such as Dave McClure’s 500startups, have made more than 300 investments over the past couple of years.

This is made possible by streamlining the investing process and avoiding legal fees. Just ten years ago, it would have taken a legal degree and many hours to interpret the many pages of terms and conditions written into an investment agreement between an investor and startup. But over the past few years both investors and founders have aligned on simple, standardized and “founder-friendly” term sheets to allow investment discussion to focus on what truly matters—the valuation and the amount to be raised.

At the same time, seed investors have developed simple heuristics to allow them to make a high volume of decisions. While no one can claim they have the ideal set of metrics that allow them to predict future startup success, most investors anchor their decisions to a few key areas—such as the tenacity and creativity of the team and the identification of a significant unsolved problem, which if solved, would create real value.

In harnessing this trend, corporate accelerators should be careful to set up dedicated funding processes, in which seed-stage investments in innovative ideas are not treated as though they were just another investment in the annual budgeting or investments cycle, subject to the same rules and rigor as an incremental investment in an existing product. While it’s certainly important to ask a teamto provide their rationale for why they need funding, it is actually counterproductive to insist on revenue projections or NPV and ROI calculations, all of which are unknowns or even “cannot be knowns” at the time of a seed investment.

Any distraction from the process of searching for a scalable business model destroys value in an accelerator, and there are few internal processes more distracting than the process of raising funding. Leaders within the accelerator should keep the internal funding processes simple and focused only on those metrics that matter, at least at the earliest stages.Coke-Startup-week (1)

To help build its innovation capabilities, Coca-Cola now runs startup weekends

4. The emergence of best practices for entrepreneurial methodology

As entrepreneurs have found increasing opportunity to connect with each other, the best practices of entrepreneurship have continued to evolve as experienced founders and mentors share their lessons learned with new founders. Investors and entrepreneurs such as Paul Graham and Eric Ries have developed huge followings due to their willingness to share their lessons learned and their insights gained from years of making investments. In just the past few years, the concepts of Lean Startup and Customer Development have emerged as the dominant methodology within the entrepreneurial communities. While many of the underlying concepts such as Discovery Driven Planning, Business Model Maps, and Rapid Prototyping have been around for many years, it is only relatively recently have they been remixed and repackaged in such a way that they have been embraced by the startup community.

Just last month, Coca-Cola wrote about its partnership with Startup Weekend and a three-day event during which teams of innovators learned and practiced first-hand many of these best practices. The arrival of these methodologies and their supporting tools allow even first-time entrepreneurs to make real progress on their ideas in just a few days and better understand the key drivers that enable a culture of innovation.

For a corporate accelerator, it’s important to embrace at least some of these best practices. It’s relatively unimportant exactly which brand or platform you choose to embrace, or whether you choose to make modifications to the methodology to fit with your own culture. The key is to ensure that the process ensures a single-minded focus on the customer’s unsolved problem, and takes a hypothesis-driven and iterative approach to discovering a scalable solution. This process then drives everything else – the metrics that determine success, the way in which progress (and funding requests!) are reviewed by the leadership team. These best practices can look very different from the core businesses outside the incubator and so managing expectations at the most senior levels of the parent company is one of the biggest challenges for the leadership of any accelerator.

5. The rise and evolution of the startup mentor

With the emergence of all these best practices, and the lowered cost of starting a company, the number of first-time entrepreneurs has risen significantly. So too, however, has the number of investment firms competing to fund all these startups. So, in order to compete, the best investment firms have worked to develop a competitive advantage. YCombinator has been among the most successful, in part because it has developed an incredible bench of mentors and an alumni network that can provide guidance to the portfolio of new startups. For example, a key attraction to joining an accelerator such as YCombinator is the opportunity to learn from the founders of Dropbox, Reddit and Airbnb – all of whom incubated their own companies within the accelerator.

Within a corporate accelerator, Innosight’s experience suggests that this mentorship is often lacking. While entrepreneurial employees can be identified and recruited, the leaders of these groups are often already senior leaders in the organization who have a different set of skills. While they are in a great position to oversee the development of the new accelerator, and to manage the tensions between the accelerator and the core business, they don’t necessarily have first-hand experience of launching, funding or scaling a startup. As such, it’s critical for the leaders of corporate accelerators to create a network of mentors to support their entrepreneurs. These mentors might be external to the organization. These mentors are not just helpful to the entrepreneurs, but can provide invaluable advice even the business leaders within the core business.

6. The hybrid accelerator

You might not be familiar with companies like Betaworks, Obvious Corp or Sherpa Ventures, but they represent a re-emerging trend of the hybrid accelerator. Sometimes called studios or labs or foundries, these companies are half- VC firm, half- business builder. The key idea here is that rather than following a pure investment and acceleration model, these firms develop specific business functions and expertise in certain areas such as a particular technology, an industry vertical (such as healthcare) or even around marketing. This ensures that the portfolio of startups has access to unique capabilities, not just the capital and guidance.

This model represents a small step towards competing against the one remaining advantage that most large companies still have when it comes to launching new ventures; access to a set of capabilities or assets, which they would otherwise have to develop from scratch. While no hybrid-accelerator will ever develop the scale, distribution network or customer base that a world-class company has, it highlights the innovation in the entrepreneurial ecosystem which is focused against making startups more successful.

For the corporate accelerator, it’s a useful reminder that the purpose of the accelerator is not to replicate the model used by YCombinator and others, but to adopt and adapt the best practices and empower its own innovators to compete better, rather than faster, than their entrepreneurial counterparts in startups. What I mean by this is that it would be foolish to suggest that a corporate accelerator should try to compete on”‘greater talent” or “more passion” than a startup. Instead, the corporate accelerator should focus on those opportunities where it has a competitive advantage over any independent startup (or other competitor), precisely because the corporate accelerator has a unique “right to win” in the market, by virtue of the resources and processes of the corporate parent.

The most innovative organizations are starting to embrace these trends, thus strengthening their capabilities to accelerate new ventures. What steps will you take? Ball’s in your court.

Alasdair Trotter is a former Managing Director at Innosight.