Business incubators have become ubiquitous in the technology startup world. Some are generalists, some are niche. Some are thought of as kingmakers, some as bottom feeders. In almost all cases (including on the fictionalized HBO show Silicon Valley), they have the same basic value proposition:
We will provide your startup with expert mentorship, services, and connections, and in exchange you will provide us with equity.
The problem, of course, is that startups must agree to give up some of their ownership before learning whether the incubator will hold up its end of the bargain. Imagine paying for a haircut upfront, or for a restaurant meal as you’re being seated. What if you end up with an inadvertent mullet or a piece of raw chicken?
That needs to change, and one of the nation’s largest tech incubators plans to lead the way.
Techstars, which has worked with more than 450 startups in over a dozen locations, tells Fortune that it will offer an equity-back guarantee to its companies, beginning next year. It has traditionally required equity stakes ranging from 7% to 10% but, going forward, “graduates” will decide for themselves if the program deserves their stock.
“Our expectation is that we’re going to earn it,” explains David Cohen, a Boulder-based entrepreneur and venture capitalist who co-founded Techstars in 2006. “We’re confident that Techstars is a very valuable product, where we feel we’re the ones who are going to help make the introduction to their next investors and customers, but if an entrepreneur ultimately has an issue, we’re not just going to make them stick to a number that they feel is unfair.”
To some extent, Techstars is just trying to better compete in a crowded incubator marketplace at a time when entrepreneurs have been conditioned to expect genuflection. But it is also responding to changing founder and startup demographics. Techstars and other incubators are beginning to see more repeat entrepreneurs express interest in their programs, often for more mature companies. A recent notable example was when Quora—a five-year-old question-and-answer site that has raised more than $160 million of VC funding—entered into the Y Combinator program. In many of these cases, the entrepreneur is even more hesitant to give up equity on day one. “We’re definitely seeing an uptick in the number of advanced companies and advanced entrepreneurs coming to Techstars,” Cohen says. “They’re maybe saying that they have momentum and aren’t sure about the value on the front end…so we’re going to remove that roadblock.”
The big question now is whether other prominent incubators—especially Y Combinator, which incubated such startups as Airbnb, Dropbox, and Twitch—will follow suit. To be sure, there are inherent risks. Techstars spends money on services for each startup—and also invests $118,000 in seed capital (specific dollar amounts vary by program). Not only could it receive nothing in return from a disgruntled founder, but it could lose out from a selfish one as well. The bull case is that those scofflaws probably are not running anything that will create value anyway, since successful entrepreneurs wouldn’t want to anger groups whose mentor rosters are filled with potential funding sources.
So I’d expect other major incubators to let Techstars de-risk the process. If there are no major flare-ups, they’ll fall into line. The result would be more equitable deals for entrepreneurs and increased applicant pools for the incubators.
Perhaps most important, it could help founders navigate better between the contenders and pretenders. If a program is confident that it will provide demonstrable value, then it should be willing to put its money where its mouth is. If not, then that should be a giant warning sign for founders. That guidance alone might be worth a few shares.
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This story is from the September 22, 2014 issue of Fortune.
