Mailbag: What Startup Accelerators Do and Why Consumers Leave the Marijuana Black Market

Q: What do startup accelerators do? Are they important?

A: I can’t imagine the startup ecosystem without accelerators. They’re a big part of what makes the whole space work… for both entrepreneurs and investors.

Founders join accelerators to learn basic business-building skills. They learn how to make a deck – a presentation for investors – and deliver a pitch. And they join a network of mentors and fellow entrepreneurs. If a startup is lucky enough to be accepted by a top accelerator – like Y Combinator, Launchpad, 500 Startups or Techstars – it confers instant credibility among investors and increases the startup’s chances of getting funded upon graduation.

Startups also get immediate funding in return for a stake in their company. For example, Y Combinator invests $150,000 in return for a 7% stake.

Investors – including many of the portals we work with – use the better-known accelerators as a source for quality deal flow. I’d estimate that at least half of the startup recommendations we’ve made to members of our First Stage Investor service have founders who graduated from accelerator programs.

It all began in 2005, when Jessica Livingston and Paul Graham founded Y Combinator. In 2006, David Cohen and David Brown started Techstars. Other accelerators soon followed.

Corporates noticed the success of these accelerators and started launching their own versions. Microsoft, Citrix and Telefónica were among the first wave of large corporations to offer such programs in the early 2010s. Since 2010, there have been 71 corporate accelerators launched worldwide.

In the state of Maryland, where I live and work, there are 13 startup accelerators that I know of. I’ve spoken at several of their events on how best to impress investors. Every state has its own network of accelerators intended to jump-start startups on the road to success. Here’s a list of the top 10, ranked by aggregate amount of dollars in exits:

  1. Y Combinator – $5 billion
  2. Techstars – $1 billion
  3. AngelPad – $493 million
  4. Dreamit Ventures – $397 million
  5. fbFund – $359 million
  6. Launchpad LA – $185 million
  7. Seedcamp – $137 million
  8. NYC SeedStart – $130 million
  9. Amplify.LA – $57 million
  10. Wayra – $44 million.

At the beginning of their long journey, startups need a great deal of help. Accelerators have carved out a critical role in providing that help. So, yes, they’re quite important.

+ Early Investing Co-Founder Andy Gordon

Q: With all the taxes cities and states are tacking on to marijuana sales, why would anyone stop buying from their local dealer?

A: Consumers are typically willing to pay a premium for legal products. Consider cigarettes. Cigarette prices are incredibly high because of city and state taxes. But the black market for cigarettes is pretty small.

Sports betting might be even more analogous to marijuana. Last year, the Supreme Court overturned a federal ban on sports betting. As a result of the ruling, several states have legalized it.

At the time of the ruling, people wondered out loud why someone would bet at a legal sportsbook when betting with a bookie was more convenient.

At legal sportsbooks, you need cash upfront. You need to get to the sportsbook (some use mobile apps, but many don’t) to place your bet. And the odds you’re getting aren’t nearly as good because legal sportsbooks have to price all of the very high taxes they’re paying into the equation.

Those impediments don’t exist with the neighborhood bookie. You can bet on credit. You can place a bet with a simple text message or phone call. And the odds are a lot more favorable. In short, it’s everything a sports bettor wants – except for the fact that it’s illegal.

And as it turns out, sports bettors are willing to pay a premium to bet legally. In March, New Jersey’s legal sportsbooks handled more than $372 million in wagers. And Pennsylvania bettors wagered more than $44 million at legal sportsbooks.

So why was so much more wagered in New Jersey than in Pennsylvania? After all, New Jersey’s population is about 30% smaller than Pennsylvania’s.

It’s quite simple, actually. New Jersey allows people to place bets using apps on their phones. Pennsylvania doesn’t. And until Pennsylvania offers mobile sports betting, it won’t close the gap with New Jersey, despite having a larger population. (And yes, I’m certain this is the case. I used to consult in the casino industry, and this was one of my areas of specialty.)

What we’re seeing in sports betting in New Jersey and Pennsylvania is similar to what we’re seeing in the marijuana industry. Consumers are willing to pay a premium for legal weed. But there are limits.

Let’s consider marijuana tax revenue in Washington, Colorado and California. Washington and Colorado combined have about one-third of California’s population. Yet California is struggling to measure up to them in terms of tax revenue.

Washington generated $367 million in marijuana tax revenue last year. California brought in $300 million. And Colorado (with the smallest population of the three by a wide margin) generated more than $266 million in marijuana tax revenue.

California is clearly underperforming. It’s an inefficient market. Taxes are high. A dysfunctional licensing process, where temporary grow licenses are expiring faster than permanent licenses are being issued, is creating supply problems. A large number of cities have opted out of legal marijuana sales, so access to legal weed is uneven. As a result, many marijuana users haven’t made the shift to legal weed. The premium in terms of price and convenience is too high.

Meanwhile, the marijuana markets in Washington and Colorado are thriving. Revenues are growing – as are the number of people entering the legal weed market and leaving their dealers behind. Now, they won’t grow forever. At some point, the last black market holdouts will start buying legal pot and growth will slow down or plateau.

But people have made the shift. And they’re continuing to make the shift. As long as the premium is reasonable, consumers are willing to pay more to go legal.

+ Early Investing Senior Managing Editor Vin Narayanan