Velocity incubator will now invest in start-ups

WATERLOO, Ont. – The University of Waterloo’s startup incubator, Velocity, will look to raise more than $1 million for an investment fund slated to launch in March, with money going to fund the new companies.

It’s part of a big change in the way Velocity finances start-up entrepreneurs, with a move away from grants and toward investments.

Since 2011, Velocity has held pitch competitions three times a year, with four winners receiving a grant for $25,000 each. The startups also work out of the Velocity facilities for up to two years, with more than 70 companies sharing the 40,000-square-foot incubator space at any given time.

“We support companies across a wide range of sectors and industries – anywhere from a two-person team starting to a 15-person team post-seed-funding,” said Jay Shah (pictured), director of Velocity, in an interview with the National Post.

With three pitch competitions per year each paying out four prizes of $100,000 plus ancillary prizes, Velocity has been paying out more than $300,000 per year in grants. This new investment fund will replace all those grants.

The idea, Shah said, is that starting at the next pitch competition in March, Velocity will to offer $50,000 to each of the winning companies – as an equity investment.

Lots of incubators and accelerators offer their services in exchange for equity in the startups they support, but Shah said they didn’t want to undermine the success of future businesses by imposing onerous terms.

So Velocity will be using what’s called a “post-money SAFE with a most-favoured-nation clause,” which is a mouthful to say, but also a popular investing structure pioneered by the legendary Silicon Valley accelerator Y Combinator.

Under a post-money SAFE (Simple Agreement for Future Equity), the startup takes the money, and then the investors get equity at whatever valuation is established at their next funding round.

“We’re not going to set a valuation or a price point or an amount of equity we’ll be getting. We’re going to let the private market on a subsequent investment set that, and we’ll just inherit those terms,” Shah said.

“This is the most favourable terms you could possibly get an investment on. We’re taking all the risk with no upside, in terms of being the first money in without any discount, and so we think we’re striking a really healthy balance between ensuring the broadest deployment of capital.”

As is the norm for venture capital investments, the fund will take a decade for the investments to mature.

The benefit for the University of Waterloo is that instead of using philanthropic capital on grants, Shah said they can spend that money on other things such as upgrades to the Velocity facilities.

“Our incubator does have a full wet lab and a full bio-safety lab. Those facilities are fully subscribed with startups. If we had more space, we could absolutely have more of those companies pursuing their ambitions there,” he said. “So that’s an example of where we’d want to redirect philanthropic gifts, to be able to support that ambitious bet.”

In advance of the launch, Velocity ran the numbers of its past startups, and if this sort of equity investment structure had been in place since the beginning, the results would have been pretty good.

For the cohort of startups that won grants in the pitch competitions between 2011 and 2013, hypothetical equity investments would have earned 57 per cent annualized returns.

Waterloo has had some good startups, including Kik, which at one point reached a $1 billion valuation; BufferBox, which was acquired by Google; and Maluuba, which was bought by Microsoft. In the case of both acquisitions, the terms were not disclosed.

North, which has raised nearly US$160 million in venture capital funding, and just recently launched a set of augmented reality smart glasses, also got its start out of Velocity.