Hatch a Baby Business- Executive Edge, Forbes Magazine –

 

By Geri Spieler – Research Director, Gartner

When CEO Josh Silverman joined Evite.com, A San Francisco-based start-up that lets users organize group events online, he never imagined he’d need the help of anything as formal as a business incubator.

But within weeks after becoming employee number four in early January 1999, Silverman realized that navigating the San Francisco labyrinths of office space, construction permits, and equipment purchases was much more than he could manage.  “We were doubling in staff size and falling all over ourselves. We had to have new space, and I didn’t the commercial real estate market that well and didn’t have the time,” he admits.

By May, Evite had crammed 15 people into one office. Two months later it employed 35 people–and still hadn’t moved to a larger space.

Trying to lead a technology start-up in a fast-as-light industry while attending to the mundane, time-consuming tasks of outfitting an office with furniture, phones, office equipment, and a technical infrastructure was a nightmare. Silverman needed help–fast. He found it in a virtual incubator service provider, Startups.com. The Redwood City, Calif.-based firm employs a staff of dozens of industry specialists who supply all the information and support work any new company might need to outfit a fully functioning enterprise.

Silverman used Startups.com for several specific tasks, including:

  • Finding an acceptable location in which Evite.com could grow. It is now located in warehouse space in the SoMo district of San Francisco, south of Market Street.
  • Negotiating the new lease.
  • Supervising the renovation of the new space, including finding equipment and office furniture.

Startups.com consists of a core group of professionals in various areas of expertise, including marketing, IT infrastructure, human resources, as well as real estate. When a new company comes to Startups.com, the incubator assesses its needs and its budget, and then matches it up with companies that can satisfy those needs. Companies providing services pay a commission to Startups.com once the fledgling enterprise chooses and pays them.

What defines a business incubator? The original concept was intended to nurture growing young companies to independence through management guidance, technical assistance, and market consulting tailored to the new firm’s specific needs. The goal is to produce companies that can leave the program financially viable and freestanding.

Traditionally, local, city, and state government created and supported business incubators as a means to economic development–job creation, economic diversification, and expansion of the tax base. Incubators typically give aid to all types of businesses, not just technology companies. Incubators sponsored by governments and nonprofit organizations make up about 50 percent of the 750 business incubators in the U.S., according to the National Business Incubation Association (NBIA).

Among the virtues of government incubators is that they typically have an experienced board and a broad range of expertise from which new companies can draw.  And they do not usually ask for more than 1 percent of a company’s equity. On the other hand, they sometimes lack the financial resources to help a company grow as fast or as far as it might.

Another incubation model involves the world of academia, which makes up about 27 percent of all such groups. Affiliated with universities and colleges, these incubators share many of the same objectives–and the pros and cons–of public incubators. In addition to taking on outside companies, they provide affiliated faculty with research opportunities and offer alumni, faculty, and associated groups with start-up business opportunities.

While these earlier business incubator models still exist, there is a fast-growing, accelerated version of technology-business incubators that is significantly transforming the incubators that is significantly transforming the incubator trade.

These private for-profit incubators, about 8 percent of the U.S. facilities, are run by investment groups or real estate development partnerships. Their primary goal is the potential economic reward they might reap by investing in their tenant firms. They also focus on the new technologies development by their incubated companies, which can mean high returns in the future.

Such incubators are frequently managed by a handful of businesspeople that made their money by investing in technology. In some cases, they concentrate on a particular type of technology, such as electronic commerce applications.

While they can provide a more focused environment based on the expertise of the incubator’s management, they may require a large equity stake in the start-up. And too often they have limited management resources apart from the owners.

Another private model involves corporation-backed incubators. An example here is the large, technology-based company that sees an economic advantage in managing its own start-up companies and new technologies. Such companies sometimes work more like a research and development unit than a standard business incubator.

Choosing a corporate incubator can provide the young company excellent opportunities for co-branding and licensing agreements with its host, and lots of in-house expertise. But it offers limited access to outside consulting and management. And if the project fails to develop as the parent corporation sees fit, the start-up company may have to relocate and start over.

Then there are the private, in-house incubators backed by venture capital firms. These are not as well known, but similar in model to the highly visible and popular IdeaLab, the venture capital firm based in Sunnyvale, Calif. Typically, venture capital firms–such as Kleiner Perkins Caufield & Byers in Menlo Park, Calif.–have three or four new technology start-ups incubating in their private facilities at any given time.

The venture capital company has staff that identifies hot new technology start-ups and manages them personally.

Such arrangements offer superior, hands-on management and rapid time-to-market for product launch. In return, the start-up will probably need to give up a significant equity stake.

Net Incubation

The new private model of business incubation began to reach critical mass in 1996 with the growth of the Internet. The flood of Internet technology and e-commerce hopefuls looking for the magic of dot-com status put more young technology experts and freshly minted MBAs out on the market. The difference for high-tech start-ups was the “need for speed.”

“In a traditional incubator, a small company may have two years to bring its product to market. In our business, if you have an idea, you have to get it out in six months,” says Donna Jensen, founder and CEO of Startups.com.

Jensen’s brainchild of a “virtual” incubator that will find rental space, order phones and even locate a human resources package arose when she saw how desperate tech start-ups were for help and services. “What makes these companies successful is to focus on their core business. They don’t have time to source all these needs,” she says.

In 1993 there were about 95 incubators that described their client types as being primarily high-tech. Today the NBIA counts about twice that many–although it cautions the number is difficult to track because of the growth of private, venture-funded high-tech facilities. Indeed, the number may be much higher.

For technology start-ups, joining a business incubation program offers clear rewards. A study conducted by the University of Michigan, the NBIA, Ohio University, and the Southern Technology Council found that 90 percent of all the clients assisted by high-tech incubators were still in business in 1997. That’s a significant improvement over the national average of 62 percent of most small businesses that fold in their first six years.

How much help?

The role played by incubators in any of these models will vary from start-up to start-up. Giving up a chunk of the company is not necessarily such a terrible thing.  In some cases, the success or failure of the company in directly related to how fast it gets to market. Barbara Harley, director of the International Business Incubator (IBI) and co-chair of the Pacific Incubation Network, says, “If you want to own the market, you have to be first, and that means lots of big bucks to fund the project, hire lots of expertise, and get out there.”

Brook Byers, a partner in the venerable VC firm of Kleiner Perkins, notes that funding and incubating new companies is a core element in the company’s strategy. “We’ve expanded our incubator space, he says.”We now have two locations, and have three to four companies in-house at any time.”

Whether you favor the traditional model, or are looking for the fast track, getting into an incubator is no slam-dunk, according to Jim Robbins, executive director of the Software Business Cluster, a high-tech incubator space based in San Jose, Calif. The incubator screening process is pretty tough, with up to 50 percent of applicants getting rejected, according to Robbins. “Incubators are looking for high growth, not old stuff,” he says.

Timing is important, too. If a business is in its early stages, without a real concept or business plan, it probably won’t pass the screening test. And if it is too far along the road to launch, with too many employees and an advanced-stage product, it will not benefit from a few months in the incubator–another reason for rejection.

At the same time, plenty of entrepreneurs developing start-up technology companies should steer clear of incubators. They should investigate whether joining, an incubator is the best decision for their new business, based on the type of incubator offered and the terms required to participate.

Good contacts and strong management are the keys to funding, notes Payam  Zamani, president and CEO of PurpleTie.com, a new online dry-cleaning service, and the founder and former CEO of Autoweb.com. When he started out as an online entrepreneur five years ago, technology incubators were not an option.

“I may have looked into incubators as a viable option back then,” Zamani says. Now he has plenty of contacts, and he suggests that other new start-ups first use any contacts they have. “It would depend on how much value they could add. It’s really about who you know,” he says.

Other reasons for rejecting the incubator model can be as simple as not finding value in the level of management expertise.

Jason Yelowitz, founder of iCastle.com, an online home improvement service says the payoff wasn’t there. “I had good management mentoring,” he says, “and I felt they wanted too much from my little company, so I rejected the offer.”

For Evite.com’s Silverman, management, funding, or guidance for his small company wasn’t his goal.  He needed plain old logistical help for making a physical move, and he needed someone else to do it. “I was brought in to find money and grow the company,” Silverman says. “I didn’t have the time or experience to run around and find office space, buy refrigerators, and remodel the floor.”

Private beats government

The good news for the overall incubator industry is that the growth of technology businesses and the need for incubating them has fueled more opportunities in other industries as well. The bad news is that government and not-for-profit incubators are quickly losing ground to privately funded facilities.

“Many U.S. incubators developed for good reasons, but they’re seriously undercapitalized. There is no centralized government policy in the U.S. to help fund these services,” says International Business Incubator’s Harley, whose incubator focuses on small, foreign companies looking to establish a U.S. presence.

Harley says other nation’s government seems to do more to bolster new business ventures. The German government, for example, has supported 400 new business ventures to independence within the past several years, she points out.

The high-tech business incubator market is the fastest-growing segment of the incubator industry.