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Mark Grossman

Incubators and Venture Capita

30 May 2000

"Incubators" are one of the hot ways of getting dot com startups going. They've appeared in increasing numbers over the last couple of years to fill a niche left open by venture capital firms. If you're contemplating working with an incubator, you have to understand what they are, their history and how they can help start your startup.

A typical (some would say rosy) scenario is that an incubator gives your fledgling company things like office space at below-market rent, free Internet access and other telecommunication services. More importantly, you get access to the expertise and connections of the incubator's backers, and seed capital. The goal is to get you launched as quickly as possible.

What you give in return is a large portion of your stock and possibly even control. When your company is ready, the incubator helps you out the door, where it will facilitate you finding venture capital funding (sometimes from the incubator's in-house VC fund), and then eventually go public.

Although there's no generally accepted "perfect" definition of an incubator (and incubators clearly have their differences), the three elements common to all is that they employ a manager, provide a comprehensive assistance program and require their startups to graduate. The goal is for the new company to eventually operate without the incubator's help.

On the flip side, what investors get from incubators is a degree of diversification, smart management, and a chance to buy into fledgling Web companies at the same low prices as venture capitalists. It can be a win-win for dreamers and investors.

Speed is Key

In the Net world, the mantra is speed. It's taken on mythical proportions. Here's the tale.

Your lawyer calls a venture capitalist (VC) on your behalf Wednesday. He pitches your business plan to the VC who asks that your lawyer e-mail it to him.

Thursday, you spend an hour on the phone with the VC. Friday, you and your lawyer spend the day with the VC selling him on your great idea. Saturday, the VC spends a "couple" of hours in your office doing his due diligence. Sunday, the lawyers negotiate the agreement. Monday, you have a $5 million dollar check. Violá!

Well, let's just say that it doesn't usually work this way. It's a bit like an actress being "discovered" in a drugstore. Maybe, it happened that way once. Maybe it didn't. Either way, it's not the typical career path and drugstores are probably not the best place to find a starring role in a big movie.

The point is that popular myth notwithstanding, doing your deal with an incubator will take you more time than you think. These are complex deals and you're giving away a lot for somewhat amorphous things like "our technical and marketing expertise" and "access to our venture capital contacts."

I'm not knocking the incubator concept. In the right situation, I think that it can be a great idea. What I'm suggesting though is that you do your deal carefully, get good legal advice, and do your own due diligence on the incubator.

You need to learn about their success stories. Talk to the people who will be giving you the "management expertise." You need to see if you're comfortable with them. Are your business philosophies compatible?

When I say "learn about their success stories," I must caution you that in setting the standard, you're going to have to take geography into account. The simple fact is that if you're in places like Silicon Valley in California, Silicon Alley in New York, and other hotbeds of dot com success, you can almost require an incubator to have a list of success stories.

In other areas of the country, like South Florida, things have been slower to get going. You might have to look to the general success of the incubator's principles in business as an indicia rather than the success of the incubator. South Florida's incubators are simply newer and slower to develop. This doesn't necessarily reflect badly on our incubators, it just means that this isn't Silicon Valley.

The one thing I can assure you is that the incubator isn't going to go from reading your business plan to incubating you in a few days. Just put the myth aside and accept the reality that these deals always take more time than you anticipate.

Where you can and should expect speed is once you and your incubator are working together. One of the major reasons to work with an incubator is because they can speed your time to market.

To Incubate or Not?

If you have an idea for a startup, you need to make a basic decision about whether you want to go the incubator route. Arguably, you don't need an incubator if you have or can quickly assemble a good management team and have access to the needed capital.

If you don't have access to capital, an incubator just may be the way to get you noticed. Your incubator should be able to make personal introductions to VCs for you.

You should strongly consider an incubator if you need to ramp up your company faster than you can on your own. An incubator may also be a good idea if you want to eliminate the need to look for office space, equipment and Internet services.

It all comes full circle back to the management team and money. If you lack either or both, you should consider an incubator.

Types of Incubators

So far, I've largely been generalizing about open commercial technology incubators. There are other types.

One alternative is what's called a not-for-profit industry cluster. Here you have companies that have some similar interest incubating together.

Their biggest advantages are that you usually don't have to give up any equity, you can leave whenever you want, and you get advice from experienced entrepreneurs. The disadvantage is that their staffs are smaller and they have less incentive to help you since they don't own a piece of your pie.

Another possibility is corporate incubators. In this group, you have large corporations with deep pockets. You'll be backed by a brand name company with strategic relationships in place that may help you, but you may find yourself competing with groups within the company that want the success to be theirs and not yours.

These corporate incubators are somewhat newer and have less of a track record, which may make it harder for you to judge whether you should be partnering with them.

Major universities and even the government are now providing incubators and they may be good alternatives to commercial incubators. Most of these incubators started as ways to commercialize technology created at the university, but they are usually open to outsiders.

You usually won't have to give up equity, but you won't see the type of dedicated support you would get at a commercial incubator.

While not giving up equity to a commercial incubator may seem attractive, a good incubator more than earns its keep. You become a team with similar, if not identical, interests. You both want to see your venture succeed. You both want to laugh all the way to the bank.

If you have a good idea, an incubator may just be the right path for you to get to the promised land. Evaluate the possibilities with some trusted advisors and professionals. Then make your move. Time is always critical, but you can't always control the loss of time. Still, you can control how long it takes you to make a decision.

Incubators and Venture Capita is republished from
Mark Grossman
Mark Grossman