Technology incubators, the entrepreneurial hotbeds that just a few months ago seemed the rage of a booming dot-com economy, could face a reality check from wary investors.
Though most successful tech companies have grown without the aid of such incubators, many consider the organizations’ mix of low-rent space, professional services and tutelage from industry veterans essential to helping promising companies get off the ground quickly. Historically associated with universities, a new breed of for-profit enterprises such as Bill Gross’ acclaimed idealab! in Pasadena have given new life to the incubator model and sparked a wave of imitators.
Orange County has at least six announced incubators, including Rapid Ascent Inc., which heralded its arrival earlier this month (see item on page 84).
Signs of Trouble
But there are tangible signs of trouble.
The highly-touted eDevelopments,a startup affiliated with Scott Blum’s incubator ThinkTank.com that hopes to manage commercial property developed specifically for the high-growth, high-uncertainty atmosphere of tech companies,saw its first development deal fall through. Officials with eDevelopments would not comment on their attempted purchase of the Parker Hannifin property at Jamboree Road and Michelson Drive or say whether the failure had anything to do with recent stock market uncertainty.
InnoLab!, the incipient incubator associated with the Tech Coast Superfund, like the fund itself has gotten off to slow start. “It’s taking a longer period to pull it all together but the (incubator) concept remains intact,” said the fund’s Tim Cooley.
And months after unveiling his Irvine-based Tech Coast Incubator, Chip Parker said he still has no tenants. He acknowledged that Southern California could see a consolidation of incubators as weaker ones join with better-established players. But Parker insisted the recent market woes have not dulled investor enthusiasm for startups. “We’ve done more in the last four weeks than we had in the last four months,” he said.
Typically, incubators have relied on liquidity events such as a buyout or public offering to pay off investors and fund operations. With the surefire exit strategies of the past few years anything but certain now, those incubators could find themselves in trouble.
Crowded Field
And those that aren’t facing immediate distress probably will become more selective in the type of companies they adopt. While officials with incubators contacted insisted they weren’t changing their models to screen out potential flops,saying they’ve always been picky about their tenants,they predicted other incubators would do so.
Business-to-consumer startups, the so-called e-tailing and content segments already scrambling to differentiate themselves in a sea of unknown brand names and look-alike business models, are the least valued. Even the fast-growing business-to-business segment is becoming increasingly crowded.
In the incubator hotbed of Los Angeles, as in Orange County, more doubts about the viability of the incubator model are being raised.
idealab! has many IPOs among its more than 50 businesses, including eToys Inc., Tickets.com, NetZero Inc., Ticketmaster Online-City Search Inc., and GoTo.com. But the shares of all of these companies have fallen dramatically of late, amid concerns that Internet companies have spent too much too soon on advertising instead of concentrating on building a profitable business.
Investors Getting Skittish
That is making investment professionals more dubious about incubators as a whole.
For one thing, there is distinct doubt over whether Internet companies can develop brand loyalty the way their “offline” predecessors have, and many of the companies that have been incubated seem to be little more than a cute name. Given that established businesses with recognizable brands are making quick inroads into the online world with Web sites of their own, a pure Internet play has to be more than a clever idea.
Unlike idealab!, eCompanies has yet to take any of its companies public. eCompanies raised more than a few eyebrows when it paid $7.5 million for the “Business.com” domain name late last year. The company defends the move by saying the name creates instant recognition for its site (a sort of portal for business professionals), but some question the wisdom of putting so much money into nothing more than a label.
“A lot of companies can accelerate a lot of their plans with $7.5 million,” said one local venture capitalist, speaking on condition of anonymity. “I can’t even imagine spending $7.5 million for a URL.”
Missing Ingredients
Then too, most successful startups have begun in the back of someone’s garage, by an entrepreneur utterly convinced of the validity of an idea and willing to sacrifice a great deal to make it work. Incubators that spend time and money trying to leverage a great concept from the secure confines of their offices may well be missing some key ingredients of starting a successful company: sweat equity, vision and dedication. And the venture capitalists who see such deals are becoming less than enthusiastic.
“How are a few guys going to sit around a room and think up companies?” said Brad Jones of Redpoint Ventures, which has yet to invest in an incubated company. “Most of the companies that are coming out of incubators are concept deals. I don’t think concept deals create as much value as technology deals. Some incubators that come up with particular concept deals may be successful, but it’s a very challenging business.”
Kevin Wall of Westwood-based Shelter Ventures agrees with the notion that Internet concept deals are pretty much a thing of the past.
“Today, two guys with a great idea about how to do Chairs.com,if they don’t manufacture chairs, if they’re not from the chair industry,won’t have a chance,” he said. “Back-of-the-napkin ideas are over. The reality is, it is all about execution. We are proactive about finding and building businesses. We want people who have already left their jobs, have used their savings and announced their intentions to start their own companies. What we want is having people who come up with the idea run with it, because they own the idea.”
Another problem with incubators is that they are often started by successful entrepreneurs who have become very wealthy thanks to the New Economy, and are convinced they can create the same success with other enterprises. But starting your own e-business and selling it is one thing. Funding and providing management expertise for someone else’s business is another.
It is a sign of the times that idealab! no longer uses the word “incubator” to describe itself. The company declined to comment, citing “quiet period” restrictions surrounding its own pending $300 million IPO. But in filings with the Securities and Exchange Commission, idealab! describes itself as “a new form of enterprise that creates, builds and operates businesses.”
While idealab! garners praise for doing just that and for capturing a significant chunk of various online niches before anyone else did, there are doubts about the long-term future of its startups.
“I can’t think of one (idealab! hatchling) that I’m sure will be around in five years,” said a prominent local venture capitalist. “None of them have unique proprietary technology that has a competitive advantage.”
But there are still bulls out there. Luis Villalobos, a well-known Orange County investor involved with GazelleLab and the Tech Coast Angels, said money for low-end startup-level deals has been increasing at a higher percentage rate than the multimillion-dollar financing arrangements that have garnered most media attention. And with increasing hesitation at the high end, more of that money is trickling down. “At the angel level, we’re seeing no change in the fundings, and just above that, we’re seeing the prices going up,” he said. “Nobody is having any trouble getting deals.”
