Do Internet incubators really work?
At a time when these financial havens for high-tech startups,like Scott Blum’s ThinkTank.com,have become all the rage, it’s an important question. Trouble is, there is no easy answer.
For many fledgling companies, going through an incubation process,in which seasoned investors and managers can keep a watchful eye on things,is a better idea than going at it alone.
But teaming up with an incubator does not necessarily lead to success. Even Idealab in Pasadena, which serves as the model that many new incubators now try to emulate, has seen some of its startups flounder. Last year, one of Idealab’s companies, ideaMarket, did not make it out of the blocks, and another, Launchpad Technologies, was reported to have had its share of trouble.
Incubators are like anything else: the quality varies, especially as more of them keep popping up. In Los Angeles and Orange counties, there are now at least two dozen either existing or in development, compared with just a handful a couple of years ago.
Big Demand
“There is a chance that it will become a me-too game,” said John Laco, co-chairman of the emerging companies/venture capital practice at O’Melveny & Myers LLP. “But there is definitely a need for these types of enterprises out there,I’ve got stacks of business plans on my desk from small operations, typically two guys working out of a living room, that could benefit tremendously from becoming part of an incubator.”
Tyler Orion, executive director of the Pacific Incubator Incubation Network, said startups that go through an incubation program typically have fared better than others, but it is too soon to tell whether the recent influx of Internet incubators will follow the trend.
“For many investors, it will be a numbers game, and they will spread the risk the same way as in the venture capital market where everybody (hits) a few home runs,” said Orion. “It remains to be seen how patient that capital is going to be if success doesn’t come quickly.”
Internet incubators provide entrepreneurs with space and support services, as well as access to venture capital and potential alliances in the industry. In exchange, the incubator gets equity in the startup, often a majority share. This arrangement works best for entrepreneurs who lack the contacts, experience and resources to launch a startup themselves and who have a concept that needs to get executed fast.
No Time to Waste
Whereas five years ago an Internet company might have had a fair chance of success by building up its business from the founder’s garage, the accelerated pace at which the industry now moves leaves no time to waste.
“The window between concept and execution is shrinking,” said Gregory Goodman, a senior manager with the e-business services group of Arthur Andersen. “Traditionally, there has been a three-year window between concept and IPO. That’s being cut down to two years now, and an incubator is crucial in speeding up the first round of financing and putting a management team into place.”
This is particularly important in e-commerce, where many companies enter the market offering similar products and services, and so-called first-mover advantage can be crucial for a firm to establish itself as a market leader.
“Just look at Barnes & Noble and Compaq,” said Goodman. “They entered the online market late and were eclipsed by Amazon.com and Dell.”
Because shakeouts are likely in various categories, whether it’s online pet stores or home furnishing outlets, it’s considered important for e-commerce startups to establish themselves as soon as possible.
“Twenty percent of the Internet has been invented, and the remaining 80% will be invented in the same amount of time it took to invent the first 20%,” said Jake Winebaum, a former Walt Disney Co. executive and co-founder with Sky Dayton of eCompanies in Santa Monica, one of the more prominent new incubators. “Speed and quality of execution are going to determine which companies are going to be successful in that market.”
Fast Turnaround
In order to stay ahead of the curve, many incubators aim to get companies fully functioning in three to six months. But even that is sometimes too long. Shipper.com in the city of Industry went in and out of Bill Gross’ Idealab in Pasadena in just two months.
“Twelve months ago we had to decide whether to go it alone or to partner with incubator,” said Andrew Krainin, senior vice president of Shipper.com. “We decided to go with Idealab, and it’s probably the best management decision we made. Besides benefiting from experience the people there have in setting up Internet companies, it was very important for us to be able to take advantage of Idealab’s reputation in order to create awareness for our business. The fact that we had the support of Bill Gross and Idealab helped us tremendously in speaking to customers and employers.”
A few incubators have distinct agendas, such as the 5-year-old EC2 Annenberg Incubator Project at USC, which is LA’s oldest exclusively high-tech incubator. But in that time, EC2 has graduated only two companies.
“If incubation were the only thing we did, those numbers would not be impressive,” said Jon Goodman, executive director. “But we’re doing a lot more in terms of research and industry development. This incubator was not designed to make a few partners a bucket of wealth, but to foster the development of new technology in the community.”
That’s hardly the case for most of the new Internet incubators that have appeared over the past six months, such as eCompanies, eVentures, The Idea Grove, and SiliconLosAngeles.com, among others. These are private, for-profit enterprises and their success will be measured not just by how well their companies do in the long term but also by how much money they make for their investors through an IPO or acquisition.
“We won’t know the real answer for a few years, but I’m sure that there will be some good companies coming out of these incubators,” said Brad Jones, general partner with Brentwood Venture Capital/Redpoint Ventures. “We will have to see whether these companies are also going to be successful beyond creating market value for their investors in terms of earnings, but also in terms of earnings growth.”
Luis Villalobos, an active Orange County “angel” investor, said incubators do indeed work,if they’re using the right model. Instead of old-style incubators that offer nothing more than low-rent space and advice from industry veterans, Villalobos points to Idealab and ThinkTank, which provide a full range of services including accounting, computer integration and web development.
The complexity of many tech-related businesses these days makes those third-party support services essential.
“Imagine being an astronaut if you not only had to be the ship’s pilot, but build the launch pad, design the computer systems and maintain ground control,” he said. “A good incubator allows the entrepreneur to just be the astronaut.”
But, the fact that incubated startups needn’t worry about day-to-day business operations and sign over the bulk of their equity may be an impediment on their future growth.
“Incubation can be very useful for a new company, but they are going to need to have an internal business plan and management team as early as possible,” said Jones. “Also, any company needs to make an arrangement that keeps future financing in mind and set stock aside for new investors.” n
Ken Spencer Brown contributed to this report.
