Incubators: The New Venture Capitalists?

Once the sleepy domain of universities and public development agencies, business incubators have shown new life in the Internet economy. Focused on providing new ventures not just with funding, but also with services, advice, connections and physical space, they offer a new way for companies to get to market fast. Four leaders from this rapidly growing industry looked at incubators and their relation to the traditional world of venture capital.
by Kenneth Liss

Move over, venture cap. There's a new kid on the block.

It's the business incubator, and it has the potential to remake the way businesses are launched in the Internet economy.

Incubators are not really new, of course. "They've been around a long time," said HBS Professor Josh Lerner, kicking off a panel discussion at Cyberposium 2000. "But I think it's fair to characterize the incubator space as rather a sleepy one."

Until now, that is.

Once largely the domain of universities and public economic development agencies, incubators — which provide new ventures with funding, staffing, services, physical space, strategic guidance and more — are popping up in the private sector almost as fast as the companies they hope to hatch.

They're pulling in veteran entrepreneurs and established Internet players eager to put their experience to work launching new businesses. They're attracting the attention of venture capital firms, who are starting their own "venture catalyst" experiments. They're catching the eye of potential startups, looking for ways to get to market faster and with more value in the ultra-competitive e-commerce environment.

There's even talk of a couple of the new incubators going public themselves.

Four leaders in the evolving incubator space — Timothy Rowe of Cambridge Incubator, Toby Corey of Intend Change, Flip Filipowski of Divine Interventures and Jeff Crown of Lycos Labs — came together to review different models and general issues on the subject at the Cyberposium panel "Incubators: The New Venture Capitalists?"

Although the forms of their organizations vary in large and small ways, one thing all the participants agreed on was that incubators are catching on in part because it takes more than just funding to get a startup successfully off the ground in the electronic economy.

Venture Capital as a Commodity

"We definitely see a major shift occurring in the venture capital community," said Corey, who co-founded the Web consulting firm USWeb/CKS before leaving to create Intend Change. "Our view is that venture capital is a commodity. If you look at the size of the funds that are being put together today, it's not difficult to put money together.

"Traditional venture capitals need to move in either one of two directions: either view it as a commodity and orient themselves much like a bank, a lending company, or an equity transaction company, or move up the food chain and be able to provide richer, higher services much like we see in what we're terming the incubation space today.

"We're focused, obviously, on the higher end of that spectrum." Intend Change, he said, combines insight into where the Internet is going with innovation and with "the entrepreneurial experience that we can bring on how to build a venture, how to go essentially from zero to mach 10 overnight."

Lycos, too, sees the entrepreneurial experience it brings as a key. "What we realized when we dug down and saw our competencies inside of Lycos," said Crown, "was that we knew a lot about starting, building and deploying businesses very quickly.

"So we wrapped all those competencies together — everything we know about running an Internet company — and launched, literally last night, Lycos Labs. Our goal will be to partner with angels, VCs, universities, in a fashion whereby several young companies will get the opportunity to start their business on our campus here in the Waltham area."

Experience and services, said Crown — and connections ("we're probably one degree of separation away from anybody who's anybody on the Internet") — are what it takes to get a business going: "It's not just dumb money."

Connections are key, agreed Cambridge Incubator's Rowe. "If you are working with people in the incubator of the stature of Toby, who can call up the major possible partners for your company and say 'These guys are real and they're strong and you should work with them,'" said Rowe, "that has such a tremendous impact on what you're doing.

"Some venture capitalists are terrific at that and they have those skills," he continued. "But most venture capitalists will not be spending time in the trenches because that's not how they're structured, they don't have the people for it."

Incubators Vs. Vcs

Divine Interventures' Filipowski sees even more differences between traditional venture capital and incubators and other new ways of launching businesses. "The Internet has changed everyone forever. It not only made it an opportune time to experiment with an organizational structure," he said. "It also made it important and relevant to experiment with a new organizational structure, because the typical partnership and corporation of this era is a dead structure, a stupid structure."

At Divine Interventures, said Filipowski, companies are brought together in an "econet," functioning as "atomic units [that] do only one thing and do it well.

"We sometime incubate those. We sometimes partner with people that have those. But what we do is create economic coalitions between those atomic units in order to provide for the delivery to the customer of a complete solution."

With venture capital funds, he said, "you don't have the synergies between the partner companies." In most cases, in fact, the companies receiving the funds "don't even know who the other partners are that are being invested in. They're being randomly invested in, as opposed to being invested in on the basis of 'This makes sense; these 10 companies working together could become a virtual monopoly.'"

Corey noted that he had tremendous respect for venture capitalists and works closely with many of them. But he also noted major differences. "I think that incubator people would probably make lousy venture capitalists," he said. "The venture capital world is basically comprised of numbers. You have somewhere between 50% and 90% failure rate in the venture capital world. That's how it works. You make bets. It's probability.

"From the incubator side, we're really driven mainly by wanting to create something, so things we get involved in we won't let fail. Our personalities won't let that fail. That's a poor personality trait in the venture capital community. There are very different skill sets that you bring."

Rowe agreed. "We've got so much skin in the game, between all our operational, engineering, design and Web development expertise. When people are that involved in your company, we can't afford to let one fail," he said.

What Cost Incubation?

But, asked moderator Lerner, what about the cost of this closer involvement? Does it mean giving up a greater amount of equity?

Well, yes, said Rowe. But it's a matter of weighing risk and reward, or upside, against guaranteed return. "Going to work for McKinsey, you have a guaranteed return and you have very little risk or upside. Or you can start a company yourself, and you have a lot of risk and upside and not a whole lot of guaranteed return.

"You can think of an incubator as a point somewhere [in between]," he said. "You have a higher probability of success, not a guaranteed return, but it's not the same kind of risk if you start yourself. And you're also going to cut your reward, your upside, significantly."

The other thing to look at, added Corey, is the post valuation an incubator can bring. "If you've got VC money, and you gave away 20% of your company but the post valuation was $10 million, or if you gave away 30 or 40 or 50 percent of your company [to an incubator] and the post was $50 million, you're ahead at that point.

"So at the end of the day, can you play market maker, can Cambridge Incubator and Lycos and Intend Change play market maker for you by getting you to market faster? That's the fundamental question you've got to ask yourself. Does it cut three to six months off your development time and increase your post?"

"It's all about the probability of success of your company," said Rowe. "Let's face it, it's going to be binary in today's Internet world. You're either going to be the player in your niche, and maybe the number two player, or it's not going to work.

"The question you need to ask yourself is, 'What happens in an incubator and not in an incubator? What is the impact of time to market? If you're to the market three or four months sooner as the result of being with an incubator — and I think that's an understatement — does that impact your chances of success?"

Of course, with so many new incubators entering the space, it's important that entrepreneurs interested in going that route find the right one. "I'd spend a lot of time with the people," said Rowe. "Interview them the way you would interview someone you're hiring for your startup."

But with the good incubators already having their hands full, said Corey, entrepreneurs are also going to make the case for themselves. "You obviously want to spend a lot of time interviewing these people, but to a large extent, you also have to sell them, because they've got limited resources and limited time."

It's an interesting dynamic, said Corey, but well worth the effort to find the right incubator, one where the arrangement is viewed as a partnership, not just an investment.

"Believe me," he said, "the right ones are going to be extremely motivated to make sure you're successful."