March - 2000 - issue > Cover

Look at the time horizon in which a startup has operated for many years now. A minimum of two years to go from inception to public. That is, if it’s lucky; four years is actually the norm.
Look at the struggles.

A startup has to deal with the pressures of trying to raise ever-higher sums of money, now thought to be in six digits, from angel investors or wealthy risk-takers. Only then does the company have a chance of getting noticed by a venture capitalist. Finally, even if the startup can attract a VC, it’s subject to a lot of control.

And as if the competitive environment is not enough!

Financiers now have a solution to this startup stress. Investors are creating new spaces, called incubators, where a sizable number of Internet startups are nourished and sheltered, a place where entrepreneurs can independently create companies from the ground up. These incubators are now the hottest fad in high-tech.

Variety of Benefits

Startups that grow in an incubator stand to gain in many different ways. Incubators typically provide experienced counsel, which may not always be available to startups. So the incubator companies tend to advise new entrepreneurs on how to operate and function for growth and development. In this, they are unlike traditional venture capital firms in that they assist through intimate interaction with the startup, providing everything and anything a company needs: funding, office space, administrative support and advice. They also provide legal advice and help in hiring.

In 1996, Bill Gross put the incubator idea in motion by creating the “Idea Lab.” His incubator gave birth to two hugely successful companies: e-commerce company EToys and search engine GoTo.com. Now, investors are building incubator companies in frenzy. In the past few months, several have rushed to market, creating competition in the incubator industry itself. This trend is happening not just with high-tech companies, but also in the non-profit sector and the entertainment industry. Incubation, seemingly, is a method that may be effectively applied to almost any industry.

A Long History

Incubation is not a new concept: it’s been around at universities across the nation for the past two decades. In the past, incubator clusters were also developed by government agencies and academic institutions in order to help minorities and the non-profit sector.

According to the National Business Incubator Association, incubation programs are playing crucial roles in communities for economic development. Incubators flourish in multiple locations in cities, suburbs and rural areas. They succeed in launching a variety of small businesses that create jobs and an amazing amount of revenue throughout the country and beyond. According to the NBIA’s 1998 State of the Business report on the incubation industry, North American incubators created 19,000 companies that are still in business and provide more than 245,000 jobs. On average, incubators serve an average of 20 entrepreneurial firms in 1997.

Dinah Adkins, executive director of NBIA, commented, “Incubator companies rarely went public. Only in the last 20 years incubator corporations have existed for profit.” Indeed, “for-profit” incubators are a definite trend: Venture capital companies and angel investors are investing millions of dollars to help Internet startups. “The spirit of entrepreneurship is growing at a fast rate and being protected ... We are seeing continuous growth all over the country,” Atkins said.

Growth is seen even in specific areas. For example, a group is trying to achieve more funding for women entrepreneurs.

Recently, Spring Board 2000 hosted a West Coast forum for women-led companies in Redwood City. The National Women’s Business Council and the Forum for Women Entreprenuers selected 25 women-led companies to pitch their individual business plans at a Venture Capital Forum.

“We’ve chosen an excellent mix of e-commerce, Internet, software and biotech firms up and down the West Coast. We are bringing innovative women entrepreneurs into the mainstream, giving venture capital, angel and corporate investors the opportunity to see new deal flow,” says Kay Kopolitz, Chair of the National Women’s Council and co-sponsor of SpringBoard 2000.

Featured companies were hand picked from 350 highly qualified applicants by a committee of leading venture capitalists in the Bay Area. “Applicants were rigorously screened for an aggressive, growth oriented business plan, a talented management team, large target markets and a clear competitive advantage,” said Denise Brosseau, president of the Forum for Women Entrepreneurs and co-sponsor of Springboard 2000.

The National Women’s Business Council is a bipartisan federal advisory panel consisting of 15 prominent women business owners and advocates, and exists to expand public- and private-sector marketplace opportunities for women-owned businesses. One of the “pitchers” was Krishna Subramanian from Kovair, a company that began in the San Jose City Cluster, a city-run incubator that does not pick up equity stakes in startups it funds..

Infrastructure Critical

Thanks to incubator clusters, companies throughout Silicon Valley are flourishing. Kovair Software, founded last April, pitched its idea to the San Jose City Cluster and won their support. SJBC founder Jim Robbins has since assisted Krishna with the management of the company. The support, Krishna commented, made networking and resources a lot easier to utilize because everything is at your fingertips.

“Speed and efficiency was a key reason why I chose to do business with an incubator cluster,” says Krishna. Under incubation, Kovair has developed rapidly, growing from two offices to 10 offices in a six-month period. Kovair makes software that enables e-commerce services and streamlines communication systems, helping companies achieve high customer satisfaction.

Santa Clara-based Paraform is another example of incubator success. Co-founder Venkat Krishnamurthy proposed a business plan to an incubator after learning about it from a friend. According to Krishnamurthy, the cluster “helped us start out. They gave us space, machines, and the ability to network with many people. The cluster helped us recruit employees from U.C. Berkeley and Stanford. It also introduced us to investors that are extremely helpful.”

“The infrastructure of running a company was really important, especially in the initial phases of the company,” he added. Paraform, which started out with a mere four people, now has 60 employees. The company develops digital-form development software for the creation of 3D computer models and organic shapes, and is a pioneer of creative imaging and modeling. Privately owned, Paraform’s investors include the Paul Allen-owned Vulcan Ventures, Tech Farm and Chase Capital Partners.

The CMGI Model

As the line between incubator and venture capitalist blurs, venture capital firms are networking companies together into closely-knit but loosely governed conglomerates, even after individual companies go public. One example, CMGI, hatched Engage technologies, an Internet advertising company that had already completed an IPO. Still, CMGI controls Engage, an arrangement that increases CMGI’s market value by linking it to CMGI’s network of companies that can feed on one another’s strength.

“The CMGI model works,” says Mahendra Negi, an Internet analyst with Merril Lynch. It gets the best of both worlds. What is causing the shift of a corporate business model is, of course, large sums of money. There is an availability of it and there is an ever-growing opportunity to increase revenue. Incubator companies routinely take 50 percent of a startup — a steep fee, but justified, people say.”

Not just a Silicon Valley phenomenon, incubators are popping up all over the country. For example, the city of Chicago is working with a private group called Divine InterVentures to create a downtown private and public incubator for IT startups. Such a venture is expected to insure that Chicago’s university- and research lab-educated “techies” will seek work in the city.

Although Silicon Valley will probably remain the center of high-tech startups, networking among these different cities’ incubators is increasing. Companies such as Hotbank, an affiliate of Softbank, plan to share recruitment and support resources with affiliate incubators around the country. Hotbank’s strategy, is to add to its strongly established Internet investment record and use its $900 million in incubator programs to leverage future Softbank deals.

Incubators in other major cities are targeting diverse sectors. Cambridge, Ecompanies and Red Leaf Venture Management have raised $100 million, $130 million, and $60 million respectively for their incubator funds. Intend Change, a Santa Clara-based incubator, is in the process of raising nearly $300 million.

Internationally, leading incubator programs are The New Media Spark in London and Ideapark in Canada, which have established incubators in several international companies. Incubator companies are being established for cross-border software and e-commerce development.

Incubators are also forming into distinct industry groups, each engineered for a specific purpose. For example, last May the SimonProperty Group, the nation’s largest owner of shopping malls, created an incubator called clixnmortar.com, which developed a program to connect online and offline retailers. FastFrog.com used their model with success.

Future Trends

Thanks to the Net, there is a strong push for speed and efficiency on the part of all businesses. The incubator trend is throwing up startup companies in large numbers, and also allowing them a greater chance of surviving the competitive environment. Company building is thriving — and growing faster than ever. Entrepreneurs with limited funding need not rely on his or her own resources but may rely upon an incubator to effectively fulfill its growing needs, get them off the ground faster, and also be assured the possibility of more growth, more capital and more company security.

Although still in the gestation phase, the Internet incubator is a model that more and more companies are taking advantage of. IdeaLab’s experimental business model has produced the best results in hatching in new companies by allowing them the chance to grow and evolve. It is a model that many industry representatives believe will increase development by 100 percent. Sometime soon, perhaps, the incubator will become an essential aspect of the venture capital industry and not just a helpful accessory.