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Putting the 'inc.' in incubators
Oct 27, 2000 07:18 AM ET
By Cal Chang Yocum, LocalBusiness.com
NEWS ANALYSIS RESEARCH TRIANGLE, N.C., Oct. 27 (LocalBusiness.com) -- During the dot-com heyday, businesses calling themselves incubators popped up seemingly everywhere.
With sales efforts pitched to the prevailing market winds -- "We can take you public in 18 to 24 months!" -- there also seemed no shortage of start-ups willing to trade large chunks of equity for start-up services, a bit of seed capital and some square feet of office space.
With the market turning its back on startups, the word "incubator" itself has taken on an unpleasant connotation. "(The oldest and largest incubators) have been absolutely creamed in the stock market of late," says David Wright, vice president of private equity services at the Aberdeen Group in Boston.
Some traditional Internet incubators -- including CMGI (Nasdaq: CMGI) of Andover, Mass; Internet Capital Group (Nasdaq: ICGE) of Wayne, Pa.; Safeguard Scientifics (NYSE: SFE) of Wayne, Pa.; and divine interVentures (Nasdaq: DVIN) of Chicago -- are undergoing makeovers as "technology operating companies." They are looking more at later-stage investments and multiple lines of business as their stock prices have deteriorated.
Even industry standard bearer idealab, which prefers the style "idealab!," is spelling its name with a question mark. The incubator was forced last week to shelve its $300 million initial public offering thanks to inclement market conditions, an underperforming portfolio and underwriters with shaky knees.
Eve.com, a San Francisco consumer retail site , was the latest casualty in idealab's portfolio. On Oct. 20, Eve.com, which was controlled by idealab since the incubator in April bought up the stakes of early investors, shuttered its operations and further tarnished the market perception of technology and Internet incubators.
Pain level: 'Extremely high'
John Ballantine, chief executive officer, president and founding partner for Seattle-based iStart Ventures, www.istartventures.com, says the market has been flooded with incubators in the past 36 months, and too many lack the experience needed to succeed.
"There are a lot of people running facilities for start-ups who do not have start-up experience, and the pain level down in the trenches is extremely high," Ballantine says.
In April, iStart, whose portfolio numbers five start-ups, raised $4 million from more than two dozen angel investors and, as of June, was seeking $10 million to $20 million for its iStart Ventures' No-Carry Fund I L.P.
Successful incubators must clearly define their paths to profitability, Wright says. And they must form alliances with large corporate research and development departments.
"The absolute downfall of the incubation industry is not being linked to a source of mature ideas that have been inadequately commercialized," Wright says.
Forming corporate intellectual property partnerships avoids some major entrepreneurial traps:
Mitigating start-up risk by supplying a mature corporate environment.
Providing customers, which often remain loyal to spinout technologies.
Assuring adequate cash, which many parent companies are willing to invest in their spinouts.
Many incubators are moving toward this model, Wright says, including incuVest LLC of New York. IncuVest, which also has dropped "incubator" from its marketing, is forging partnerships with large companies and universities -- including the University of Texas in Austin -- with reputations for finding commercial outlets for their technologies.
For example, incuVest will announce next month its ties with chipmaker Labnetics, a UT-Austin spinout whose specific lab-on-a-chip technology incuVest won't discuss in detail.
IncuVest, www.incuvest.com, employs "enterprise factories" that function as technology think tanks to conceive technologies that have $1 billion in market potential. These factories, including the largest in Sebastian, Fla., then create companies that hold the potential to go public in three years to five years.
Variations on a theme
StarTech, a business accelerator and incubator with offices in Dallas and Austin, wields a $25 million seed fund and a network of "stakeholder" companies. The companies, including Sun Microsystems, Oracle Corp. and Lucent Technologies, pay the incubator $25,000 per year and are a potential source of spinout companies.
"They're interested in new customers and suppliers, they're interested in being channel partners, and they're interested in acquiring some of our companies," says Rob Carruthers, a managing partner.
StarTech, www.startech.org, takes no cash from its portfolio companies, opting instead for a 3 percent to 4 percent equity stake that pays off when a start-up goes public or is acquired.
Fusion Ventures in Durham, N.C., is an incubator with a similar model. The 2-year-old incubator, with five portfolio companies, takes cash and equity from its companies and injects each with about $500,000 on average.
The best business model for an incubator varies depending on the market you're in, says Paul Mayer, a founding partner at Fusion, www.fusionventures.com. "We think that for the Research Triangle market, a business model that combines facility, people and capital is what's needed, what the market wants and what's going to be most successful."
Future holds fewer, better incubators
While iStart's Ballantine isn't sure where the estimated 800 incubators will be by 2003, he is certain dot-com and wireless incubators will fare worst.
"I think a lot of the dot-com incubators will go away," he says, "and wireless incubators are going to get caught in a 'wireless bubble' in the next 6 to 12 months."
Fusion's Mayer predicts 100 to 200 U.S. incubators will survive.
"Additionally, incubators face competition from angel groups that don't rise to the level of an incubator, but can provide some heavy lifting," says Chris Matton, an associate at Raleigh, N.C.-based law firm Kilpatrick Stockton LLP.
Health care and biotech might hold the brightest hope, says Jim Fitzsimmons, managing director of Kirkland, Wash.-based, Scout Medical Technologies LLC. Fitzsimmons says the medical device incubator market is wide open after long being ignored.
"Many multidisciplinary venture firms eight years ago dropped medical device investing in favor of chasing faster money with Internet companies," says Fitzsimmons, whose year-old incubator raised $8 million with backing from Cambridge, Mass.-based MPM Capital. "Those venture funds that have stayed out of the picture are so big now that an incubator makes great sense to them."
NightFire Software Inc., a maker of software for broadband providers, was incubated in 1997 at Roda Group, Berkeley, Calif. Venkates Swaminathan, NightFire founder, executive vice president and chief strategist, sees a refinement period ahead for incubators.
"There will be a greater need for incubators," Swaminathan says. "Yet, there are plenty of people out there calling themselves incubators who are going to go out of business, and deservedly so."
Staff writers Rolf Boone, Marla Dial and Teri Sprackland contributed to this report.
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