These days it seems that everyone wants to be a part of a business incubator or business accelerator (I’ll discuss the difference in a bit). Since 1980, the number of incubators has grown from 12 to over 850 today, with much of the recent growth occurring in Internet incubators. I know of at least seven incubators/accelerators planned or operating in Nevada. With all of the money and energy (and hype) surrounding these shiny new entities, let’s take a look at how they operate and what the long-term prospects are for an entrepreneur hoping to take an idea to them with the hopes of building the next “New New Thing”.
Incubators are organizations that offer start-up services to entrepreneurs who have a unique idea and are trying to rapidly build a successful company. Incubators usually provide resources that include a combination of fully-furnished office space, computer and network infrastructure, legal help, printing, and business consulting (e.g., accounting, marketing, recruiting, administration, finance, etc.). Incubator facilities can range from thousands to hundreds of thousands of square feet of office space, which might house amenities such as exercise rooms, mail rooms, printing facilities, and cafeterias. Accelerators are essentially incubators with a fancier and more sophisticated-sounding name (though they don’t like to admit it) – the occasional difference between the two is that certain accelerators don’t provide office space.
An entrepreneur who is nurtured by an incubator/accelerator can expect to pay up to 50% or more of the equity in his/her company for the services that they provide. Ostensibly the benefit to the entrepreneur is that his/her company will get to market faster, will have access to a greater number of contacts, and will share with other entrepreneurs a deep pool of brilliant strategic talent in the form of the incubator executives.
Incubators/accelerators by their very nature grow companies with three structural challenges that must be overcome in order to succeed: low barriers to entry, diminished market spaces, and a lower probability for superior execution.
First, success of many of the emerging incubators is predicated on building a large portfolio of companies that need to get to market so quickly they’re willing to pay the incubator to help them do so. Typically, these are Internet companies with “low barriers to entry” (i.e., they’re relatively easy to start), which explains why there has been an explosion in Internet-centric incubators. Because almost anyone can start an Internet company, incubators try to offer entrepreneurs value by helping them get started faster than their many competitors.
Second, these low barriers to entry cause many companies to chase the same opportunities, so the market sizes of the opportunities being pursued diminish greatly. At any given point in time there is a finite set of opportunities with large enough markets to justify an investment of high-risk capital. Incubated companies will either be relegated to small market niches, or they will face literally dozens of competitors in their market space (all having been incubated themselves).
Third, true value is created for new companies through superior execution – whether the business will be highly valuable in the long run depends on its ability to consistently out-perform its competitors. Unfortunately, an incubator cannot execute on behalf of the company, and an entrepreneur who needs an incubator to get started may not have the executive skill required to build a winning company.
There is another minor factor that might be noted as well. Many incubators tout their brand names and credibility as one of the primary sources of value to a fledgling entrepreneur. If this “star power” is the reason an entrepreneur pursues participation, he/she has fundamentally ignored the premise of successful business: great companies are built on customer demand, not on media hype or even investor interest. Great companies are built on real (and yes, difficult) value additions to a defined market group.
At this point you might be curious to see how these concerns have played out in the actual track records of incubators. In short, the evidence seems to confirm that emerging incubators might have serious flaws in their own business models: Although there have been thousands of successful companies incubated throughout the country since the 1970s, most statistics cited about these successes are referring to non-Internet companies. In contrast, consider idealab, one of the Internet’s most prolific incubators (eToys.com, NetZero (free ISP), Tickets.com, GoTo.com, etc.) What are idealab’s results? In four years, it has yet to turn out a profitable public company.
We’re still in the midst of learning whether the emerging incubators and accelerators will provide solid, long-term value to our economy. My guess is that like the more traditional incubators before them, they will, but only after adopting a higher-quality, less quantity approach that stresses solid business fundamentals and higher barriers to entry (an approach used by venture capitalists). Until then, these incubators will be a great place for entrepreneurs to gain hands-on business education, if not necessarily millions of dollars.