Quality, Success Rate Vary for Internet Hatcheries

Do Internet incubators really work?

At a time when these financial havens for high-tech startups 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 alone, there are now at least two dozen either existing or in development, compared with just a handful a couple of years ago.

Some tangible benefits

"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.

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.

Speed and quality are key

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 percent 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."

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."

Despite the recent proliferation, incubators have been around in various shapes and guises for many years.

A number of research institutions either have or are setting up incubators so that faculty members and researchers can develop commercial ventures using the technology they have developed. The Business Technology Center in Altadena was established by the Los Angeles Community Development Commission to facilitate the technology transfer from Caltech and the Jet Propulsion Laboratory. Cal Poly Pomona is in the process of forming a similar program, the NASA Commercialization Center.

UCLA does not have a full-fledged incubator, but it has a Venture Development Program that hooks up MBA students with medical and engineering faculty at the university to set up companies.

The concept of nonprofit, small-business incubators designed to promote job growth in blighted areas has been around since the '80s, when it originated in rust-belt cities in the Midwest and on the East Coast.

The Pasadena Enterprise Center is one such small-business incubator and focuses on minority and women-owned businesses in northwest Pasadena. Other similar incubators include Downtown Enterprises, which focuses on the fashion industry, and FAME Renaissance in South Central Los Angeles.

Various goals

That kind of variety makes for distinct agendas. For example, the EC2 Annenberg Incubator Project at USC, L.A.'s oldest exclusively high-tech incubator, has graduated only two companies in its five years.

"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 last 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.

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."

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