When Kevin Wall and his partner Art Bilger put together a $300 million investment fund and set up Westwood-based Shelter Ventures a few months ago, they and their marketing staff grappled with how to describe themselves.
The business model was to commit financial and human capital to help tech entrepreneurs from a very early stage with their business plans. With some trepidation, they decided to call themselves an "incubator."
"I was against it, and only agreed reluctantly," Wall said.
That's understandable, because seemingly overnight, "incubator" has become something of a dirty word or at least an unfashionable one. While two years ago there were only a handful of organizations calling themselves incubators, and most of them were nonprofits, today, profit-hungry incubators are a dime a dozen. In fact, the nine-letter word is now so commonplace that the very company that popularized it, Idealab, no longer refers to itself as an incubator. Moreover, the very idea of incubators is coming under more scrutiny than ever.
At a time when the stock market is shying away from Internet companies, particularly commerce-based ones, there are questions as to what incubators are really building. Are they creating viable businesses, or little more than flashy brand names that go public with huge valuations only to plummet in a matter of months?
"Incubators are cool, so there are a lot of people who are now calling themselves incubators, but have no idea how to execute a business plan," said Tyler Orion, executive director of the Pacific Incubation Network, an organization of nonprofit and for-profit incubators. "It's a matter of buyer beware. It behooves entrepreneurs to use their best judgment in working with (incubators.)"
The term "incubator" originally applied to nonprofit organizations, often associated with universities, that helped build nascent businesses by providing them with resources the entrepreneurs couldn't afford themselves. EC2, the business incubator project at USC's Annenberg School for Communication, is one such traditional incubator that concentrates on Internet companies.
But the word took on new meaning when entrepreneur Bill Gross formed his Idealab incubator in Pasadena in 1996 and set about creating Internet companies from his offices.
The Idealab model has been to come up with a winning idea, hire management, develop the business strategy and eventually go public. It is one that many are emulating.
Perhaps the most prominent local Idealab copycat is eCompanies, started by EarthLink Network founder Sky Dayton and former Walt Disney Co. executive Jake Winebaum. Like Idealab, eCompanies has a venture capital arm, but it is incubating companies at the rate of one a month, providing services such as financing, strategy, recruiting and marketing to its hatchlings.
ECompanies has yet to take any of its companies public, unlike Idealab, which has many IPOs among its more than 50 businesses, including eToys Inc., Tickets.com, NetZero Inc., Ticketmaster Online-City Search Inc., and GoTo.com. But the shares of all of these companies have fallen dramatically of late, amid concerns that Internet companies have spent too much too soon on advertising instead of concentrating on building a profitable business.
That is making investment professionals more dubious about incubators as a whole.
For one thing, there is distinct doubt over whether Internet companies can develop brand loyalty the way their "offline" predecessors have, and many of the companies that have been incubated seem to be little more than a cute name. Given that established businesses with recognizable brands are making quick inroads into the online world with Web sites of their own, a pure Internet play has to be more than a clever idea.
ECompanies raised more than a few eyebrows when it paid $7.5 million for the "Business.com" domain name late last year. The company defends the move by saying the name creates instant recognition for its site (a sort of portal for business professionals), but some question the wisdom of putting so much money into nothing more than a label.
"A lot of companies can accelerate a lot of their plans with $7.5 million," said one local venture capitalist, speaking on condition of anonymity. "I can't even imagine spending $7.5 million for a URL."
Missing the sweat equity
Then too, most successful startups have begun in the back of someone's garage, by an entrepreneur utterly convinced of the validity of an idea and willing to sacrifice a great deal to make it work. Incubators that spend time and money trying to leverage a great concept from the secure confines of their offices may well be missing some key ingredients of starting a successful company: sweat equity, vision and dedication. And the venture capitalists who see such deals are becoming less than enthusiastic.
"How are a few guys going to sit around a room and think up companies?" said Brad Jones of Redpoint Ventures, which has yet to invest in an incubated company. "Most of the companies that are coming out of incubators are concept deals. I don't think concept deals create as much value as technology deals."
Wall of Shelter Ventures agrees with the notion that Internet concept deals are pretty much a thing of the past.
"Today, two guys with a great idea about how to do Chairs.com if they don't manufacture chairs, if they're not from the chair industry won't have a chance," he said. "Back-of-the-napkin ideas are over. The reality is, it is all about execution. We are proactive about finding and building businesses. We want people who have already left their jobs, have used their savings and announced their intentions to start their own companies. What we want is having people who come up with the idea run with it, because they own the idea."
Another problem with incubators is that they are often started by successful entrepreneurs who have become very wealthy thanks to the New Economy, and are convinced they can create the same success with other enterprises. But starting your own e-business and selling it is one thing. Funding and providing management expertise for someone else's business is another.
"I have seen two entrepreneurs who created a dot-com once calling themselves incubators, and they have no (institutional) funding and no credibility," said Orion of the Pacific Incubation Network. "There are quite a few opening or about to open who have a lot of credibility. But you have to look at what are their credentials."
You say tomato
Many feel the word "incubator" is becoming outdated, and as a result is being replaced with such terms as "accelerator," to describe the process of moving the entrepreneur along at a faster but better-managed pace in building a business. A firm recently put together by sports agent Leonard Armato, called Digital Media Campus, puts together entrepreneurs for sports-related Internet ventures under the same roof.
"We don't call it an incubator, we're calling it a campus," Armato said. "It's an evolved strategy; we're putting together all the resources and education necessary."
No matter what it's called, Armato's group may have some problems fighting for brand recognition in the growing incubator/accelerator/campus field, because there are already two others using similar names. KPMG Peat Marwick has started an entity dubbed Digital Media Business Incubator. The manager of that incubator left in January to form her own venture called Digital Media Incubator.
"There is a certain amount of packaging going on," said David Cutbill, a partner in the L.A. office of Arthur Andersen who has worked with many of the local incubators in business development strategies. "So many incubators are occupying the same space."
It is a sign of the times that Idealab no longer uses the word to describe itself. The company declined to comment, citing "quiet period" restrictions surrounding its own pending $300 million IPO. But in filings with the Securities and Exchange Commission, Idealab describes itself as "a new form of enterprise that creates, builds and operates businesses."
While Idealab garners praise for doing just that and for capturing a significant chunk of various online niches before anyone else did, there are doubts about the long-term future of its startups.
"I can't think of one (Idealab hatchling) that I'm sure will be around in five years," said a prominent local venture capitalist. "None of them have unique proprietary technology that has a competitive advantage."
Not to say that eToys, or Business.com, or any other of the locally incubated companies don't have a chance. But the jury is definitely still out.
"The quality of concept deals that will come out of incubators will vary," Redpoint's Jones said. "But with a concept deal, you better be there first."
And you better have plenty of cash to burn.
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