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When the going gets tough

by Kristin Woeste

August 2002

Success in assisting start-ups, creating jobs and having a positive economic impact on a community doesn't necessarily translate into success for an incubator. Just ask John Palmquist, former manager of Foodworks Culinary Center in Arcata, Calif., and Woody Maggard, president and CEO of Arizona Technology Incubator (ATI) in Scottsdale.

Both cite funding struggles and poor communication among problems that led their incubation programs into rough waters. Yet both can point to statistics that any incubator manager would be proud of. Foodworks' program assisted 22 start-ups, creating more than 140 jobs. The incubator also aided another 25 to 30 businesses each year in its shared-use community kitchen. So far, ATI has won several national awards, graduated 20 companies and delivered more than $100 million in total economic impact to its community from only $3.3 million in funding.

Despite those successes, both programs are dry-docked while they're being rebuilt. Palmquist and Maggard both can offer hard-earned advice to help other incubator managers steer clear of stormy seas and strengthen their incubation vessels.

Foodworks to resurface

For the last several months, Foodworks leaders and clients have been treading water while the fate of their incubator remains uncertain. The Arcata Economic Development Corp. (AEDC), a private, nonprofit economic development organization that is the incubator's parent entity, is attempting to transfer Foodworks to the city. With $600,000 in accumulated losses after nearly 10 years in operation, the incubator is too much of a financial burden for the corporation to subsidize. Foodworks had borrowed nearly $1 million to construct its facility, creating a major funding drain as the incubator could not escape its creditors. With 20/20 hindsight, Palmquist suggests that instead of building a new facility with borrowed funds, renovating an existing building (preferably with grant money) could have helped.

Foodworks planners at AEDC had envisioned a self-sustaining cooperative that occupying businesses would purchase after five years. But after seven years, Foodworks remained in the parent organization's hands and was still losing money. At that point, the corporation transformed Foodworks into an incubator to assist clients through graduation, with the hope of operating it on a break-even basis. "Excluding depreciation, I was able to bring the project to break-even for its last two years," says Palmquist, who managed Foodworks for three years. "However, I had no reserves to renovate or upgrade the facility when clients vacated."

Further complicating matters, the city of Arcata seemed reluctant to assist Foodworks, Palmquist says. As a result, other grant and loan sources shied away. Palmquist says better communication early on with the city could have led to more funding, so he suggests incubator managers start talking now to keep financial backers and other interested parties regularly informed of incubator developments and progress.

AEDC and the city of Arcata are attempting to resolve the politicized situation. Half the funds used to construct the incubator came from the city, giving it the right of first refusal on the property. Although six of the incubator's 10 clients remain in Foodworks' space (with little to no incubator-type support services), much of the facility has been rented to another organization. The other Foodworks clients graduated and found accommodations.

Palmquist's other suggestions for smooth sailing include:

  • Install a good accounting and financial system. Foodworks faced accounting troubles because the incubator's finances were bundled with those of the parent corporation's other operations, so AEDC did not realize the full extent of Foodworks' losses.
  • Ensure that rents and fees from clients cover operating costs. The $80,000 AEDC initially invested to cover operating costs wasn't enough when the vision of a self-sustaining cooperative failed to materialize.

ATI sails new seas

In 2002, the Arizona Technology Incubator set a course for new waters. All of its in-house clients graduated, leaving it with two off-site clients. ATI's board of directors used the opportunity to switch ATI to an incubator without walls, a format they hope will free it from the financial strain of a bricks-and-mortar facility. "ATI has never had its own debt-free or rent-free building," Maggard says, "creating an unrelenting, and singularly onerous, albatross around its neck in the form of lease payments." Paying market rates for rent, while offering below-market rents to clients, proved a heavy burden for the incubator in its nearly 10 years of operation.

Lease payments were not the only financial burden the incubator faced. It also lacked a primary sponsor or stakeholder to fund it when times got tough. Maggard says this put ATI in a state of perpetual fundraising, and left little time for business coaching and mentoring as he and the staff concentrated on funding month-to-month operations. The incubator also suffered from miscommunication with its supporters. Early on, the incubator emphasized a liquidity-event model, anticipating that ATI clients in which the incubator held stock or equity would be sold or go public, providing returns that would allow the incubator to become self-sufficient. When the liquidity events occurred on a smaller scale than envisioned, supporters began to feel that the incubator was falling short of expectations and fundraising became even more difficult.

To help keep incubation programs afloat, Maggard suggests:

  • Limit the number of governing board members. At one point, ATI had 47 members on its board of directors in an attempt to represent many segments of the community. The time necessary for so many individuals to agree on decisions made the board slow to react to the incubator's mounting troubles.
  • Make sure your incubator is integrated into other engines of economic development. According to Maggard, Arizona's tendency to promote company recruitment at the state level, paired with a nascent university technology transfer system statewide, meant inadequate deal flow for ATI. "My experience has been that even the best incubators are no better than the capacity of their regions to both appreciate and make use of them," Maggard says.

Smooth sailing ahead?

The experiences of Foodworks and ATI serve as reminders that even a solid incubation program can meet stormy seas. The direction that Foodworks will sail remains uncertain. The city of Arcata delayed a decision on acquiring the Foodworks property after a preliminary business plan showed that even with a quarter-million-dollar investment, the facility would show a loss for at least two more years. If the city does obtain Foodworks, AEDC Interim Executive Director and CFO David Marshall says it will probably operate the program as a mixed-use incubator rather than a kitchen-focused facility.

Maggard is optimistic about establishing a strong incubator-without-walls program for ATI with the capacity to return to a with-walls facility when the time is right. Although he still battles the misconception that the incubator is unsuccessful, Maggard is positive about the future. "We would rather work on continuing to be part of the national incubator success story," he says.

Keywords: financial management -- incubator, incubator failure, stakeholder development, stakeholder relationship management, strategic partnerships

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