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Research Roundup: Studies Explore the For-Profit Incubation Phenomenon and Best Practices for All

by Carol James

With business incubation finally on the way to becoming a household phrase, it’s little surprise that the model has piqued the interest of researchers.

Explosive growth of the for-profit business incubation industry and two states’ exploration of how incubation can develop their economies provided the impetus for six recent studies. The authors, ranging from business incubation experts to Ivy League and private researchers, are examining everything from how incubators can provide value to their companies (and thus themselves) to shifts in the for-profit incubation model.

There is a huge market for this type of information, and these recent studies fill some of that need. We’ve talked with authors of the studies, and provide some highlights here. In the meantime, NBIA is preparing to conduct its fifth industry-wide study. Much has changed statistically since NBIA conducted its last industry study in 1998, largely due to the boom (and some subsequent busts) in the for-profit incubation segment.

Several of the new studies deconstruct the for-profit incubation phenomenon while others detail industry best practices. All incubation programs – for-profit or not – can gain insights from the best practices studies into how to grow and nurture successful companies.

We offer information about three studies focusing on for-profit incubators and three relating to best practices in business incubation. They are:

  • The State of the Incubator Marketspace, by Morten Hansen, Nitin Nohria and Jeffrey Berger, Harvard Business School, June 2000.
  • Internet Incubators: A New Value Proposition for Entrepreneurs and Investors, by Ed Black, Lara Abrams and Keith Soifer, Aberdeen Group, April 2000.
  • Incubators in the New Economy, MBA thesis by O. Mac Chinsomboon, Sloan School of Management, Massachusetts Institute of Technology, June 2000.
  • Best Practices in Business Incubation, by Chuck Wolfe, Dinah Adkins, and Hugh Sherman for Maryland Technology Development Corporation, June 2000.
  • Incubator Focus Group Study, prepared by Cathy Lange, The Staubach Co., for Maryland Technology Development Corporation, May 2000.
  • Technology Innovation Centers: A Guide to Principles and Best Practices, by Chuck Wolfe, in conjunction with San Diego Regional Technology Alliance, December 1999.

Internet frenzy

Until their stock prices fell last spring, Internet companies’ high valuations were a major impetus for the incubation boom. New incubators – mostly for-profit – were springing up at the rate of about four a week. “Some who jumped on the bandwagon were qualified and others weren’t,” says Adkins, NBIA’s executive director. As one would expect, some have succeeded and others have not.

As researchers make their lists, some are finding that for-profit incubator developers better think twice if they’re looking for a fast buck. Their reports indicate that Internet and other for-profit incubators, despite a few spectacular successes, need to stay focused on their main business: incubating businesses that will thrive.

While the current for-profit studies provide snapshots of this new incubation model, it’s too early to make large-scale conclusions about the impacts of the for-profit phenomenon.

“It will take another year or two before we can speak definitively about this class of incubators,” Adkins says. “Since the markets influence how they work, we have to let some time pass to get an idea of how they do generally.”

At least one thing can be said now, based on the current research and industry observation.

“Incubators all provide targeted services to entrepreneurs to push up the learning curve faster and give them the resources they need,” Adkins says. “That’s just as true of the effective for-profit incubator model as it is of the nonprofit incubator model.”

State of the incubator marketspace

Harvard researchers Hansen, Nohria and Berger paint a statistical picture of the for-profit Internet incubator market in The State of the Incubator Marketspace. Unlike many for-profit pundits, the authors acknowledge that business incubation has been around for a long time. “What’s different today is, first, the intensity of incubator activity and second, its focus: the vast majority of Internet incubators are for-profit enterprises that concentrate on the development of for-profit ventures,” their study says.

“There were a lot of myths; people were just throwing out numbers,” Hansen says of reasons the researchers set out to study the new organizational model. “Sometimes you see a new organizational model that gets diffused rapidly,” he says of the for-profit incubator explosion. “[But this is] rare, and it’s happening around the world.”

The Harvard researchers’ statistical representation of for-profit incubators “tried to capture the entire universe, instead of just a few examples,” Hansen says. They interviewed 169 of 356 for-profit incubators that had made public announcements between Jan. 1, 1998 and June 10, 2000. They found, among many other things, that 58 percent of these incubators are start-ups, and “rely on external VCs to develop a pool of seed capital.” The study also shows that:

  • 35 percent is the average equity stake taken in client companies.
  • 55 percent of those taking equity charge no additional fees.
  • More than 90 percent focus on Internet companies, but not on a specific technology or industry.

The study’s numbers allow a better understanding of what’s going on in the industry, Hansen says, although the study alone can’t define what’s effective because this new breed of incubators doesn’t have a long enough track record.

“We’re seeing that they’re not doing well,” Hansen says. Some are being discontinued or merged. “This new breed of incubators is clearly under distress.” He speculates that fully half of them will go out of business, while the remainder will re-emerge in some different form. “[We’re] seeing winners and losers already.”

The Harvard researchers’ data analysis found that the level of organizational capacity, intensity of client services and the extent of organized networking are the characteristics that most clearly define Internet incubators. The latter is particularly important and is the topic of a Harvard Business Review article, “Networked Incubators: Hothouses of the New Economy.” Hansen says the test of success is not whether incubators can take their companies public quickly but whether they can provide the bundle of services to develop thriving businesses.

The Harvard study looks only at the phenomenon of for-profit incubators as it has developed over the past couple of years, Hansen says. That phenomenon is occurring in part because of differences between today’s entrepreneurs and those of a decade ago. Entrepreneurs today are younger, and although many of them have MBAs and great ideas and talents, they have little business experience and need the help that incubators can provide, he says. Also, for-profit incubators offer an “attractive combination of coaching and funding,” he adds.

The Harvard study says that the next six to nine months will be critical for this class of incubators, “with 70 percent of the incubators that commenced operations over the last year scheduled to graduate their first class of start-ups.”

Internet incubators: A new value proposition

The Boston-based Aberdeen Group’s study Internet Incubators: A New Value Proposition for Entrepreneurs and Investors began last fall tracking for-profit incubators that tried to make a media splash, Black says. “The rush to market … of various firms defining themselves as Internet incubators” piqued the firm’s interest, as did “a lot of organizations claiming a high-order level of value in terms of what they could do,” says Black, Aberdeen’s senior vice president for western operations and coauthor of the study. The initial analysis developed into ongoing research to follow the emergence of the Internet incubator market.

The first edition of the study includes profiles of 20 Internet incubators and discusses funding, the equity investment market, and information to help entrepreneurs find the right incubator, Aberdeen reports. It provides statistical information and analysis, Black says.

The firm, which provides marketing strategy and consulting services emphasizing emerging technology markets, has developed a database of 450 North American for-profit incubators and is expanding the study for its second edition, scheduled to be released this month, Black says.

Aberdeen’s research has uncovered widely divergent models and investment philosophies, Black says. “When you look at the range of incubator-offered services – financial, legal, recruiting, PR, marketing, etc., some companies are staffing all those functions [and] some fill them through referral relationships,” he says as one example of differences in operational structures.

Now not much is a sure thing except change.

“[There have been] definite shifts in business models and approaches of incubators that we’re tracking from six months ago to now,” Black says. The reasons are “based on … the public markets, the response and involvement of the venture community as well as the maturation [of incubators] as they better understand taking on and nurturing new companies.” These new incubators are evolving to provide services and access to expertise that will make their portfolio companies stronger, he says.

In addition, the new incubators “have slowed the pace of acquiring new companies,” Black says. “[They have] also started to revise and extend expectations of how long a portfolio company needs to be incubated … more toward a year to two years,” up from incubator claims of taking companies to a liquidity event in six months. “The early movement was toward liquidity rather than building companies,” Black says, echoing Hansen’s comments.

The use of for-profit incubators as investment vehicles is simply a phenomenon of the booming economy, which has an abundance of venture capital to invest, Black explains. “It’s all about return,” he says. “In Silicon Valley … equity is the medium of exchange … to try to catch a piece of that wealth creation engine.”

What is the “ideal” mix of money and services for a for-profit incubator?

“I don’t think we’re there yet,” Black says. But to do a quality job, incubators need to focus on the resources and services they offer and on how to do justice to the companies they’re incubating, he says. “A key priority for most incubators we talked to is discussion of how they capitalize their operations,” he says. “Do they create their own investment fund, seek private placements or work with venture or corporate sponsorships? It’s kind of a mix right now.”

Two as yet unconfirmed trends appear to be evolving, Black says. For one, top-drawer for-profit incubators will have to provide professional services to client companies in technology, business management and business development. Secondly, these incubators potentially will have to develop service agreements to detail specifically what the incubators will provide and what companies must do to receive those services, he says.

“People are starting to think about this for differentiation as well as their own benefit,” Black says. “Not everyone has best practices and milestones.”

Incubators in the new economy

The third study drives home similar themes, chief among them the idea that incubators need to focus on growing and mentoring companies. Incubators in the New Economy provides a broad-based interpretive look at the for-profit high-technology incubation phenomenon. Chinsomboon, who is continuing the research he started at Massachusetts Institute of Technology, says his findings are bearing out some of the predictions he made in the thesis, including “greater vertical specialization, morphing of models, merging of investment banks, consulting, and VC firm services, and …more scrutiny of investments … more Fortune 500/1000 firms partnering with incubators and VCs.”

Although his thesis focuses on for-profit incubation models, Chinsomboon includes glimpses of other models, such as university programs. He identifies three characteristics that make incubators sustainable: brand name, network affiliations and operational experience. Echoing his colleagues, Chinsomboon says “the for-profit incubator itself is also a start-up … on average less than a year old.” After interviewing more than 80 incubator leaders, venture capital firm senior partners and other experts for the thesis, he surmised that many incubators were too busy jockeying for position to truly focus on serving clients.

How are some for-profit incubators changing to meet market needs? Chinsomboon observes that some are merging to create larger service organizations, while others are staying put but are pulling back to stabilize their investments and take a hard look at how they mentor portfolio companies. Still others are moving on to different pursuits.

Chinsomboon comes to the same conclusion as Harvard’s Hansen: Many likely will go out of business, perhaps consolidating into their respective incubated companies, “if those survive.” Chinsomboon notes that many of those incubators have learned important lessons: They must better scrutinize investments; focus on mentoring companies rather than growing the firm; work with VCs and bigger, more traditional players; and vertically specialize without becoming too narrowly focused.

For all their early-stage wobbles, for-profit incubators can fill a number of needs in today’s marketplace, Chinsomboon believes, giving a laundry list of pros in his thesis: “[They can] capture potentially successful deals missed by venture capitalists, facilitate idea creation, enhance product[s] and services, accelerate speed of implementation, provide supplemental management, offer more ‘hand holding’ than a typical venture capitalist, give access to expertise in marketing, operations, human resources, [technology], management, strategy, business development, finance and others, facilitate business development and partnerships, help in finding clients, facilitate sources of funding … portfolioize seed-stage ventures [and] provide additional deal-flow and vetting of deals for later-stage investors.”

Vetting best practices

CEO’s and stakeholders of nonprofit and for-profit incubators alike may benefit from three studies that look at ways business incubators can add value to their client companies.

Maryland’s Technology Development Corporation (TEDCO), an independent, state-funded agency promoting technology economic development, commissioned two studies, Best Practices in Business Incubation, a technology and innovation best practices report, and Incubator Focus Group Study, a client focus group study. A California initiative resulted in another best practices study, Technology Innovation Centers: A Guide to Principles and Best Practices.

TEDCO aims to develop a technology-based economy in Maryland, and business incubation is one of the tools the agency is using to do that. “Specific to technology, I think that it’s essential,” says Bill Stroud, TEDCO’s chief administrative officer, about incubation. “I think that technology is really the vanguard of economic development,” he adds, whether in manufacturing, information technology or biotechnology. “All of these areas lead the way toward expanding the job base in any economy. Technology does come to mind for most people as expanding the country’s economic base … [Incubation programs can] provide the backdrop for pushing the envelope.”

The California effort has among its goals to expand the use of best practices to better support early-stage technology businesses.

The Maryland studies

A TEDCO incubator advisory committee is using Best Practices in Business Incubation and Incubator Focus Group Study to develop program ideas with the state’s incubator managers and connect the state’s nonprofit and university-affiliated incubation programs. The committee created a matrix combining the focus groups’ priority areas with corresponding best practices from the NBIA-led best-practices study. To work toward meeting those objectives, incubators can apply for up to $25,000 to pilot a best practices program. Grant applicants must demonstrate how they’ll share what they learn with other incubators. The idea is to create a network to leverage the resources of the incubators in whose success the state has a stake. TEDCO has earmarked $500,000 for incubation programs, awards and grants.

“No other [U.S.] state has developed such comprehensive information on incubator best practices and the needs of state incubation programs,” Adkins says. “Nor has any other state worked so closely with NBIA with an eye to improving incubator performance to insure the growth of competitive businesses in a competitive state.”

Best Practices in Business Incubation looks at national and international technology-based incubation programs and identifies 10 best-practice areas. Each chapter includes a summary that reiterates key points. The first chapter, for example, deals with comprehensive business assistance programs and lists three best practices – needs identification, coaching and facilitation, and monitoring client progress – that are essential to “successfully nurture emerging ventures.” The role of each practice in supporting successful incubator programs also is outlined. Each chapter also features examples of programs that demonstrate the best practices it describes. Appendices include profiles of eight best practices incubation programs (it’s worth noting that four of them are headquartered in California).

In addition to the best practices study, TEDCO sponsored a series of focus groups to solicit opinions from incubator clients regarding state-supported incubation programs and what’s needed to improve those programs. The Staubach Co., an international commercial real estate strategy and services company, led the focus groups.

Why should an incubator manager in Texas care what incubator clients in Maryland say about their programs?

For one thing, information about ideal conditions is “useful for people thinking about creating incubators and accelerators … to see if they are [adequately] preparing to serve their clients,” says Staubach’s Lange, vice president of innovation, who prepared the focus group report.

Officials of state business incubation initiatives also may want to pay special attention to sector needs. “One thing Maryland needs to pay particular attention to is the feedback of biotech companies,” Lange says, because these companies have a different business model with much longer product development cycles and some specific laboratory needs.

The focus group study revealed great disparities among incubation programs in services, facilities and graduation procedures. “The level of inconsistency in services that incubators provide, that was probably the most surprising thing to me,” Stroud admits.

Although Adkins, Wolfe, of Claggett Wolfe Associates of Auburn, Calif., an economic development consulting firm, and Sherman, of Ohio University’s College of Business, wrote Best Practices in Business Incubation for Maryland’s TEDCO, its contents are applicable to technology and nontechnology programs around the United States and the world.

The state of the industry in Maryland is similar to the rest of the continent: “There’s a wide range of performance among incubators in the United States and North America,” Adkins says. “We’ve learned a lot [over the years] about meeting the needs of growing companies and have developed resources that can help them succeed.”

The key to ensuring best-practices incubation programs is an institutionalized, quantitative evaluation program – one of the best practices the study includes. “The only way to ensure best practices programs is to develop program performance measures that quantify results and identify where a program needs to improve,” says NBIA’s Adkins. “Evaluation is really critical and hard to find.”

Incubation programs cited in the study include award winners and others that stand out by reputation. “We then identified what they’re doing that is a best practice,” Adkins explains. “Best practices are best practices, and they can be adapted. The things we talk about are basic and general.” (See “Best Practices for All.” )

Nor are they limited to technology programs, although that’s what Maryland is focusing on. “With different kinds of companies … an incubator manager should be able to look at [the practices] and see how they can be adapted for their purposes,” Adkins notes.

The upshot is that incubator managers who achieve the best results are relatively systematic in the way they operate and their incubation programs have institutionalized procedures. “An incubator program shouldn’t massively change its way of doing business with every manager who comes in,” Adkins says.

The California study

Nearly 300 organizations provided information for the project, currently in final draft form. Wolfe, its principal author, says its purpose is to learn from some of what has happened in California in terms of early-stage technology business formation, determine the role incubators and innovation centers play, and to outline best practices so present and future incubator/technology innovation center operators can “improve the climate for supporting early-stage technology ventures.” In a separate, internal report, the researchers also identified the state’s potential roles in supporting such activities.

Jeff Newman of the California Trade and Commerce Agency’s Division of Science, Technology and Innovation (DSTI), was project manager for development of the guide, which received grant funding from the U.S. Department of Commerce Economic Development Administration as part of a five-pronged California effort in technology-based economic development.

“What we want to do is have something that we know beforehand is going to be successful,” Newman says. The guide is a way to promote understanding of best practices and also marks the start of collecting comprehensive data about technology business incubation.

In addition, entrepreneurs can use it as a checklist of what to look for when selecting an incubator, says Clifford Numark, president and CEO of the San Diego Regional Technology Alliance (SDRTA).

The alliance, one of three regional alliances in the DSTI, oversaw development of the study that Wolfe describes as “a fairly comprehensive guide to assessing whether a technology-focused incubator is appropriate as well as practices for designing and operating” such an incubator. It shows that business incubation is a growing field in California where, Wolfe says, “like incubator programs around the world, [the industry] is evolving to meet the changing needs of client businesses.”

It’s also applicable beyond California’s borders and in any incubator niche. The guide is a “crystallization of ideas that were already out there,” such as “run the incubator as a business,” Numark points out. “I think it’s pretty clear that … any governmental resources used for an incubator should be looked at through the screen that the guide developed.” Of course, high-growth technology companies must have access to capital, Wolfe says. But providing only money likely won’t establish a business for the long haul.

“There have been people with a lot of money who have taken the venture model and just plopped it into a building,” he says. “My feeling is that’s not true incubation – they aren’t in many ways nurturing the concept. They’re forcing the concept to go to market ... A business model takes some time to mature. You need to give people the experience necessary to grow a venture. You may make [getting to market] happen by taking away the educational process that a typical entrepreneur will go through … From a financial perspective that’s perfectly fine. [But] you could be undermining the long-term stability of the company,” Wolfe says. “I think people have to pay attention to the fact that there is a basis of incubation – building a capacity – not just throwing capacity” at a product or company to get it to market.

Best practices for all

To obtain optimum results from an incubator program, adapt these best practices as appropriate to its mission:

  1. Comprehensive Business Assistance Program – requiring ongoing needs assessments, coaching and facilitation and monitoring client progress
  2. Professional Infrastructure – developing and making use of a know-how network, mentors and advisory boards
  3. Client Capitalization and Financing – providing financial training, access and links to funding sources, and relationships that can provide services in lieu of capital
  4. Client Networking – encouraging, providing opportunities for, and having management that can facilitate connections
  5. Technology Licensing and Commercialization – developing partnerships, managing conflicts and establishing interfaces that promote technology commercialization through new company formation
  6. University and Federal Laboratory Linkages – establishing links to leverage assets and making sure all parties get value from the relationships
  7. Facility Fit – providing flexible space and services that meet client needs throughout their development and encouraging client interaction and financial sustainability for the incubator
  8. Governance and Staffing – ensuring an effective governing body, consensus on mission, appropriate skill level of president/CEO, sufficient, high-quality staff and a CEO who lets clients learn about and grow their businesses
  9. Client Screening and Graduation – selecting clients who can benefit from incubator’s value-added services, assessing client needs, and setting up graduation criteria
  10. Incubator Evaluation – instituting qualitative and quantitative measures of mission fulfillment, client feedback during residence and after graduation and using this information to improve performance

(From Best Practices in Business Incubation, prepared for the Maryland Technology Development Corporation, June 2000.)

By definition

What’s in a name? A lot, if the name is business incubation. Here are a few of the definitions found in the recent studies:

The State of the Incubator Marketspace (Harvard Business School) – Any organization that helps start-ups develop in an accelerated fashion by providing them with a bundle of services, such as physical space, capital, coaching, common services, and networking connections.

Internet Incubators: A New Value Proposition for Entrepreneurs and Investors (Aberdeen Group) – Incubators have three primary characteristics. First, they provide investment (i.e. seed capital, etc.); second, extended management advisory services; and third, facilities, including space, technology and administrative services.

Incubators in the New Economy (Chinsomboon’s MBA thesis, Massachusetts Institute of Technology) – A controlled environment that fosters the care, growth, and protection of a new venture at an early stage before it is ready for traditional means of self-sustaining operation. In today’s world, where information technology and the Internet are normal parts of the business environment, the term “controlled environment” could be either physical (real estate and office facilities) or virtual (networks).

Best Practices in Business Incubation (for Maryland’s Technology Development Corporation) – Business incubators accelerate the successful development of entrepreneurial companies through an array of business support resources and services, developed or orchestrated by incubator management, and offered both in the incubator and through its network of contacts. The goal is to produce successful firms that will leave the program financially viable and freestanding. These incubator graduates have the potential to create jobs, revitalize neighborhoods, commercialize new technologies and strengthen local and national economies. An incubator must provide management guidance, technical assistance, and consulting tailored to young growing companies. Incubators usually also provide clients access to appropriate rental space and flexible leases, shared equipment, technology support, and assistance in obtaining the financing necessary for company growth.

(Adapted from a 1996 NBIA Board of Directors-approved definition.)

Profile of a For-Profit

92 percent serve only Internet-related companies

88 percent offer at least informal networking

69 percent focus on early-stage companies

70 percent have 25 or fewer employees

68 percent have one location

58 percent are start-ups

56 percent invest to hold

55 percent take only equity

41 percent charge fees in addition to equity

38 percent have graduates

Equity Stakes (median stake is 30 percent; average is 35 percent):

  • 21 percent take less than 15 percent
  • 27 percent take 15-29 percent
  • 26 percent take 30-49 percent
  • 18 percent take 50-75 percent
  • 7 percent take more than 75 percent

Source: The State of the Incubator Marketspace, Harvard Business School, June 2000.

Keywords: best practices, for-profit incubators, research -- incubation

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