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What history teaches us about startup incubators

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The wheel turns. Nothing is ever new – Sherlock Holmes, A Scandal in Bohemia.

Earlier this morning, I was reading this post by Andrew Clay Shafer where he artfully and correctly rants on the incubator madness that has spread across the planet. I’ve republished a portion of it below, but please do read the full piece for this snippet doesn’t do it justice:

“There has been an explosion of incubators in the last few years. Most of them suck. Some suck so bad that the net value created by the program is probably negative.

Let’s start with a story. The story goes like this. An incubator has a class of companies, they give them a little cash, they have a weekly session with a mentor or whatever, time goes by, demo day, no one gets funding, fail, fail, FAIL.

They tried to copy the Y Combinator model, and by ‘copy’ I mean cargo cult. They performed the outwardly obvious ceremony, but didn’t understand and thus couldn’t replicate the mechanics of cause and effect. Y Combinator has had impact on the dynamics of startup formation and funding not because of the exact details of a program. But the details are what cargo culters can see: three months, a dollar figure, weekly sessions, gogogo, demo day… the end, most of the companies dissipate.

At the end of the day, there is a fairly narrow band in the total spectrum of business opportunities that are venture fundable (though that band still represents infinite opportunities).

If you have an incubator that can’t make that hand off personally, or get the right audience in the room for demo day, then the value of the program is severely limited.  As much as anything that’s what the successful incubators are leveraging. YC leverages the personal connections and reputation of Paul Graham et al. Dave McClure is PayPal Mafia. He knows people and more importantly, people know Dave.

Updated At 7.45 pm PST: Paul Graham, one of the founders of YCombinator added.

I don’t think they will all flame out. We don’t seem to be. The model is different this time. The old model was practically an adverse selection filter. That’s why we’ve always resisted being called an “incubator.” Though frankly we may as well give in to that, because few people now remember the previous generation of them.

Well Paul, some of us still remember them :-)

Call it serendipity! An hour or so later, Hunter Walk shared an old article of mine, about what else: incubators, circa 1999, a few year before everything crashed and burned. I was naive and young when I wrote, Hatch Them Young.

Nevertheless, when I was reading back over that piece, it was quite noticeable that incubators (then and now) are essentially talking about the same thing. Same arguments are being made in 2012 that were made in 1999 though the execution is different. Seed rounds are smaller. The paid professionals are now called mentors. The cost of starting and failing is much lower. And as a result we have many, many more startups. I would also point out that the Internet of today is a whole different beast compared to what it was in 1999.

Here’s a portion of that article I wrote way back then:

“During the past couple of months, the number of new Internet incubators has shot up dramatically. The latest being Camp 6, a San Francisco-based incubator started by David Wamsley, the founder of Ad-Auction, an online advertising marketplace. At last count there were a dozen or so incubators that had cropped up in places as far apart as Washington, D.C., Colorado and Atlanta.

The current trend of incubators everywhere is a perfect illustration of the Net economy at work. In the fast changing Internet economy, it seems the only certainty is that if you have a smart idea, expect someone to duplicate it in less than a month. And then raise millions from venture capitalists! Or how else could one explain the myriad of online pet stores, e-drugstores, and an endless number of CD-retailers?

If run by a known name with an established track record, an incubator’s offspring can do very well. Take the example of first generation quasi-incubators such as CMGI or the Internet Capital Group and their spectacular run on the stock market. Those backing these incubators are surely thinking about their billion dollar fortunes. As one industry wag put it, why start one company at a time when you can start a dozen and profit many times over.

Nevertheless, incubators claim that they are doing both the startups and the venture capital community a favor and are bringing better companies to the fore front. “What we are doing is basically acting as a filter for venture capitalists who are finding it hard to invest the money they have in the startups,” says Neil Cohen, chief marketing officer at Camp 6. Four years ago, a typical first round investment from a top-tier venture capital firm such as Benchmark Capital or Kleiner Perkins would be around $3 million. “Today, unless they can invest $30 million or higher, these VCs do not even bother taking a second look at the business plans. We are filling a very important need,” boasts Cohen. As a result, he expects to see the number of incubators to increase sharply.

“This is not the end of the new incubators and within a couple of years there could be maybe 50 or 100 such incubators,” says Cohen.

What do these incubators really do? For starters, they provide office space, technology infrastructure, seed-capital (mostly about $250,000 or so), and access to some vital talent such as marketing and financial people, according to Cohen. “Mentoring and the hands-on approach is what is going to help the companies which are being incubated get to market faster,” says (Jeff) Levy.

“It takes about six months for a startup to get ready before they can face the venture capitalists for the first round of funding,” Cohen adds. “We bring in about 30-35 professionals that help in everything from brand positioning to public relations to fiscal management,” to get the companies on the fast track and ready for the first round of funding.Getting big time investors to fund an Internet startup is relatively easy. These big investors are counting on Levy and the team he has put together to find the next big thing.

“Speed is the name of the game,” says Pete Estler, who recently launched a Colorado-based incubator firm, iBelay. “We are an incubator on steroids,” says Estler, who started MatchLogic, a direct marketing company that he sold to [email protected] for $90 million in 1998. “I like to describe it as Internet accelerator.”

Well all these incubators ended up flaming out. Why do I feel that the history will repeat itself!

17 Responses to “What history teaches us about startup incubators”

  1. Ricardo dos Santos

    Hi Om. Think you’re definitively humorous but a little too harsh on the poor ol’ incubators…and especially the younger sibling, the accelerator. The ‘batch style’ accelerator can provide value in three forms. First, the ‘artificial’ timeline to get a better plan ‘A’ on the table just seems to work for most people. Second, if it’s established a high likelihood of a decent exit, e.g. $150K convertible note or something, then it ‘signals’ value just to get in, and thirdly, unless we’re all completely cynical about our capacity to learn anything new past the age of 13, it is a good way to pick up a few tricks of the trade for the current or future venture, aided by the peer environment (and competitive pressure)…thus, reality learning. Now this could mean that crap coming in just gets done quicker, has a better chance of a zombie life with a little funding and erroneous cause and effect gets propagated…but no one said this was easy or perfect :-)
    Yours, Ricardo dos Santos

  2. Saul Klein

    have always believed with seedcamp that:

    (1) you need to take a long long view
    (2) you need to build something that fits the needs of its market (in the case of europe – ours – it was about bringing a network together where there had been fragmentation)

    its all about the people – and as Andrew Shaffer says – the network behind and around them

    i agree there will be a lot more before there are less – like most innovation cycles ;)

    BTW _ my view in 2009 –

    “I know people say that long-term thinking is unfashionable in our industry, but I agree with Fred Wilson and my dad that great things take time. In my mind, helping to bring some cohesion to our region’s distributed network of talent, capital and advisors is a 15-20 year project.

    No single organization can achieve this. Even if Seedcamp is not ultimately a success – as measured by the success of the entrepreneurs who have been funded by it or experienced its programs – hopefully it will have helped to inspire some of the right thinking.”

    happy new year man

  3. Pascal Finette

    Om –

    Great read. And as much as I agree with Dave on the fundamental differences between 2000 and 2012 I also see a ton of incubators simply not offering enough of real, actual support for their portfolio. Their networks are weak, their differentiation is negligible and the money they offer is too little to make a difference.

    At the same time – let them be. The worst they can do is pour (some) money and resources into companies which might not be fundable. But hey – that’s okay. Consider it a free real-world MBA course for the founders. And if all we get out of this a couple more people who are bitten by the entrepreneur bug – that’s an awesome outcome!

    On the other hand you do have the amazing work YC, TC, Seedcamp, 500 Startups and many more are doing – and they clearly inspired some amazing offsprings in very different markets such as The Unreasonable Institute who incubates social change ventures or The Designer Fund incubating strong, designer-lead solutions.

    So – life comes and goes in waves. It’s all good.

  4. Harry Lin

    An interesting piece, Om – thanks for writing it.

    At the risk of initiating a semantics debate: an “incubator” isn’t the same as an “accelerator”. I don’t think that’s a distinction without a difference.

    The financial and organizational structure and the business philosophy at Idealab (15 years and still going strong! here in Pasadena Calif.!) are fundamentally different than Y Combinator or any of the other accelerators. Not necessarily *better* – just different, in both theory and practice. (We love the YCs of the world and want them to succeed.)

    I can’t speak officially for Idealab but if you wanted to see what’s different here, you’d probably get a good reception by asking.

  5. Kirsten Osolind

    Yup. I worked with Cyberstarts, an Atlanta incubator, in 2000. And I now live in Chicago, where Healthbox has recently sprouted (although they call themselves an “accelerator.” Also served on the Springboard Enterprises Midwest Venture Forum Committee (Springboard is a not-for-profit accelerator for women entrepreneurs). The #1 reason incubators fail? People. #2? Funding. If there is no link to funding, incubators have a hard time creating sustainable businesses. Sadly, university tech transfer efforts outside of Silicon Valley and Boston don’t work much better. Take for instance, U of M.

  6. Tony Fish

    Om, Happy New Year- great rant. I was one of those heading a wireless incubator in 2000/2001 and spot on it was a mess. Wrong model! Yes there is a lot of new ones out there today, “living the dream!” However, having launched one in London last year – there are other models now that you have not addressed, ones where we have learnt, grow up and now working. At IW ( we have taken a totally different approach. 1. no filter on the way in. 2. stay based on performance and delivery 3. only co-investment (no favoritism) 4. no mentors, training, coaching – teams have to be able to succeed 5. some “adult supervision” 6. no services and no extra charges 7. dedicated growth program 8. only share in growth upside 9. vibrancy trumps occupancy.

    Love to chat through the details. Please don’t put us all in the same camp…. thanks and speak soon.

  7. Joshua Ledgard

    I can’t speak for 1999, but having gone through a couple of application rounds ( and talking to some folks behind Techstars in the Seattle area I’m not sure how it could be a bad thing. Sure, a lot of the copycat incubator businesses won’t make it… but if there is a higher goal to advance technology and human knowledge… they seem to be all winning there.

  8. Chet Jain

    What you have mentioned is super correct, the real help and motivation is really missing! Everyone is getting into an illusion of starting up but their passion is not concrete enough to survive… money takes your passion away, passion keeps you dream alive, one should start something only if their passion is going to drive it not money. NoPay Startups is doing that experiment and trying to help true entrepreneurs to get going without money and just passion….. Cheers! – Chet Jain

  9. Om –

    “this time it’s different…”

    well actually, it is.

    differences between 2012 and 2000:
    – substantially greater audience (billions of people globally rather than barely tens of millions domestic)
    – broadband vs. dialup: way more high bamdwith usage than ever before
    – broad consumer use of social platforms; hundreds of M of people using facebook, twitter, etc that enables distribution
    – ever-improving monetization & payment platforms, even in developing markets
    – dramatically reduced cost for building, testing products, acquiring customers using free sw, cloud services, etc

    these days it does NOT take $5M to build a company; fail-testing can occur on a $50k budget rather than a $500k or $5m budget.

    that may not sound like much, but it is a lot when u factor in aggregate costs & sample sizes.

    • Dave

      Having known me as long as you have – the arguments you are offering up are nothing new or alien to me. In fact, I was writing about them long before they were conventional wisdom. So, yes, I get it.

      What has not changed – and won’t change is human greed. Back then too it was over-population of incubators that killed the ones that were working. Please don’t tell me the sprouting up of half-baked incubators is not a troublesome idea as Andrew outlines so well in his post.

      The analogy I was thinking was “strip mining” :-)

      Thanks for sharing your comment. As always, speaking from the heart. I like that.

      • well of course… “90% of everything is crap.”

        but still, in previous times they DID all flame out (altho Idealab still had it’s share of multiple-hundred million dollar successes)… and that WILL NOT be the case here.

        no effing way YC goes away, unless PG gets tired & retires. I don’t think TechStars disappears, and damn certain I’m doing my best to make sure 500 Startups not fade away.

        There will be some attrition for sure, but we ain’t all going quietly into that dark night good sir…