From the February 2001 issue of Entrepreneur

NASDAQ paints a picture that, at times, is grim; at others, uplifting. But there's no doubt: Tech companies that were riding a huge wave of prosperity just one year ago are now trying to plan for the erratic ebb and flow of a slightly less confident economy. Does that mean potential dotcoms have decided to wait for the next big wave? Hardly. Internet start-ups are still popping up in large numbers, and fueling those businesses are investors wanting to get in on the game. One of the fastest-growing areas of investment is the incubator.

As the name implies, start-up companies still in the "egg" come to incubators to get hatched. Armed with nothing but their experience and an idea, entrepreneurs can be in business overnight if selected by an incubator company. Entrepreneurs who would have started out in the garage can now start their companies in fully furnished offices with phone lines and servers, some cash if needed and high-level mentors just down the hall.

Today's incubators are a different breed than their predecessors. Whereas incubators were once the purview of universities and small-business organizations that typically charged entrepreneurs fees for their services, most new incubators are for-profit entities that help you in exchange for a piece of your company.

Choosing incubation over angel or venture capital financing means choosing different risks and rewards. Angels and VCs don't help as much on a day-to-day basis; the incubator, however, is always there. The incubator staff fills needed functions, freeing you up to focus on your com-pany's larger goals and strategies.

But you give up substantial equity with for-profit incubators. Tyler Orion, executive director of the Pacific Incubation Network, a San Jose, California, incubation organization that serves all Pacific Rim incubators, emphasizes the need to investigate for-profit incubators. "In for-profits, you'll give up 50 to 75 percent of equity," Orion says. "You have to carefully evaluate what you get and what it's worth. You cannot presume you're going to get what is promised. And you should talk to one of the companies they're working with."

Steve Sanford, CEO and co-founder of Icebox.com, and Peter Gumbel, editor in chief of Business.com, say their incubator experiences were invaluable in moving their companies forward in the competitive world of the Internet.

Why One Company Chose This Route

Icebox creates original online animation. The four founders of Icebox started in November 1999 with an idea for a Web site that would be fresh and cool and different for their 15- to 34-year-old audience. They wanted to attract the top creative talent in Hollywood as contributors, but they knew they had to do it quickly, for their competition had already organized. Pop.com, the partnership that included Steven Spielberg, David Geffen, Ron Howard and Paul Allen, had announced its intent to deliver digital content just one month before. (That venture never materialized, and the site is now owned by another company.)

All four founders of Icebox had quite impressive resumes. Sanford, 35, had founded and managed the new technology division at International Creative Management. The other three-Jonathan Collier, 39; Howard Gordon, 39; and Rob LaZebnik, 37-had built Hollywood reputations for their work on King of the Hill, The X-Files and The Simpsons.

The financial terms would have been substantially better with an angel in-vestment, but the Icebox team felt an incubator would accelerate the start-up phase. "We went to the incubator because we needed speed to market and we needed to scale the business quickly," says Sanford.

They chose a major incubator in the Los Angeles area: eCompanies, started by Jake Winebaum and Sky Dayton in mid-1999. The two are experienced entre-preneurs: Dayton, whom Sanford had known for several years, is the founder and chair of Earthlink, and Winebaum is a Disney graduate who worked on most of the Mouse's internal Internet projects. "We came here because Sky Dayton understood what we wanted to do and was passionate about it," says Sanford. "And we knew that Jake [Winebaum] had to think about content models before at Disney."

Icebox fit the eCompanies profile: It was a start-up with the potential to become No. 1 in its category, it used a concept that was fundamentally better online, and it met similar eCompanies criteria. Like most incubators, eCompanies is looking for entrepreneurs with track records who, while knowing what it takes to build a company, need help.

Starting with Sanford and a computer (the other founders kept their day jobs and contributed creative content), Icebox grew along the same path all incubatees at eCompanies follow. Sanford met with experienced teams headed by second-generation Internet executives in each of seven areas: business strategy, finance, recruiting, creative, technology, business development and marketing. The teams help founders build their companies until a permanent staff is hired-but, even then, they still work together in a symbiotic relationship. It saves time. For instance, the eCom-panies' recruiting department hires staff for all the start-ups. That frees up the entrepreneur's time for building the company fast.

Icebox went from idea to incubatee in only two months and launched its Web site five months later. The founders graduated soon after, sporting a strong man-agement team and a couple million in revenue. In addition, Icebox has continued to expand its offerings and has more than 23 programs, including its animated series "Starship Regulars," which is licensed to appear on Showtime.

Ideas Hatched Internally

Business.com serves as a combination directory and business library. The site allows users to search for businesses on the Internet by company name or industry. The information on Business. com is selected and organized by a team of 50 industry experts and library scientists-your own "librarians," if you will.

Business.com is new kind of incubatee, one where the idea is hatched inside the incubator and then handed over to a professional executive to develop as his or her own. Gumbel came on board with a founder's stake and the charge to oversee the development of content on the site, bringing his 16 years of experience as an award-winning reporter and senior editor at The Wall Street Journal.

Although Business.com had only incorporated in November 1999, the site "graduated" to its own space and self-sufficiency by May 2000 and launched in June. "The real challenge was to build the company quickly and efficiently, and that's where the incubator was a tremendous help," says Gumbel, 42. "We could focus on building a really strong product and didn't have to worry about being bogged down by details."

Christian Gunning of eCompanies says that 80 percent of the ideas incubated there are generated internally. In its first year, eCompanies reviewed 4,713 ideas, built business plans for 42 and chose 11. Companies are rejected for a variety of reasons, primarily unworkable revenue models, weak audience demand, lack of addressable markets or low expectation for VC funding down the road.

Companies that choose the incubator route still need to seek outside funding to grow. But when the incubated start-up seeks additional capital, the valuations are typically higher because the company has a launched site and a strong management team.

Is It Right For You?

Given that eCompanies created the very backbone of Business.com, Gumbel feels that the cost of the incubator was well worth it: "The most important thing that happened was when eCompanies bought the URL of Business.com for $7.5 million. That received a lot of publicity and was really the founding moment of the company."

Another graduate of eCompanies, however, thinks his venture's worthiness is only conditional. Because he gave such a large portion of equity to eCompanies, Brett Morrison, 31, co-founder and chief information officer of ememories.com, believes it will have been worth it only if his business becomes a billion-dollar company. Ememories offers film processing, online photo albums and free digital uploads. Morrison, along with partner Carlos Blanco, founded the company in 1998. They joined eCompanies in November 1999 after a cool reception from other investors. The incubator staff went to work in its usual, ex-pedient way; and according to research company PCData Online, by March 2000, ememories' site was No. 1 among sites that offer photo processing or photo sharing. The company recently signed a deal with Kodak that brought investment capital and affiliated contacts. Despite the early advantages an incubator delivers, Morrison cautions entrepreneurs to evaluate carefully the loss of equity. "If we execute the plan, we'll reach a billion, but we're not there yet," he says. "If it's not a billion-dollar company, it wasn't worth it."

Incubation seems right for many companies. The speed to market is a big advantage for Internet start-ups. With many of the functions handled by someone else, and with the help of mentors, the entrepreneur gets a jumpstart on the competition. But each founder has to decide whether the equity they give up to the new for-profit incubators is balanced by what they get in return.


Cynthia Harrington, a freelance writer in Austin, Texas, writes about business for a variety of publications, including Bloomberg Wealth Manager and Senior magazines.