Pros and Cons of Incubator Funding
Prior to launch, new businesses have to hire people; register the business name; formally organize the company as an Sub-S corporation, C corporation, limited partnership or LLC; and get banking services in place. Entrepreneurs also have to set up:
- Office space for managers and staff.
- Lobby and reception space.
- Meeting and conference space (white board, projector-screen capability).
- Communications infrastructure (phones, fax, internet).
- Computing capabilities (PCs, networks).
- Website hosting.
- Postal and overnight delivery addresses.
- Document processing.
And, most importantly, the venture has to get funded. For most startups, getting everything in place is a major headache. But for many emerging companies, launching at an incubator might be the one-stop solution to all the tasks outlined above.
Incubators are essentially ready-to-go space and support infrastructure for startup companies. They also may have a full-time incubator support staff to help you and your personnel with finance, marketing, sales, IT, strategy and other areas of operations. Under one roof, entrepreneurs can have turnkey access to professional reception and waiting area, mailboxes, parcel pickup, office space, meeting and conference rooms, and access to all the hardware and gadgets needed to conduct daily business.
Remember, a business incubator is itself an entrepreneurial venture, as investors have pooled their funds to secure a large building and outfit the space with its own support team and everything needed for dozens of startups to engage in business. The incubator generates revenue by charging monthly rental-access fees to the tenant companies.
But many incubators also have investment capital as part of their overall buffet of goods and services for entrepreneurs, taking an equity and/or debt position in incubator companies, thereby creating a portfolio of investment positions that provide some significant upside potential to the incubator's investors.
Having provided consulting services to more than 125 entrepreneurial growth companies since 1984, I'm very well acquainted with a wide range of incubator types and sizes used by more than a dozen of my clients. I also have hands-on knowledge from the insider's perspective, as a founding member of the Advisory Board for the Santa Barbara Technology Incubator (SBTi), which opened in late 1999. And I'm an incubator alum who launched my own company--TechKnowledge Point Corp.--at SBTi in 2001. (We "graduated" to our own facility one year later.)
There are, of course, both pros and cons to securing capital funding from the operating partners at the incubator.
The benefits include having a hands-on team of incubator support staff working closely with you and your company. The staff works for the incubator partners, so they have a vested interest in seeing your firm succeed, beyond simply collecting rent on your space. Other startups in the incubator who are also in the investors' portfolio of companies can also develop with you a good degree of camaraderie among the many entrepreneurs, company employees and the support staff, as all parties get to see tangible evidence every day of each other's struggling and working hard to be successful. The incubator investment team will also likely have a wide range of network referrals with specific expertise that your firm can tap into. After all, the investors want the incubated company to grow and be profitable, so once again the vested capital stake can serve as a powerful link to bridge your operating and strategic needs to knowledgeable and well-connected professionals in your industry and market space. And finally, the incubator investors may also like to take an additional personal investment stake in your firm or have excellent referrals to serious qualified investors who will have interest in your firm.
But the irony is that many of those benefits can also be reasons not to do capital funding through an incubator. The incubator staff and management team might actually end up being more of a distraction to you and your personnel, as they may exhibit stronger allegiances to the incubator investment manager, whose perspectives and expectations for company direction and plans may be at odds with those of the entrepreneur. There could be various forms of micromanaging from the incubator personnel and/or investors, with the pervading feeling that the site staff, investment manager and even incubator shareholders are always looking over your shoulder to monitor business progress.
The decision to get capital through an incubator's investment fund must be carefully evaluated, regarding both tangible financial and other intangible costs to the startup business. But the right fit and situation could also be the perfect place from which to gain both money to implement your business plan, and the market/industry traction in those critical early months of the launch, that are together the keys to your success.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.