Tag Archives: Angel Investment Incubators

INCUBATORS: AN ANGEL INVESTOR’S BEST FRIEND?

 I.  OVERVIEW

Angel Investment Incubators were created originally as a way of making use of abandoned industrial space. However, recent events have encouraged incubators to focus on providing true value-added services. According to the National Incubator Association:

“A business incubator is an economic development tool designed to accelerate the growth and success of entrepreneurial companies through an array of business support resources and services. A business incubator’s main goal is to produce successful firms that will leave the program financially viable and freestanding.

These incubator “graduates” create jobs, revitalize neighborhoods, commercialize critical new technologies and strengthen local and national economies.

Critical to the definition of an incubator is on-site management, which develops and orchestrates business, marketing and management resources tailored to a company’s needs. Incubators usually also provide clients access to appropriate rental space and flexible leases, shared basic office services and equipment, technology support services and assistance in obtaining the financing necessary for company growth.”

Business incubators have experienced a tremendous surge in growth over the last two decades, swelling from just 12 in the United States in 1980 to over 900 by 2000, with 3000 in existence around the world. Much of this growth was fueled by a desire to find an active way for companies, government and the financial community to stimulate innovation and new business creation. Over 80 per cent of the incubators created in North America were “not for profit,” created as a tool of government economic development or linked to research organizations eager to see the benefit of their research work applied to the marketplace.

In the late 1990s, the dot-com boom created what appeared to be a major opportunity for a new generation of incubators in the private sector. Many saw this approach as providing a superior route to business success, as compared to traditional venture capital funding. Unfortunately, this business model was based on the false premise that money ploughed into start-ups in the first 12 months could be returned within 12 months, due to the high valuations that the stock market and acquisitions were placing on these companies. The collapse of market capitalizations for such companies resulted in a reappraisal of this model, not to mention the spectacular collapse of some incubators, such as NRG and Itemus in Toronto. Incubators created by large corporations, such as Nortel or OnX, which were seeking to capitalize on innovation from within their companies, have met similar fates. It has become obvious that current market conditions will not support such enterprises in the private sector.

Given this experience, universities and governments have begun experimenting with new “not for profit” models. These approaches are based on links between a community and a mixed-use incubator, and between a strong research organization, such as a university, and a technology incubator. Each of the new incubators has a different agenda, with different models achieving varying levels of success and sustainability. Today’s incubator manager needs to build on the most successful practices of other incubators, while fully engaging the local business community in fostering

Angel Investment Incubators

Angel Investment Incubators

new enterprises. Angels, too, are making an important contribution to creating regional wealth and, under certain circumstances, facilitating the growth of technology hubs.

The fundamental needs of new businesses remain the same – access to resources and support to help them survive the critical first phase of development. Indeed, the importance of business fundamentals and strong early stage development are being re-emphasized in the post-dot.com world. Incubators can play a critical role, not just as providers of space and equipment, but as a real axis of business advice and services and an environment of mentoring and encouragement.

Angel Investment Incubators can also fulfill four important functions for angel investors:

  • Supporting and developing angel investments in early stage companies.
  • Providing a source of high-potential, qualified deal flow.
  • Facilitating the creation of win-win relationships between angels and entrepreneurs.
  • Accessing a large community of interested parties who can provide networking opportunities for the new company.

Each of these roles is examined below.

SUPPORTING AND DEVELOPING AN ANGEL INVESTMENT IN

EARLY STAGE COMPANIES

The traditional model of incubators is changing. In addition to offering inexpensive and flexible space, as well as technology infrastructure and support equipment, incubators are also providing start-up companies with many value-added services and a much more comprehensive development process. This includes such help as refining the USP, active mentoring, providing the start-up with training, expertise and new businesses tools, and facilitating access to the financial community and to a range of business services, such as accounting, legal, public relations and recruitment.

Two examples of the training programs available to new business owners are the Ventures Innovation Incubator at the TIME Centre (Simon Fraser University), and the Exceler@tor (University of Toronto). Both programs offer workshops and training sessions for start-ups located in the incubator and for new technology businesses in the wider community. The TIME Centre has also held a one-day workshop focused on board governance for start-ups, designed to forge links between start-ups and the investment community.

One of the ways in which incubators help start-ups is by bringing them in contact with one another and with the wider business community. It is important for new businesses to have face-to-face contact and opportunities to network and share experiences. The Harvard Business Review, in an article entitled Networked Incubators, talked about the importance of these interactions in distinguishing successful incubation models3. Incubators, whether housing the start-ups in a collective space, or reaching them more remotely, are creating opportunities for new businesses to meet and interact. These interactions help to generate new ideas and encourage business owners to drive their enterprises forward.

The provision of shared physical space and equipment is still a core part of most incubation programs. This is especially critical for specific business sectors, such as biotechnology, which have a protracted pre-revenue development phase and where labs and equipment are very expensive. Incubators providing such facilities include the Laval Biotechnology Incubator, which provides inexpensive space and pools costly equipment so that the start-ups can focus on testing and building their businesses, rather than covering significant capital and operating costs. This is also true in IT incubators such as the Exceler@tor, where sophisticated IT technology infrastructure can be shared by the 25 companies housed in this Toronto facility.

As incubators evolve from sympathetic landlords to a source of significant knowledge and resources, they will dramatically increase the chances that a new company will succeed and grow and that an angel’s investment will be rewarded. The incubator will reduce the company’s burn rate, both by reducing its operating costs and helping it to secure more flexible financing terms. It will improve access to technology infrastructure and partners. It will allow start-ups to become better prepared to present themselves to the investment community. And it will provide a tightly formed network of colleagues and mentors, while helping enterprises to develop the necessary skills to thrive.

PROVIDING A SOURCE OF HIGH QUALITY DEAL FLOW

Angel Investment Incubators have traditionally set three major requirements for admission: technological innovation, willingness to learn and significant market opportunity. This makes them an ideal source of high quality deal flow for angel investors. In addition to helping turn technology innovations into businesses that are investor-ready, incubators can also prepare the start-up for negotiating a specific deal. The ability of an incubator to facilitate this marriage between new companies and angel investors will greatly increase the deal conversion rates and lead to higher levels of investment success.

Incubators, especially those run on or by universities, have unique access to research talent. This opportunity to build relationships with faculty and to raise the profile of business creation on campus often encourages researchers in the lab to create new businesses. This synergy is illustrated by the number of large and successful incubators located adjacent to campuses in Boston, North Carolina, California and elsewhere. Simply being close to the source of the discoveries, and connected with the research community, encourages the creation of new businesses and investment opportunities.

The second way that Angel Investment Incubatorsdevelop a strong pool of investments is by providing training and resources to make the new businesses “investor ready.” Incubators assist start-ups in developing a coherent business plan and offer presentation training, which can transform a lab researcher into an articulate businessperson. In some cases, they will find the right person, other than the inventor, to lead a technology company. Some angel investors say that this preparedness means that they pay more for investments coming out of incubators, as the business owners are more savvy and have thought through the value they bring more clearly. But this training is also reflective of their overall management skills and development, which makes them better deal partners than the average new business owner.

FACILITATING THE CREATION OF WIN-WIN RELATIONSHIPS BETWEEN ANGELS AND ENTREPRENEURS

Incubators serve investors by bringing them together with a hub of pre-screened investments. The creation of this unique “marketplace” facilitates deal flow and allows angel investors to identify investment opportunities that have received and will continue to receive training and support.

The incubator can also provide guidance on technology or market development to angels with limited experience. Many incubators even offer customized presentations, which introduce the angel to a set of potential investments that meet the angel’s criteria. This pre-selection allows the angel to achieve a higher deal conversion rate per presentation and makes the deal-making process more efficient. Such synergistic relationships between incubators and angels are just beginning to develop. Both sides can do a lot more to encourage this natural partnership.

ACCESSING A LARGE COMMUNITY OF INTERESTED PARTIES WHO CAN PROVIDE NETWORKING OPPORTUNITIES FOR THE NEW COMPANY

Angel Investment Incubators, given their role as a hub and their linkages to universities and research facilities, are in an excellent position to elicit partnerships with many organizations. For example, the Exceler@tor has strategic partnerships with Microsoft and HP, which enable it to provide more sophisticated technology solutions and a ready partner for early stage commercialization. Such partnerships also allow incubators to help their tenants by arranging for technology evaluations and collaborations and by putting these new companies in touch with prospective partners and even acquirers.

These relationships bring considerable value to the early-stage company, as do the interactions that incubators facilitate with the investment community, potential employees and the academic community. Start-ups operating outside incubators are unlikely to have the same level and number of relationships available to them.

AN EVOLVING MODEL

While Angel Investment Incubators have undergone tremendous evolution, there are still important developments underway to better align the interests of incubators, investors and innovative businesses.

In the original, rent-driven business model, incubators had little incentive to push start-ups to develop and outgrow the incubator, as this would truncate revenues. Today’s incubator is more likely to incorporate a model that allows for a return of value to the incubator at a subsequent stage, thus providing an incentive to encourage the new company’s growth. The Exceler@tor, for example, uses a warrants model to achieve this.

Angel Investment Incubators are also looking at new business models that allow them to generate revenues by providing training and continued access to services for their alumni. This could be done by taking a further equity or royalty position in the new business. Such an approach provides the incubator with much greater incentive to push the start-up to develop, leverage training and resources and grow the business, which in turn aligns the start-ups more closely with the interests of investors.

To attract investors, start-ups should be seen as ready to take on the challenges and realities of the business world. VCs sometimes consider incubators as negative selectors because the comfort of the incubator could prevent the aggressive growth of the business. If start-ups feel that their welcome at the incubator is never-ending, with cheap access to resources, they may become complacent and not push their businesses forward. To this end, incubators must set and enforce ongoing performance expectations and strict exit policies. They should also ensure that start-ups are paying appropriately for the resources they consume and meeting regular payment schedules. In some cases, substantial increases in monthly rent or service charges are advisable.

A specific challenge in university-run incubators is ensuring that decisions are based on business considerations. It is not unusual for a founder to maintain an academic mindset, instead of a competitive, commercial frame of mind. This will inevitably inhibit growth and commercial success. The incubator must ensure this issue is dealt with firmly, otherwise it will create problems for investors trying to instill a returns-driven approach to these businesses.

CONCLUSION

The mission of most “not for profit” technology-based incubators is to increase the survival rate of graduates and foster their acceleration in the commercial market space. Angels with limited technology knowledge and networks can significantly benefit by working with incubator management to:

  • identify likely incubator investment opportunities
  • rapidly complete the engagement process
  • maximize return on the investment, and
  • take full benefit of the resources and networking opportunities available through this special resource.

By forging strong partnerships with incubators and by sharing common goals, angels can identify superior opportunities among incubated companies and enjoy higher returns than they would otherwise receive by investing in individual opportunities alone.