What history teaches us about startup incubators

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.

Call it serendipity! An hour or so later, Hunter Walk shared an old Forbes.com 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 Excite@Home for $ 90 million in 1998. “I like to describe it as Internet accelerator.”