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About Business Incubators… November 29, 2010

Posted by David Dirks in business strategy, Solving Business Problems.
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Do business incubators really create jobs in a substantive way?  According to the National Business Incubation Association, the answer is a resounding ‘yes’.  According to the NBIA, nearly 87% of small businesses using a business incubator survive to their fifth year in business versus only 44% of small businesses who didn’t use an incubator.  Business incubators are once again a hot topic in economic development circles around the country. According to the NBIA, there are about 1,200 active business incubators in the U.S. today.  Conceptually, small business incubators make all the sense in the world.  By providing low operational costs during the early stages of business development, incubators are placing a bet that by subsidizing some of the operational costs of doing business, these start-ups will have a better chance for survival.

Recently, Syracuse University published an extensive research project that focused on the performance of incubators.  Their research tells a different story.

“The findings reveal that the effects of incubation are potentially deleterious to the long-term survival and performance of new ventures. Incubated firms outperform their peers in terms of employment and sales growth but fail sooner…claims that incubators are highly successful and serve a significant number of businesses are overstated.  The comprehensive process used in this study to identify the largest possible sample of incubated firms uncovered a fraction of the number of incubated ventures that supporters of incubation claim exist.  While improvements are likely possible to the methods used in this study, this study roundly refutes the poorly documented and unpublished studies that cite much larger numbers of incubated firms and much higher levels of performance.  The methods and findings of this study showcase that more research is necessary to fully understand the effectiveness of incubation programs. Until then, these findings are instructive in helping and motivating business incubators to improve their past performance.”

The truth is, there isn’t a lot of substantive and unbiased research on the long term results of small business incubators.  If you don’t believe me, just look for yourself.  Lots of claims of success from the likes of the NBIA, which has an obviously biased interested in promoting the concept of incubation and others.

Are incubators important to economic development (since it’s reported that nearly 94% of them are non-profit and sponsored for local economic development)?  The short answer is yes.  There are certainly success stories of small businesses who have survived the early years and have grown out of incubation.  And we know that small business is the engine of job creation in the U.S.

Is public/private subsidized incubation an good long term investment?  Here are my thoughts on this based on my own research so far.

1.  Tighter vetting of potential applicants for an incubation program is a must. There is no amount of incubation that can fix a badly designed business model.  The failure rate of small business is high mostly because people start a business that has an inherent flaw.  Like starting a cash-intensive business without proper funding for the first 3-5 years or starting a business because it sounds like a neat idea until we found out that few people are willing to purchase the goods or services.  Having a business plan in hand means little if it isn’t vetted against the same kind of tough questioning and criteria a venture capitalist would use.  You don’t just let any business who can show you that they can pay for the incubation services in unless their business plan and model have been deeply vetted.  Many incubators are funded with public money and what I’m proposing helps insure that taxpayer dollars are invested in only the best of the start-ups.

2. Even after vetting the best small business opportunities, failure is part of the process. You have to expect to fail to some degree in order to succeed in the long run.  If you study the vetting process used by venture capitalists, you find that despite their best efforts, a percentage of their investments will fail.  That doesn’t mean you should run from the idea of either using or creating a incubator.  This just means that failure is an expectation in the early start-up phase.

The key question is: what have we learned from the failures that we can successfully transfer to new participants?

3.  Targeted versus generic incubator? Most incubators are general purpose in focus, which means they will entertain any type of start-up for admission into their programs after meeting their criteria.  My business sense is that a focused, industry-specific incubator program has the best chance of impacting economic development.  For example, if an area was focusing on solar power panels, then creating an incubator program to attract and retain those kinds of firms would be inherently a powerful way to have real impact in business attraction.  A industry-focused incubator program would operate on a triad of providing 1) specifically designed space suited to that industry, 2) Access to research & development available in that industry, and 3) access to investment capital be it private angel networks or other investment programs.

For an area that wants to put a stake in the ground that targets a specific industry, having an incubator program that has industry-specific expertise is a winning differentiator.

4. Intellectual capital is just as important as investment capital. The incubator subsidy is surely helpful to a start-up but I believe the quality of the intellectual capital that is made available to these incubator start-ups is even more vital.  There is no substitute, especially in the early stages, for providing seasoned and unbiased business professionals who can ask the right questions in their field of expertise.  Asking the right questions leads to helping the business owner/manager in their own learning process and education.  I believe an incubator has to have only the best available expert talent available to its participants.  Those that serve as the intellectual base for an incubator need to be vetted as well. 

5.  Regular and intensive business reviews of all participants is required. Incubation participants should be prepared to go through an intensive business review process based on performance benchmarks that have been set up as a part of the business plan/model.  If a business wants to participate and receive subsidized business services (especially from public money), it should be prepared to undergo a rigorous business review process that does a deep dive on current business performance.  This process allows the incubator leadership to assess and help identify resources for areas that need immediate attention…and before they become a real threat to long term success.

6.  An incubation program takes long-term vision. Community leadership, both public and private have to have a clear vision for the long-term effort required to create enough success stories to offset the public and/or private investment required for organic business growth. 

7.  Equity in participating start-ups should be explored. Today, most incubators look to break-even on the services they subsidize to start-up companies in return for the potential for new job creation and tax base expansion.  However, I would argue that to qualify for access to a powerful incubator program, start-ups would be required to give a percentage of equity to the incubator.  It might be a small percentage (perhaps between 5-10%) but it would at least provide an additional possibility of the incubator program generating more capital to invest back into the program when their equity position was sold.  The incubator equity would be in exchange for the subsidy received by the business.  In this scenario, incubators would not have to provide any additional funding other than their current program offerings to receive an equity slice.  I think that’s a fair proposition, especially for incubators that receive funding from public tax dollars.

8.  Organic business growth is a key differentiator for economic development. Traditional economic development relies primarily on new business acquisition and current business expansion as a measurement of performance.  Developing the infrastructure for becoming a magnet for new start-up business is a way for regions or counties to differentiate themselves from their competitors.  A high-performing, fully funded, and well-equipped start-up program tells other potential businesses looking to relocate that the area is truly committed to business expansion and job growth.

Business incubators I believe can play a critical role in long-term organic business growth.  The key to incubator success starts with engineering the program to run itself like a for-profit business.  An incubator with a strong, well vetted intake process along with a substantive and ongoing business performance/review process, and the best business support resources stands the best chance of creating lasting jobs for any region.

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