HOW INCUBATORS WORK
Even before startup entrepreneurs are ready to seek out a first round of venture capital, they need the time and resources to develop their businesses into models that venture capitalists will find attractive. This is especially true for companies seeking to attain venture capital from the leading VC funds, which typically gravitate toward larger projects and have less time for seed investment for the initial development stage. Incubators thus saw a market niche in the business development market to provide an economy of scale unavailable to early-stage companies. Business acceleration is their line of work, in that they take a concept under their wings and nurture it through its early growth period and turn it into a living company. They exchange their initial capital investment and expertise for equity in the startup company.
Incubators are full-service company accelerators, offering everything from finance capital and management expertise to marketing analysis and legal advice. They tend to provide their e-commerce companies with office space, ample facilities and infrastructure, and recruitment services so as to attract executives capable of making the business stand on its own. Typically, incubator firms maintain their own staff to comb over the companies' business plans and implement Web sites and technological infrastructure, while at the same time seeking out venture capital funding and creating equity pools for each client. Once the companies are prepared to stand on their own, they are turned loose to generate their own later-stage venture capital and move toward an initial public offering (IPO). Incubators generate their own profits primarily by reaping returns on their initial investment, as the formerly incubating firm grows and its stock price soars, the value of the incubator's original stake grows as well.
Incubators vary considerably in the degree of control they exercise over their incubating companies. Some incubators concentrate primarily on sheer volume, and therefore have less time and resources to devote to the development of their firms. Others, however, exercise extensive authority over the direction of the companies' development, since the incubator's success depends on the eventual success of their companies and because brining startups to life is, after all, the incubator's area of expertise. In general, this is the main feature distinguishing incubators from venture capitalists. While some VC firms take an active role in guiding a company's development, incubators' activities often border on co-founding firms, and even the most hands-off incubators have more direct participation in the company's early gestation and growth than do venture capitalists.
Successful incubators require more than just a thick wallet and high-powered connections, a fact many incubators in the early 2000s discovered to their dismay. In addition to ample capital, for an incubator to truly generate a sustainable business model, it must be able to provide the kind of hands-on support that will be able to generate excitement about the product or service the business is offering. It also must be able to put the firm directly into contact with its potential customer base. Most importantly, the business must have a long-term plan for profitability and a route toward repaying its benefactor's initial investments. This seemingly obvious rule was often lost during the height of dot-com mania, which had some enthusiasts insisting that the laws of business were forever changed by the new economy. Incubators in the 2000s were likely to be much more sober-minded in their expectations, analysis, and in the practical guidance they offered to incubating firms.
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