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The Risks of Corporate Incubators May Outweigh the Generous Rewards

Corporate incubators can nurture a small startup with big company resources.

Corporate incubators can nurture a small startup with big company resources.  Photo by Pete Prodoehl.

We have seen a recent wave of fortune 500 companies breaking into the entrepreneurship game by establishing their own corporate incubators – Nike, Google, Microsoft and Samsung just to name a few. This article provides an overview of considerations for whether your start-up should accept an offer to join a corporate incubator.

Overview of Corporate Incubators

Corporate incubators are industry specific accelerators that help start-ups and entrepreneurs build a successful company/product but only within the structure of a large corporation. As compared to the traditional accelerator (e.g. Techstars or Ycombinator) that invest money and resources in a broad array of startups which span many platforms, corporate incubators are designed to help the sponsor build a portfolio of long-term product options, develop offshoots to existing products and generate innovative ideas that can help the sponsor grow its profits.

Why Established Companies Seek to Incubate Startups

Corporate incubators and accelerators are a vital source for idea generation and growth. Particularly for markets that are constantly evolving, an in-house incubator can help large companies pivot and change directions or develop a new business quickly. Even for companies in mature industries where M&A is drying up quickly (i.e. manufacturing or many food & beverage sectors), incubators and accelerators have become a part of their corporate structure to derive new profits. Not only do corporate incubators provide valuable ideas but they can also provide a company with home grown talent if the company runs short on valuable human capital. Given the level of visibility and access corporate executives have to talented young entrepreneurs through the incubator, it is not uncommon for the sponsor to make employment offers from its toy chest full of start-ups.

Benefits to Joining a Corporate Incubator

While joining a corporate incubator may seem like “selling out,” the benefits of a corporate sponsor may be too much temptation for any starry-eyed entrepreneur to resist. Corporate incubators give a start-up access to the company’s vast array of resources such as R&D, legal services, mentorship and often stable financial assistance to help the start-up scale its business. Furthermore, as compared to your typical accelerator or incubator, corporate incubators are generally industry focused and can provide tailored mentorship and resources that even some of the top accelerators such as Ycombinator or Techstars may not have access to. Not only are the resources a substantial benefit but another advantage is that a corporate incubator can immediately place a start-up on the radar of a strategic acquirer. Getting support from a corporate sponsor can be a significant step in the right direction for a start-up and often signals that the entrepreneurs may be on to something big and therefore should think seriously about an offer to join a corporate incubator. Like most things in life, however, there is often no such thing as a free lunch and there some serious challenges that start-ups should be aware of before joining the corporate payroll.

Considerations to Joining a Corporate Incubator

(1)  Make sure you have clean title to your intellectual property

Joining a corporate incubator can be tricky when it comes to IP related issues especially when dealing with who owns any new IP that comes out of the incubation process. Before starting at a corporate incubator, make sure that all IP that has been created by any of the founders or employees has been documented and assigned to the business. While negotiating with a corporation is not easy and offers are often provided on a take-it-or-leave-it basis, try to work with legal counsel to ensure that any and all IP developed while in the incubator belongs to your start-up.

(2)  Corporate bureaucracy can crush a start-up’s flexibility

One of the best aspects of being a start-up is the ability to be nimble and make quick decisions when needed. Large corporations are often not afforded this benefit as their size and governance structure can slow decision-making. If the corporation running the incubator obtains certain veto or control rights in a startup, that startup may lose its ability to make quick decisions. Getting caught up in such corporate bureaucracy and indecision (or a slow and lengthy decision making process) can quickly destroy a budding company. A startup can protect against this risk by closely reviewing the deal documents and avoiding granting the company running the incubator control over important decisions that a startup needs to make quickly (i.e., hiring, product direction, market strategy, issuances of equity to new hires, etc.) If the company running the incubator insists on such control rights, a startup should get to know and staying aligned with the key corporate decision makers and stakeholders.

(3)  Corporate sponsorship may drive away venture capital funding

If you do choose to join a corporate incubator, don’t be surprised if you don’t have too many venture capitalists knocking on your door at the end. While VCs won’t necessarily be bothered by the “selling out” aspect of corporate sponsorship, they will be very concerned about having to deal with XYZ conglomerate as a significant investor not only with a sizeable equity stake but also potentially pro-rata rights and big city corporate lawyers to enforce all the initial investor rights agreed to by the start-up. Even if VCs can get over having to deal with the corporate sponsor, many will be concerned with whether the management team has that magical start-up wherewithal that makes them worth investing in. VCs often view companies in corporate incubators as being hand-held and as a result may not have learned the hard lessons necessary to run and scale a successful business.

Conclusion

Joining a corporate incubator or accelerator can be one the best steps a young and potentially successful company can take and should be given serious thought if such an offer should present itself. It is important, however, to understand the risks of doing so and what it can mean for your company’s brand, image and future opportunities as it starts to take-off. Finally, if you do choose to join a corporate incubator, always always always have a well thought out Plan B in your back pocket as large companies are known for pulling the plug on such corporate programs without much notice even with the slightest downturn in quarterly earnings.

 

 

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Financing a Startup Company Series: Incubators

Incubators may be able to nurture the early development of your startup for a more prolonged period than an accelerator program.

Incubators may be able to nurture the early development of your startup for a more prolonged period than an accelerator program.

This post continues our Financing a Startup Company Series and focuses on startup incubators.

Somewhat similar to accelerators, incubators provide office space, mentoring, networking opportunities and access to investors for startup companies.  The ability to share office space and business services (financial, accounting, legal, etc) with other startups can lower costs and lead to useful exchanges of ideas and advice.

There are major difference, however.  First is the time that the startups spends with each option, and the intensity of the experience during that time.  An accelerator program is designed to get business on the fast track and have them in and out within just a few months.  An incubator, on the other hand, will often allow startups to stay for multiple years as they develop and grow.  There is thus less time pressure to prove your business idea in an incubator.

A further difference is that incubators don’t usually offer seed financing like accelerators do.

Third, while most accelerators take equity in the startups in their program, many incubators simply charge a monthly rate for the use of their space and services.

Not all incubators are the same.  There are huge differences among incubators in their mission, services offered, industries served and other aspects of the incubator experience.  It is vital to check out the available options and ask a lot of questions before choosing the right one for a particular startup and its team.

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Financing a Startup Company Series: Accelerators

Accelerators can provide an early source of seed capital along with intense mentoring, pitch practice, and access to other resources.

Accelerators can provide an early source of seed capital along with intense mentoring, pitch practice, and access to other resources.

This post is part of our Financing a Startup Company Series and focuses on accelerators.

Accelerators, such as Y Combinator and TechStars, differ from other sources of early capital: a startup and its founding team move to the accelerator’s location and participate, with other startups, in roughly a three month rigorous program of business development.  As part of the program they provide significant mentoring and education, as well as cheap office space and business services.  As such, they are well suited to help relatively inexperienced entrepreneurs build their network, hone their pitch skills, develop their product or service, and find their first customers.  If a startup successfully completes the program, it can gain valuable access to the accelerator’s network of angels and VCs for the next round of funding.

Accelerators often invest around $25,000 and take a 5-12% equity stake.  Some will participate in later rounds, others do not.

Before enrolling in an accelerator, get to know each of the incubators: there are a lot of them and they differ greatly.  It is very important to research the program’s strengths and weaknesses. Finding the right fit is very important as a lot of the value provided by an accelerator is bringing together complimentary businesses (and entrepreneurs) into a class, its network of advisors, and its connections in the VC world. Just as there are tiers of universities and universities that are good in one area but not another, there are tiers of accelerators and accelerators that are better in certain industries.

When considering entering an accelerator, read the terms of the deal carefully!  Although many try to create “company friendly” term sheets, some accelerators seek ongoing control rights over the company, even after it leaves the program.  Be sure that you understand, and are comfortable with, each of the terms before signing.

Finally, often times the money itself is not an attractive economic proposition.  It is usually cheaper (in terms of the amount of equity that must be given up) to get cash elsewhere.  Founders should think carefully about whether the other aspects of the accelerator experience (mentoring, publicity, education, etc.) make an accelerator a worthwhile undertaking.