all
them instigators. Or catalysts or accelerators. Just please
don't call a company that hatches Internet companies an
"incubator" anymore.
Now that the fiery crash of Internet stocks has many
investors cursing dot-coms as the devil's spawn, the investment
companies that hatch dot-coms consider incubator a tainted term.
"It's like if your name was Monica before the Clinton
scandal, it was fine; but it's not now," said Bill Gross,
chairman and chief executive of Idealab, a Pasadena,
Calif., company that was the first and best-known, um,
I-word.
Mr. Gross knows the ignominy. Twelve days ago, tired and
dragged down by a cold, he canceled a much-anticipated initial
public stock offering for Idealab, warning that tough times were
ahead. Two days later, Eve.com, one of the largest beauty
sites on the Web and a company that Idealab had fostered, said
it was shuttering its doors and laying off most of its 164
employees. And last week, Scout Electromedia, another
company Idealab invested in, went out of business.
For an entire segment of the technology-financing industry,
Idealab's string of bad news has been a chilling sign of the
times. If Mr. Gross is losing faith in the incubator approach
these days, who else might hope to make it work?
"It's pretty clear by pulling the offering they admitted what
everyone knew all along," said David Dusenbury, a research
analyst in Credit Suisse First Boston's technology group. "There
is no market for incubators right now."
It was five years ago that Mr. Gross, already wealthy from
the sale of his software company Knowledge Adventure, conceived
and executed the idea of a technology incubator. The notion was
to offer shelter and succor for new Internet-related businesses
intent on getting quickly to market. By providing office space
and administrative support, marketing and public relations in
return for an equity stake in each of its wards, Idealab was
offering much more than venture capital firms which typically
dispense only money and advice.
Mr. Gross's concept was widely imitated as other
entrepreneurs and financiers watched fledglings like CitySearch
(which later merged with Ticketmaster Online) emerge from the
Idealab hatchery and show signs of taking flight. In 1999, when
Idealab spinoffs produced some of the year's hottest stock
offerings, like the e-tailer eToys and the Web search
company GoTo.com, Mr. Gross seemed to be sitting on a
nest of golden eggs.
Now, though, with the stocks of eToys and GoTo.com trading at
a fraction of last year's highs, the business model that Mr.
Gross cultivated is being called into question. Within two days
of Idealab's Oct. 18 announcement, Garage.com, which
provides financing and other services for high-technology
start-ups, announced that it, too, would delay its initial stock
offering.
And publicly traded investment companies like CMGI and
the Internet Capital Group, which have managed and
nurtured Internet start-ups but bristle at the I-word, have seen
their own stock prices plummet. CMGI's shares, which touched a
high of $164.75 in January, closed on Friday at $16.75. Internet
Capital, which traded at $212 last December, ended last week at
$12.
CMGI's chairman, David Wetherell, is as insistent that his
company will ride out the current turbulence as he is adamant
that CMGI is not and never has been an incubator. It is,
according to the Web site, a "leading global Internet operating
and development company."
"There is a method to our madness," Mr. Wetherell said.
"There aren't a lot of incubators with $1.5 billion in
revenue."
In any case, whatever they may be called, there are now some
400 companies, all pursuing a business similar in many ways to
Mr. Gross's Idealab. And some analysts and academics are
predicting that within a year, fully half these companies will
be out of business.
"The success of Idealab portfolio companies was noteworthy
but was not proof that the incubator model works," said Dave
Witherow, chief executive of Venture One Economics in San
Francisco, which tracks the venture capital industry. "It proves
the challenges and suggests that the model itself is not so
simple."
But like many of his peers, Mr. Gross contends that there is
nothing wrong with the business plan. Idealab has spun off 55
companies over the years, company executives said. About 50 are
still in business, while the rest have failed. It is currently
incubating 12 companies and will continue to create new ones.
"It's a mistake to read too much over all into this," Mr.
Gross said of the recent gloomy announcements. Investors are now
focused on profitability, he said, and any layoffs at the
companies Idealab backs are simply a reflection of that concern.
Besides, he added, Idealab spends only about $72 million a year
and recently raised $1 billion in a round of financing.
"I need to show people I can create value in bad times," he
said. "When people see what we can do, then they will come
back."
Of the $1 billion raised, two-thirds has already been spent,
said Howard Lee Morgan, Idealab's vice chairman. Much of that
money went toward buying larger stakes in companies in which
Idealab has already invested, but needed to increase ownership
so it could retain control, including CarsDirect.com. As
for the remaining $300 million or so, "we have enough money for
the next two to three years," Mr. Morgan said.
According to Morten T. Hansen, an assistant professor of
business administration at Harvard Business School, the median
first round of financing for a start-up at an incubator is
$690,000. But that does not take into account the additional
money burned if a company has to stay under incubation longer
than planned (say, for a third or fourth round of financing) or
if jittery investors demand that an incubator commit money of
its own as a show of confidence.
"You can go through money quickly," Mr. Hansen said. "For the
average incubator, that is expensive depending on how many ideas
fail."
In the old, time-honored approach to starting a business,
start-up expenses used to be paid for by the entrepreneur
(remember all those stories about plucky young companies
financed on the founder's credit card?), or by a venture
capitalist.
But after the notion of "Internet time" caught on and made
the old evolutionary approach to entrepreneurship seem as quaint
as carbon paper and Dictaphones, incubators popped up as the
sort of place where entrepreneurs could hatch their embryonic
ideas while getting instant access to technical experts,
marketing strategists and executive recruiters until their
businesses matured and could thrive on their own.
Of course, none of this came free.
Generally, like some venture capitalists, incubators command
a 25 percent to 40 percent stake in a company, according to a
study conducted by Mr. Hansen and his colleagues. And many of
the incubators in the study required a fee along with an equity
stake. Idealab, for its part, generates most of its own ideas so
it is able to keep a larger equity stake than in cases where an
entrepreneur brings an idea to the incubator.
Innovative as the concept might have been in the early going,
Mr. Hansen said that by now more than 8 of 10 incubators are
providing the same basic services, like public relations and
accounting. "It is a commodity," he said.
Of the 400 or so incubators in existence today, he said, at
least half have never hatched a company and will probably fail
in the next 12 months. "They have no viability," he said, citing
inexperience as a widespread problem.
Another criticism voiced by several analysts is that some
incubators that were formed more recently have focused too much
on the Internet fashion of the moment. Often mentioned in this
regard is the Internet Capital Group, which specializes in the
business-to-business e-commerce market. As that sector has
fallen out of favor, so have the companies that Internet Capital
invested in like Breakaway Solutions, a provider of
e-business products, and Onvia.com, a marketplace to help
small businesses buy and sell services and products. Shares in
both companies have tumbled more than 90 percent since reaching
52-week highs. And Internet Capital has also suffered from the
collapse of its own share price, making it difficult to use its
stock as currency for acquisitions.
"The size of the opportunity hasn't decreased," said Ken Fox,
co- founder of Internet Capital. "But building companies is
hard, and the Internet didn't make it any easier."
In Idealab's case, it may have focused too much on Internet
companies aiming their products or services at the consumer
market.
Idealab's portfolio of companies lets you buy almost anything
on the Web from pet products and cookware to bridal wear and
cosmetics. But analysts say the failure of the beauty site
Eve.com, which had almost all the makings of a winner lots of
traffic, $1 million in monthly sales and name recognition, but
no profit could foreshadow doom for the rest.
"We crushed everyone in the market and it wasn't enough," Mr.
Gross said. He said that in the future, Idealab would not limit
the types of companies it would create or invest in.
Mr. Hansen of Harvard contends that perhaps the most valuable
service incubators can provide start-ups is access to a network
of business relationships with more established companies. Some
incubators already do that, he said, pointing to Hotbank, a
Mountain View, Calif., company managed by Softbank Venture
Capital, an affiliate of the big Japanese investment company
Softbank.
Hotbank gives entrepreneurs access not only to the usual
incubator services, he said, but also to Softbank's roster of
partners, including Yahoo and Cisco Systems. But
only about one in four incubators are able to provide this kind
of relationship network, Mr. Hansen said.
In various ways, some incubators have begun to adapt to the
new, less hospitable financial climate. Ecompanies, an
incubator set up last year by Sky Dayton, founder of Earthlink,
and Jake Winebaum, the former chairman of Disney's Internet
unit, had trouble last summer raising a new round of financing.
So it has formed a partnership with Sprint to develop
wireless communications ideas. And last month, Ecompanies sold a
stake in itself to Evercore Partners, a long-established,
New York-based investment bank that was an adviser in the
Viacom-CBS merger and has traditionally put money in old-economy
ventures.
In the meantime, Mr. Wetherell's company, CMGI, has put the
brakes on acquisitions and is concentrating on consolidating
what it already owns. In the last few years, CMGI has acquired
34 companies and started eight others, Mr. Wetherell said. But
by next July, he intends to whittle those holdings down to 15
companies.
Idealab's Mr. Gross acknowledges that he has learned hard
lessons these last few months. "We've become very
self-reflective," he said. "Maybe it was hubris to think it was
easy."
He said Idealab would no longer acquire other companies, a
strategy he said had not paid off for his company anyway. But it
is conceivable that, if he regains investor confidence, Mr.
Gross would consider trying to take Idealab public again though
he would probably not call it an incubator.
"I believe I can take an `idea generator' public," he said.
"Just not in this market."
