COMING UP FAST: INCUBATORS COULD SOLVE YOUR CATCH-22 PROBLEM - Through Brainspark, three ex-investment bankers are nurturing 16 internet start-ups. What are they doing to help? Chris Blackhurst reports

COMING UP FAST: INCUBATORS COULD SOLVE YOUR CATCH-22 PROBLEM - Through Brainspark, three ex-investment bankers are nurturing 16 internet start-ups. What are they doing to help? Chris Blackhurst reports - How good it felt. Standing on the roof terrace of a

by CHRIS BLACKHURST
Last Updated: 31 Aug 2010

How good it felt. Standing on the roof terrace of an office building in Clerkenwell, London's area of the moment, munching salami rolls, drinking Bud, drum and bass pumping out from the loudspeakers, everyone exchanging views and ideas. There was a feeling of belonging, of being at the cutting edge of the new economy.

The poster in the ground-floor reception said the Thursday evening gathering was a 'chance to meet other great minds'. So there we were, about 70 of us. I was conspicuous by being the only one in a suit and tie - as one of them said, 'so old economy'. Everyone else was dressed casually, in V-neck jumper, T-shirt, Dockers, trainers. Name badges were mandatory. No badge, no drink.

Looking at them, it was impossible to judge which would become dot.com millionaires. Perhaps all, possibly one or two, maybe none. But, thanks to their hosts, a company called Brainspark, they were on their way. These were the 'cubs', the fledgling e-entrepreneurs being nurtured and supported by Brainspark, one of the leading examples of a new type of business, the internet incubator.

Founded in May 1999 by three ex-WestLB Panmure investment bankers, Stewart Dodd, Richard Davidson and Noah Freedman, Brainspark is valued on AIM at pounds 155 million. Like all internet incubators, it specialises in funding internet start-ups in return for an equity stake.

In the past you might have associated the word 'incubator' with images of sickly premature babies, emergency care for infants in need. But, as we keep hearing, the new economy changes everything. The incubator is now, at least in theory, a symbol of health, sending clear signals to the financial community that this little investment baby is well worth keeping an eye on. As we shall see, commercial sickness has come back to haunt too many of the incubator community for comfort.

Some incubators like Brainspark offer more than simply funding. Unlike traditional providers of seed capital, they give their cubs office space and free access to administrative, management and technical know-how.

And they advise on securing that vital next stage for growth: second-round financing.

Parties, like the one at Brainspark's offices, are part of the getting-to-know-you process, of encouraging the would-be internet moguls to mix and spark off each other. As the rest of the poster said, with that curious, stilted punctuation of new media: 'Keeping the spark in Brainspark. To: Everyone. Opportunity: No limit. Aim: Grow.'

George Anderson was working in distribution and logistics for the Royal Mail. Now he helps run Petspark, an e-tailer of pet products, and one of no fewer than 16 internet ventures backed by Brainspark. For people like him, says Anderson, the role that Brainspark plays is enormous. 'Incubators take a lot of the hassle away. For people with no experience but a good idea, these firms allow them to concentrate on developing their idea, of realising its potential.'

In his case, Brainspark invested an undisclosed sum in return for a stake of around 25%. Typically, an incubator will invest anything up to pounds 1 million and can take as much as 40% of the business. Brainspark's Davidson says the investment his company makes is more than just plain money. 'Capital is just a small part of what we provide.'

There is an evangelical zeal about Davidson. And why not? At 25, he has seen the Brainspark family grow from three to 308 people, its premises expand and move from 500 square feet to 5,000 to the current 20,000 - and all in little more than the 12 months since the group was founded.

Since the idea of incubators was first conceived on America's West Coast, these nurseries have exploded onto the scene.

There are now some 350 worldwide. In this country, the industry leaders include Brainspark, New Media Spark (founded by dealmaker Luke Johnson and broker Mike Whitaker); Oxygen (PR guru Matthew Freud, Rupert Murdoch's daughter Elisabeth and others); Antfactory (a group of internet entrepreneurs); and E-start (Harvard graduate Jamie Mitchell). E-start claims to be different in that it does not take an equity stake in the companies it incubates (or 'launch-pads'), instead helping them to obtain venture capital from a number of big-name partners such as Nokia, Atlas and Amadeus.

No sooner has the incubator train started, though, than the wheels have begun to come off. Oxygen shares have plummeted since its stock market debut; NewMedia Spark bought Softechnet to strengthen its balance sheet; JellyWorks, another incubator, has been taken over by Shore Capital, a small investment bank.

The wounded list goes on and on. Pick almost any of the 50 or so incubators floated on AIM since September 1999, when dot.coms were all the rage, and you will find a tale of sky-high valuation, enthusiastic private investors and, to date, large paper losses. So concerned has been the Stock Exchange that it issued a letter to stockbrokers asking them to take greater care when recommending incubators.

The pricking of the dot.com bubble has left incubators holding chunks of equity in some businesses with little or no hope of ever going public - and of realising a return for its backers. The figures are alarming. A report from webmergers.com discloses that of 238 internet start-ups in the US, 41 have collapsed so far this year, 29 have been sold and 83 have withdrawn their initial public offering plans.

According to Tim Miller, president of Webmergers: 'A number of sites currently are running into brick walls when it comes to their 'B' round of financing or their initial public offerings.'

Miller now has more than 100 companies paying dollars 295 to list themselves on his site in the hope of finding a suitor to extricate them from the mess in which they have got themselves. For many, and for their incubator promoters, being bought is their only chance of any payback.

Still they come. Brainspark sees 10 business plans a day - down from the 20 to 30 at the market's peak but still a sizable number. The reduction has its advantages. Jamie Mitchell of E-start says: 'We're getting less of the dross. In a hyped-up market everybody and their dog thought they could be an internet entrepreneur. Now the dealflows are down.'

Across the industry the heady flush of excitement has gone, to be replaced by a grim pragmatism. 'If you've gone bust a few times it's like having a few swastikas on your fuselage - it's a badge to be worn with pride,' says David Bowen, chief executive of Net Profit, the e-business analyst and publisher.

The buzzwords in the market now are 'risk filter' and 'de-risking'. Incubators now like to talk in more conservative terms, of coming between the would-be dot.com king and the venture capitalist, of ensuring that, by the time serious money is sought, the risk of failure has been diminished. This subtle change hints at the prospect of upheaval to come. Mitchell predicts 'a lot of consolidation' for his industry, with the market eventually comprising 'three or four major players across Europe'.

Significantly, two giants have just entered the market. Benchmark has raised pounds 650 million for an incubator fund and Kohlberg Kravis Roberts has also set up a dollars 1 billion pot for internet start-ups. Debbie Wosskow at Mantra, a PR firm specialising in e-commerce, also believes that smaller incubators will disappear.

'Size matters,' she says. 'Don't forget, incubators take on the cost base of their start-ups. It's a Catch-22 - they need the scale to attract great businesses, they need great businesses to build the scale.'

Another key ingredient is quality of management. 'It is very important for incubators to attract well-qualified people from the big law firms, management consultants and accountants,' adds Wosskow.

So far, no internet start-up has become a major profitable success. Some ventures are washing their faces, the rest - if they are lucky - are still building. But if dot.coms, backed in their initial stages by an incubator, truly hit pay dirt, there are those in the industry who predict storms ahead.

Bowen at Net Profit, for instance, says there is little mystique about incubators. 'In the main, they are fancy venture capitalists who take a large chunk of the company in return for a bit of cash and an office.'

The management team of the start-up, says Wosskow, makes sacrifices.

'They might feel resentful towards the incubator, that they have given away an awful lot for nothing and too soon.'

Anderson of Petspark disagrees. 'They make a big investment in time and money and effort that justifies the return they might get. After all, without their investment we would not be in a position to head towards an IPO.'

At the Brainspark party there was no sign of any nervousness, no hint of worry. Of Brainspark's 16 cubs, three are cash-positive and theoretically could survive without further funding, three have achieved second-round funding, and three are close to securing more backing.

None has yet to make it to the IPO stage; equally, though, none has gone to the wall. There is no sense of a plan turning sour. Rather, there is a strong determination that their job is one of nursing and of tender loving care, of incubating, with all that implies. If targets take longer to hit, so be it.

Says Davidson: 'It will always take time to grow an investor base, to grow revenue streams. We are an incubator business and we are doing exactly what we are supposed to be doing.'

HOW AN INCUBATOR CAN MAKE IT HAPPEN FOR YOU

You have your big dot.com wheeze but you have no idea how to take it forward. The mainstream venture capital houses will not look at you - they're only interested in advancing large sums and at this stage you're just too small, and too much of a risk. Step forward the incubator.

Draw up a business plan - not too detailed but showing clarity and realism.

Ring one up. Ask to go and see them. Depending on their impressions of you, your presentational skills and your previous track record in business, and, above all, your idea, a lot can happen quickly. One incubator said its record from first contact to approval of an investment was two weeks.

Even that, in an economy that prides itself on speed and is still searching for 'the big one', may be too slow. If your idea is a cracker and you've got a good CV, you watch them move.

INVESTMENTS AND STAKES VARY Anything under pounds 50,000 will not get you anywhere.

Something in the low six figures with a 25% stake should tide you over.

Think, though: do you want to give up a quarter of your money-spinner for a six-figure sum? Can you get the money elsewhere, and still keep 100% of the business?

To be fair, incubators do not add other strings. They do not expect houses to be remortgaged or even the sums they put in to be matched. And they bring a lot more to the table than mere cash - the good ones, at least.

YOU ARE ON YOUR OWN You've quit your job to develop your idea. Friends and family think you're crazy - it can be very lonely. Good incubators end the isolation, putting you into a fully equipped and serviced open-plan office alongside fellow novice entrepreneurs. You may have to pay for computer hardware but, again, the incubator can use its size to get you a good deal.

AN INCUBATOR CAN HELP FIND YOU STAFF Nothing is more crucial in the early life of a dot.com than to secure decent management. Like you, an incubator will be in at the beginning. Later, you'll be able to chop and change employees, but right now you need people who are good and who share your vision and commitment.

SETTING UP THE SITE IS A MUST You have the idea but do you really know how to put it into practice on the web, to make it commercially viable, to ring-fence it from the competition? Good incubators have technological teams who do just that, who take your idea and make it work.

You may have been a marketing wizard in the old economy but do you have any clue about selling dot.com? Again, good incubators can tell you how - and chuck in specialist internet legal and accountancy advice as well.

ROUND TWO The endgame for the incubator is second-round financing, which involves going to a venture capital house and securing enough cash to take your idea on to an initial public offering. Forget pounds 1 million. That is peanuts. You will need many millions if you are one day going to become a dot.com millionaire. That is the incubator's main job, to assist you in growing your business and developing a plan that you can present to a big-time investor.

The incubator will not secure the funding for you - that is your job - but they will put you in touch with the right people (their recommendation can count for a lot) and help you every inch of the way. When you see the venture capitalists, you are on your own. But, without the incubator, the VCs would probably not be seeing you.

Oh, and good luck.

Find this article useful?

Get more great articles like this in your inbox every lunchtime

Upcoming Events

Subscribe

Get your essential reading delivered. Subscribe to Management Today