Revisiting Incubators: Think Locally, Act Locally –

They are a tried-and-true dating spot for venture capitalists. U.S. Venture Partners used one to find portfolio company Engineered Intelligence, Blueprint Ventures got matched with SpectraSensors, and MPM Capital used one to find a soul mate in PharmAthene.

They are incubators run by local and state governments.

Some seek to make themselves a new focal point of up-and-coming technology where little or no venture investing exists. Others look to take advantage of large companies that have already brought technology to their area. Still others are happy to break even at the end of the day and have a handful more jobs in town than before they started. However they’re structured, local incubators all share the same desire: getting VCs to fund and help spin out their companies, thereby lifting the economic fortunes of their communities.

For venture capitalists, local incubators serve to not only add an extra layer of due diligence, but also to give their portfolio companies a leg up with free or low-cost resources.

Mark Lieberman, the administrator who runs the Business Technology Center (BTC) of Los Angeles County, says he has noticed a heightened level of interest from traditional VC firms. “The atmosphere has changed,” he says. VCs are showing renewed interest in incubators such as BTC, Lieberman says, because they need better sources of deal flow. A more rigorous due diligence process requires greater resources, and VCs are served well by incubators that require a healthy level of due diligence themselves, he notes.

As proof that incubators are doing what they’re supposed to, Lieberman points out that more than half of the companies supported by the BTC have received VC backing since BTC was founded six years ago. Among them is SpectraSensors, a fiber optic sensor provider that raised $6 million from Blueprint Ventures and Forrest Brinkley & Brown.

Lieberman says that another of his portfolio companies recently received a term sheet from a venture firm and expects to raise some capital soon.

ViaSpace, a BTC portfolio company whose mission is to spin out technology from labs, was valuable to Blueprint. It helped spin out key technology from the Jet Propulsion Laboratory that forms the core of SpectraSensors. BTC’s ability to spin out intellectual property in the shape of a viable company worthy of venture investment was what made it useful, says George Hoyem, a managing partner at Blueprint and a SpectraSensor’s board member. “From our perspective this is all about IP [intellectual property] spinouts,” says Hoyem, who points out that seven of Blueprint’s last 11 deals were IP spinouts. “Two guys with a PowerPoint presentation sitting in an incubator isn’t that interesting, but to take a deep technology and leverage a group like Viaspace to get something out of Jet Propulsion Labs is pretty interesting.”

No one tracks the entire universe of government-run incubators, but industry watchers estimate the number is in excess of 160, and includes incubators backed by economic development agencies, states and universities. There are 20 state-run incubators alone in the United States, according to the National Business Incubation Association (NBIA).

Like the local venture funds that have sprung up over the past several years in places such as Pennsylvania, Ohio and Illinois, local incubators have been launched to spark local economic development and establish beachheads for venture-backed technology outside the traditional spheres of Silicon Valley and Boston.

Focus, Focus, Focus

The City of Beaverton, Ore., is the lead investor in a new incubator that wants to make the Portland suburb a hub of open source technology. The Open Technology Business Center (OTBC) officially opened for business on Feb. 1 with $1.2 million in funding from the City of Beaverton, the State of Oregon and the Open Source Development Labs. It hopes to raise another $1.5 million over the next three years from corporate sponsors, says LaVonne Reimer, executive director of OTBC.

“I equate the evolution of the incubator models with the evolution of dot-coms,” Reimer says. “We had a first wave and we had a noisy crash, but that doesn’t mean dot-coms went away. It’s just that the concept evolved and the second wave started. It’s the same with incubators. We have opportunities to re-think the model.”

Re-thinking the model is what led to the narrow focus of OTBC. “The [incubators] that really have a sharp industry focus are far more likely to turn out more successful companies than ones that act like an executive suite,” Reimer says. “It allows for better relationships and alliances between industry and the startups. If you try to be all things to all people you run the risk of being mediocre.”

Reimer says that an incubator’s sharp focus allows for better relationships and alliances between already successful companies and the incubator’s startups. Local VC Gerard Langeler, a general partner with OVP Venture Partners’ Portland office, agrees. “By having a focus you limit your market, but your chances of success are also higher,” he says. “You can be sure we will be camped out around LaVonne Reimer’s incubator looking for the best ideas and teams.”

Home Sweet Home

John Elstner, executive director of the Chesapeake Innovation Center in Annapolis, Md., credits his incubator’s focus on homeland security with its success in finding funding for its companies. Among its success stories is PharmAthene, which makes anti-anthrax drugs. PharmAthene raised a $27.8 million Series B in November 2004 from Bear Stearns Health Innoventures, Healthcare Ventures, and MPM Capital.

While incubators still have not entirely lived down their reputation as poster children of dot-com excess, observers say that the venture industry will be seeing more incubators, particularly as cities outside of Silicon Valley try to get their slice of venture funding pie. “As the economy continues to improve, it further encourages efforts and new starts,” says Matt Blanton, managing partner and CEO of STARTech, a privately backed incubator in Richardson, Texas. “There’s a need for it, and hopefully we’ll see more incubator and accelerator models and people coming forward to create them.”

“The attitude of VCs that are really paying attention is getting better and better,” says Brian Clevinger, a managing director with St. Louis-based Prolog Ventures. “That’s because the incubators are getting better and better.” Clevinger sits on the board of an incubator in St. Louis called the Center for Emerging Technologies (CET).

“VCs are more interested in incubators not because VCs have changed their tune, but because more incubators are providing what they’re looking for,” Clevinger says. “Incubators used to be just real estate plays. These days most people understand that simply filling buildings doesn’t just work and you have to have good management and value-added services for these companies.”

Like many government-backed incubators, CET is a partnership between government and the academic world. CET’s operations are funded by the University of Missouri-St. Louis and the Missouri Department of Economic Development. Local venture firms Prolog and RiverVest Partners were instrumental in getting outside VCs to invest in portfolio companies from the incubator, and the incubator estimates that its companies have raised more than $500 million in outside funding, including venture and other funding.

CET saw its first exit last summer when Stereotaxis, which develops therapeutic and magnetic medical surgery technology, raised $44 million in an IPO. The company, which is still housed by the incubator, had raised about $120 million from VCs, including Advantage Capital Partners, Advent International, Alafi Capital, CID Equity Partners, Gateway Associates, Innoven, Mellon Ventures and Sanderling Ventures.

The Filter Factor

One of the reasons VCs are attracted to incubators is because they act as a type of filter. “Walking the halls of a university or a federal lab and trying to do tech transfer is brutal,” says Matthew Harris, a managing general partner with Village Ventures. “If you have someone who can filter that for you and do the first line of due diligence, that can be incredibly useful. Having a successful dynamic incubator is definitely on the list of positives.” TEXbase, a Village Ventures portfolio company that was incubated by Tech Ranch-an incubator sponsored by Montana State University-illustrates how successful companies can emerge from unlikely areas, Harris says.

Kathy Kregel, executive director of Colorado’s Fort Collins Technology Incubator, says she is very selective in determining which companies to bring into the incubator. VCs “said they appreciated any companies I brought to them because they know that they’ve been through at least one level of screening,” she says.

Kregel credits the success of her incubator’s portfolio companies to her selectivity of companies and her setting up the incubator from a VC-centric standpoint. “When I was hired to get the program going, one of the first things I did was to visit with as many VCs as I could. Those meetings set the direction for the incubator,” she says.

It shows. Companies housed by the Fort Collins Technology Incubator have raised a total of $37 million in venture funding. Kregel cites Engineered Intelligence (EI), which is backed by U.S. Venture Partners, as one particularly successful company.

Jim Gutowski, vice president of marketing with EI, credits the Fort Collins incubator with giving EI “some credibility” and helping it with fundamentals. Kregel “brought in successful and unsuccessful local executives,” Gutowski says. “They told us what was good, what was bad and what to watch out for.” In addition, the incubator provided services, such as a patent attorney, at a discount, he says.

Unconvinced

Not everyone is sold on the notion that government-backed incubators are a good idea. Donald Elmer, managing general partner of Seattle’s Pacific Horizon Ventures, spent a good part of the 1980s with Trinus Partners, a Seattle-based IT incubator. “If I go back to my own experience, one of the underlying thoughts was, Gee, if you can isolate some of the real world factors from the entrepreneurs, you can really help them,'” he says. “Twenty years later, as I think about it, it makes more sense to not try and remove real world conditions. That’s part of the entrepreneurial process. We’re looking for entrepreneurs that are able to deal with those things.”

Elmer says he’s not anti-incubator. “For some people they work OK. But they don’t work for us,” he says. He declined to name names, but says three or four companies that he has worked with that were previously incubated have not fared well. “What is not helpful about the incubator mindset is the culture that goes with it,” Elmer says. “It’s not that they do specific things or don’t do specific things. It’s the culmination of those things.”

Some VCs have not been impressed with state or local government-sponsored incubators and describe them as generally lacking in services to their portfolio companies and out of touch with the venture community. “The state and local incubators don’t have that same kind of sizzle,” says Village Ventures’ Harris.

He adds that his firm hasn’t had the same attraction to state or municipally sponsored incubators as with other incubators (like Tech Ranch), which are sponsored by VC firms or affiliated with universities. Municipalities or states will often simply offer office space at a below-market rate and call it an incubator without adding any of the services needed to attract venture money, he says.

Email: