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Incubators and Angel Investors
Woody Maggard Woody Maggard
President, CFI
Associate Vice Provost of the University at Buffalo SUNY
Director of the UB Technology Incubator
Amherst, New York

From the first incubator facility in Batavia, New York, about 50 years ago, today's business incubators have evolved into complex technology-focused settings that mirror society's own development. Now, in the U.S. alone, there are over 1000 incubators and new ones open each week.

Why this growth? Simply, incubators help to remove risk from enterprises, an extremely valuable outcome. Incubators are often one of the first investors in a start-up or early-stage company. Like "angels" (high net worth individuals, usually accredited investors), incubators provide more than money to create and grow new companies. Most incubators invest far more in a company than they receive in return and take on the role of a generous angel investor. Angels, because they invest at an enterprise's earliest stages, can find great va1ue in working closely with an incubator, not simply for development of a deal stream but for a compatible partner as well.

Incubators provide a structured environment for mentoring and services needed to establish successful companies. Whether the incubator operates a facility or delivers services in a virtual setting, all provide a set of targeted services and a value network designed to dramatically improve a company's chances for success. Research by the National Business Incubation Association (NBIA) has shown a success rate (still in business after five years) of 87% for companies developed within an incubator compared to a success rate of 20% of those outside an incubator.

Most incubators are non-profit entities focused on expanding local economies through development of high-growth, wealth-generating companies. They can provide client companies a range of valuable services such as on-site mentoring by seasoned entrepreneurs and professionals; advisory teams of top experts in the community in each area of business and technology; access to payroll administration, employee benefits and insurance; links to a major research university; support in applying for research and development funding; counsel on intellectual property, licensing, and related areas; and connections with ange1, venture, and lending financial sources.

The business incubator uses many of the tools of the angel investor to ensure company success. Both incubators and angels begin by screening the potential investment. Most incubators require at least a draft of a business plan to make certain that the business is considering the major issues in launching a new business. Along with the business incubator application, client companies must normally supply detail on near-term financials. Then incubator management interviews the company, and, if all goes well, the company is either approved, or is referred to a committee of volunteer professionals representing key business areas such as legal, accounting, technology, marketing, and entrepreneurial experience. Typically, about 1 in 10 applicants is selected, and an effort is made to have compatible, and not competitive, companies and technologies. Incubator companies often develop a family structure, based on their own interactions and programs of the incubator. This leads to companies assisting one another in marketing and business development.

Incubators often take a royalty or equity position in the company in return for the value-added services of mentoring, networking, and preparation of the company for financing. Usually these interests are small, about 3-6% in a mix, and designed to not interfere with raising capital. Many incubators have abandoned rental agreements, and instead use either permit or license structures.

Although the average applicant will initially state that money is only ingredient missing for their success, the incubator view is that the money will be there for the company if the company is properly prepared. The incubator maintains strong ties to capital sources, especially angel investors. The key factor for a successful incubator company is the willingness and capacity of the company to be mentored. While the incubator always respects the private ownership and investment of the company, it also expects to have its services valued. In addition to the mentoring, most incubators develop strong relationships with key large corporations that may create vertical pathways to market for their client companies.

This matrix of incubator services is nearly impossible to duplicate on a company's early capital, and they need to show a willingness to use the services. Angel investors, who often want to provide the value of their experience and insight in addition to funding, fit well with this structure.

Incubators and angels often go together. They have relationships with the prototypical angel investor who invests either on their own or with only a few others, and with angel groups that prefer to invest smaller individual amounts but benefit from group due diligence. Then, rounding out these contacts, incubators work closely with venture capitalists, banks and private equity sources to access alternative sources of capital.

Most incubators, particularly those taking a royalty or equity interest, focus on high-growth and wealth-creating companies. They seek companies with a high probability for a liquidity event (either an IPO or acquisition) as a means of providing an exit for investors. With this starting point they can often select and mentor a strong, de-risked candidate for angel investors. However, even with stringent criteria and efforts to create a growth candidate for IPO or acquisition, most companies will not produce a near term liquidity event. Instead they will evolve into a lifestyle company with private ownership and control that has a better than average annual growth rate. The good news is that the odds are in the angel investor's favor that they can either benefit from a liquidity event or work out an alternative exit if they invest in companies developing in a successful incubator.

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