Business incubators for sharing services were all the rage back in the days of the dot-com bubble (700 for profit, many more non-profit). About that time the bubble burst, causing more than 80% of them to disappear. Now they are coming back, and the best even provide networking, technical leadership, and seed funding, as well as shared facilities and space.

By way of a definition, a business or startup incubator is a company, university, or other organization which provides resources to nurture young companies, helping them to survive and grow during the startup period when they are most vulnerable. The goal of most business incubators today is to strengthen the local economy, and commercialize new technologies. A few are still trying to make money doing it, but it is hard to make money off startups.

Most incubators today provide one or more of the following:

• flexible space and leases, often at very low rates
• business support services for a fee, including administrative support, telephone answering, graphic services, bookkeeping, copy machine access, and meeting rooms
• group rates for health, life and other insurance plans
• business and technical assistance either on site or through a community referral system
• assistance in obtaining funding, or direct seed funding
• networking with other entrepreneurs

Incubators differ from research and technology parks, in that most research and technology parks do not offer business assistance services, the hallmark of a business incubation program. However, many research and technology parks also house incubation programs. Another variation is technology business incubators, which nurture high-tech startups and present a technology oriented variant of business incubators.

To find what’s available in your area, take a look at the National Business Incubation Association (NBIA) web site, and use the lookup tool provided. This organization claims to be the world’s leading organization for advancing business incubation and entrepreneurship. Another sure-fire approach to finding what’s available is to check local university resources – almost every one offers some services along these lines, or certainly can refer you to local alternatives.

The only down-side I have heard is that many business incubators used to be notoriously high-pressure environments where a lucrative exit strategy was more important than the half-baked products. If that’s the toughest problem you face as a startup, then you probably didn’t need an incubator in the first place.

The up-side is that startup incubator programs allow new startups to benefit from the wisdom of other startups and veteran companies through mentoring and by co-existing — in the same office or through the same venture funding — with other startups.

Incubators I hear mentioned most often include YCombinator, led by Paul Graham in Silicon Valley, and the VT KnowledgeWorks Business Acceleration Center at Virginia Tech, led by Jim Flowers. Both provide excellent networking, relationship building, and on-site technical leadership, which I believe sets them apart.

Jim argues that the real value of an incubator is in the relationships, and these work best when the entrepreneur has selected a real market opportunity, and plans to address it in a unique, powerful, and direct manner.

For that reason, he is a strong proponent of screening prospective clients carefully, selecting the best ones, and assuring that they can handle responsibilities, like paying the rent, and “graduate” in a timely fashion to stand on their own two feet.

Thus, if you are looking for an incubator for “free” money and services, you should think again. Look first for people there who can help you, by their introductions, mentoring, and experience. A successful startup is more about the right people than the right amount of money.

Sooner or later every entrepreneur thinks about raising funds from outside investors. Although many look forward to the process, others find the prospects daunting.

Few of us are personally acquainted with a venture capitalist or even an angel investor. But we have all heard stories about how difficult, capricious, and predatory they can be. What we tend to forget is that they are real people, businessmen and women just like us. Their business is making money by making investments, and it is important that you understand their business before you approach them. This summary is intended to shed a little light on the industry and the individuals who comprise it.

VC Firms

For our purposes, venture capital firms are defined as partnerships that invest and manage funds raised from major institutional investors. Investment banks, who primarily borrow the funds they invest, share many of the characteristics summarized below.

• VC firms are partnerships run by their general partners. These partners are very bright and work very hard. Most had highly successful careers in other industries before they became venture capitalists.
• Individual VC firms normally, but not always, focus on a combination of specific industries, geographic areas, and firms at specific stages of development. The industry as a whole tends to focus in certain of these areas, which change over time.
• Individual partners who make up a VC firm each have different areas of focus and expertise. One will be assigned to take the lead if they agree to consider investing in your business.
• VC firms raise the money they invest in the form of limited partnerships – primarily composed of institutional investors such as pension funds. They normally manage multiple partnership funds simultaneously, only one or two of which may be making new investments at any time.
• Each limited partnership fund is raised with specific industry and other investment goals in mind. The various funds under management by one firm may or may not have similar goals.
• VCs categorize potential investments by stages of development. The earliest stage any VC will consider is normally referred to as seed funding. Despite its name, this requires more than just an idea. In general, seed funding requires that the product or service be defined well enough to be tested in potential markets, that key members of the startup team have been identified, and that a business plan, either formal or informal, has been developed.
• Because of the higher risk involved, many VCs will not consider any seed stage investments. Many of those who say they will are, in reality, reluctant to do so. Investment banks almost never make early-stage investments.
• Each partnership fund has a finite life, usually 8 to 10 years. This means that any investment made by that fund must have the potential to be liquidated within that timeframe. Investment banks may have longer time horizons.
• VC firms seldom invest alone, preferring to spread their risk by investing in each deal as part of a consortium. Although some firms may work with other firms more than once, each deal is unique and is negotiated separately. One firm will agree to be the “lead” investor, which means it will be your primary contact and that one of its partners will probably sit on your board of directors.
• Some VC firms prefer to invest in startups where there will be an opportunity to make repeat investments as the startup matures. Others prefer to get involved only once, usually at one of the later stages of development.
• VC firms are concentrated in a few geographic areas, primarily Silicon Valley and the Boston area. Most have more than one office, with an increasing number of these branch offices being overseas.
• VCs never sign non-disclosure agreements. They see such a volume of deals that signing NDAs would be impractical and expose them to lawsuits if they eventually invest in a similar startup which came in independently.
• VCs invest a substantial amount of time and money (due diligence, legal fees, etc.) in each investment they consider seriously. Accordingly, they only make a handful of new investments each year.
• No matter how good the business plan and the team which executes it, VCs know most startups they invest in will never achieve their goals, and a few will fail completely. Thus, each investment must have the potential for a significant return on investment (usual 10X or more for early stage startups) to mitigate this risk.
• Because of their need for high potential returns, most will only consider investing in businesses based on a paradigm-shifting technology or other idea.
• VC firms are never passive investors and will insist on at least one seat on your board. They can be a great help to a startup, as they have extensive expertise and networks in the industries involved. If the startup starts to miss key milestones or otherwise gets into trouble, the VC’s involvement will become more proactive and, in extreme cases, may result in their insistence on new strategies or even new management.
• VC firms receive hundreds of unsolicited proposals each month. Some actually assign a junior staff member to review these – but few, if any, are seriously pursued. Plans outside the firm’s areas of focus are especially apt to be discarded quickly.
• The best way to approach a VC is through a reference from someone they know – often a law or accounting firm. Even better would be an entrepreneur they have previously funded, or another VC or Angel Investor with whom they are personally acquainted.

The banking crisis which started in 2008 has been hard on the VC industry.

• Liquidation events, both IPOs and sales to established companies, have been harder to arrange and are at substantially lower valuations than previously.
• Many of their portfolio companies are in trouble, requiring that VCs focus most of their time sorting them out, with limited time left for evaluating possible new investments.
• Many VC firms have reserved most, if not all, of their remaining uncommitted funds for helping their existing portfolio companies weather the current economic storms. This leaves them with little, if any, funds available for new investment opportunities.
• New limited partnerships have been harder to organize and fund.
• The industry is contracting. There are an estimated 600 firms in the U.S. today, down from 2,000 a few years ago. It is expected to shrink even more, to around 450 firms, within the next couple of years.

Despite the above challenges, some firms are beginning to consider early-stage investments again.

Angel Investors

In the broadest sense, the term angel investor refers to any individual who is investing his or her own funds. They vary widely, from individuals who make this their full-time job, to others who only occasionally invest in projects they find of interest. Although many of their objectives are the same as VC Firms, some of the differences are summarized below.

• Angel investors only invest their own money, which they usually made as highly successful businessmen or women in another career.
• Angels normally make smaller investments than VCs.
• Angels are less apt than VCs to insist on paradigm-shifting ideas.
• Angels are more likely than most VCs to make true seed-level investments. A few may even be prepared to do pre-seed funding, i.e., provide the funding needed to develop the product or concept to the seed-funding stage.
• Most try to emulate VC-type professional investment criteria, but are more apt to invest in opportunities which appeal to them on a personal level.
• Angel investors may or may not focus their investments in a specific industry or technology. They usually, but not always, restrict their investments to the communities in which they live or at least have some involvement.
• They are more inclined than VC firms to pursue unsolicited proposals.
• They are less likely to have a target date for liquidating their investments and may be willing to stay involved with a portfolio company on a long-term basis.
• They are generally less involved in their portfolio companies than VC firms. Some, however, will only invest in companies where they can play an active role, at least at the Board level.
• Although most operate independently, some invest primarily through networks of other angel investors. There is no standard form for these networks, but most provide lead sharing and may also assist with due diligence. Some networks also require that multiple members participate in any investment they are involved with.
• Some prefer to invest in startups that will require future rounds of VC funding to meet their goals, while others refuse to participate in such opportunities.

Angel investors are steadily becoming a more important part of the investment community. The number of angels is growing while the number of VC firms is decreasing.

In Summary

Raising investments for startups has never been easy. But through knowledge, planning and perseverance, entrepreneurs succeed every day. The key is to do your homework before you start.

• Learn what investors want. As in any successful business relationship, you need to develop a win-win scenario that meets their needs as well as your own.
• Have a business plan. Whether a formal 30 page document or just a PowerPoint outline, it needs to be comprehensive enough to show you can turn your idea into a profitable business. You need to have answers for any questions that are asked.
• Have the core of your management team in place. Investors invest in people more than in ideas.
• Identify potential customers and have a marketing plan. The lack of a marketing plan is the number one reason investors turn down proposals.
• Identify specific investors who might be interested in your opportunity and go after them – don’t waste your time sending emails to everyone in a directory.
• Network. Try to find referrals to your targeted investors. And if an investor says no, ask if they know other investors they could refer you to who might be interested.

Good luck!

Did you ever hear about the entrepreneur who, upon returning from a quick lunch, finds his angel investor sitting in his office? The angel greets him with the question, “Where have you been?” Upon hearing the answer, the angel responds, “I don’t see how you have time for lunch given the fact that last months sales were 3.5% below budget.”

Don’t laugh, it happens more than you think.

Obviously this isn’t exactly what you were expecting when you took your angel’s money. In addition to your angel’s money, you expected him or her to provide advice, contacts, and support, but not unwarranted sarcasm and criticism.

So how do you ensure that your relationship with your angel meets your expectations and your angel’s expectations in a positive and productive way?

The answer is really quite simple: In addition to the legal agreement that covers the exchange of shares for cash, you need a written or unwritten agreement that carefully and thoughtfully sets forth the terms and conditions of your working relationship. Issues to be covered might include:

• Detailed discussion of the contributions you expect from your angel;
• A very clear understanding of how you intend to run the business;
• Type and frequency of shareholder reports;
• Most appropriate forms of communications; and
• How and when the angel might expect repayments or distributions.

If you and your angel are unable to mutually agree on any of the above points as well as other expectations specific to your business, then do not take their money. Find an angel that you can harmoniously live with. It will be more pleasant, productive, and profitable for all concerned.

If you have some stories about dealing with difficult angels, or if you have some tips to share, please leave a comment below!

Do economic cycles of boom and bust affect the number of start-ups? Most analysts have linked entrepreneurial activity to economic growth as though it was a given … and conversely, believed that when recession struck, start-up activity slowed substantially. A recent study by the Ewing Marion Kaufman Foundation concludes that both theories are pure bunk. And as though that bombshell was not enough, the Kaufman study goes on to explode several other theories about what factors stimulate new business formation.

Do start-ups increase in proportion to the availability of venture capital? Nope. Kaufman Foundation researchers Dane Stanler and Paul Kedrosky dispel that myth as well. The authors note that the doubling of start-ups from the period 1960-1978 to the decades since may indeed have been due to the advent of the personal computer and the expansion of the venture capital sector. (One wonders if the baby-boomers coming of age may not have contributed to this step-change as well.) However, the constancy of recent start-up data belies the influence of venture funding. Start-up activity fluctuated by only 3% to 6% each year between 1977 and 2005; but the data shows that venture investment varied by as much as 500% during the same period.

Do tax or bankruptcy law changes, technological advances or entrepreneurship education affect the number of new ventures? No again! The report, Exploring Firm Formation: Why is the Number of New Firms Constant?, also finds no correlation between start-up activity and tax policy or any of these other factors; so much for the theories of our most vocal politicians. Instead it documents the same steady half-million start-ups per year, give or take a 3 to 6 percent. The authors discuss a few possible explanations for the unexpected constancy, some rather arcane, but they do not seem to buy into any of them.

Common sense suggests that certain of the factors discussed in the Kaufman report must have at least some influence on the number of start-ups, even if they do not affect substantially the total for a given year. For example, limited amounts of available venture investment must surely delay some particular start-up decisions. I have been involved in a few such decisions. Similarly, high interest rates and tight credit must also have an effect on many decisions, especially those involving sole proprietorships and mom-and-pop operations. So perhaps a study with greater granularity would reveal that while the total number remains relatively constant, the mix of start-up types changes, maybe even substantially. Perhaps in recessions when venture funding declines, a fall in interest rates turns entrepreneurs toward credit sources. It could also be that more innovation-based entrepreneurs test their business innovations when the economy is booming, and that more laid-off workers start enterprises when unemployment is high during recessions. I suspect that the “mix” of different kinds of start-ups changes a great deal even though the total number may not change much.

The Stangler and Kedrosky study does not encompass the current Great Recession, of course, it is too soon. Yet surely this anomalous economic epoch will surely add some telling figures. The investment portfolios of the wealthy individuals and institutions that comprise the limited partners of venture firms declined substantially since 2007 and venture investment has fallen by 40% or so since then. At the same time, credit tightened historically and unemployment soared into double figures. Will start-up totals for this period continue the constancy that Kaufman reports? And if not, how will it vary? Will the limitations on available capital drive start-up numbers down, or will necessity and cheap assets power them up? Or will past constancy persist despite alterations in the mix? Only a study based on more granular data could reveal that. I doubt that such data is available or could be economically derived, though that information could prove useful to an economy so reliant on small businesses to create jobs.

The MoneyTree report of U.S. venture capital activity for the third quarter was just released by PriceWaterhouseCoopers and the National Venture Capital Association.

The $4.8 billion invested in Q3 is a significant jump from the $4.1 billion in Q2 and $3.3 billion in Q1, but still well off of the $7.1 billion invested during Q3 of last year. The number of deals has remained in the 600 to 700 range each quarter this year, compared to 900 to 1,100 per quarter last year. Clean Tech experienced an 89% increase in Q3 over Q2. As in previous quarters, the four strongest sectors remained biotechnology, industrial/energy (including green tech), software, and medical devices. Very little money – only $633 million – flowed to companies raising venture capital for the first time, down from over $1.5 billion during Q3 of last year.

Meanwhile, several weeks ago, the Center for Venture Research released their analysis of the angel investor market for the first half of 2009. The CVR reported that 24,500 ventures raised capital during this period from 140,200 individual investors. Although the dollars raised fell relative to the first half of 2008, the total number of investments increased slightly.

Combining this data with anecdotal evidence from elsewhere, it’s clear that great opportunities are still finding investors. It’s obviously harder to raise capital than it was before, but I think we all knew that. The keys to funding success haven’t changed much: create a great opportunity with a lot of growth potential, develop as much traction as possible before trying to raise capital, and package the venture in the most compelling way you can when you take it to the investor community. We can help you with that last part.

The Center for Venture Research has published their 2008 report of angel investor activity in the U.S. The report contains both good news and bad news.

• The Good News:  The number of active angel investors in 2008 and the number of deals they invested in remained comparable to 2007. In 2008, a total of 55,480 ventures received angel investment, down only 2.9% from the previous year. The number of active individual angel investors remained steady at 260,500.

• The Bad News:  The total dollars invested in 2008 fell 26.2% to $19.2 billion. This indicates a contraction in average deal size, presumably due to lower valuations.

The six sectors receiving the most angel investment are as follows:

• Healthcare: 16%
• Software: 13%
• Retail: 12%
• Biotech: 11%
• Industrial/Energy: 8%
• Media: 7%

In 2008, 45% of angel investments occurred at the seed or start-up stage. Only 10% of the deals brought to the attention of angel investors succeeded in obtaining an investment.

Note that the study only includes accredited or “sophisticated” angel investors who invest through angel investing groups; the study excludes investment activity by informal “friends and family” investors.

The Business Journal reported some cheerful news for entrepreneurs:

In the second quarter of 2006 alone, fifty venture capital funds raised a total of $11.2 billion — the highest level in five years, Heesen says. Venture capital firms invested $6.3 billion in 856 deals during the past quarter, representing the highest dollar amount invested by VC funds and the most deals signed since the first quarter of 2002.

“The U.S. venture capital industry is in its best period than at any other time in the past 15 years,” Heesen says. “It’s a very stable environment. Funds are not over-investing and there’s not just one hot technology that everyone is running after.”

Perhaps it is true that no single technology is garnering excessive attention. However, “clean-tech,” consisting of businesses in fields like “water purification, solar power, biofuels, materials based on nanotechnology and clean-coal technology,” is starting to break out by raising over a half billion in just one quarter:

Clean-tech businesses received a record $513 million in venture capital in the first quarter, according to the latest figures available from the Cleantech Venture Network. The first quarter saw 67 companies getting financial backing, down from 73 in the fourth quarter of 2005 but up from 49 in the first quarter of 2005.

Furthermore, the National Venture Capital Association reported an increase in seed and early-stage deals, making this a great time for experienced entrepreneurs to get a new venture launched. Let’s see how long this window of opportunity stays open.