Sources of Capital: Incubators and Community Development Government Programs

Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser et al

12 minutes to read

Many resources providing services and funding for the start-up of companies exist, most having an economic or social development thrust. Here we provide an overview of some of these.

Incubators

The base content of this section is adapted from work provided by the National Business Incubation Association, www.nbia.org.

To help navigate the process of starting and growing a company, some entrepreneurs turn to business incubators, which provide start-up firms with an array of customized business support services, such as mentoring, flexible leases, and access to office space, research facilities, and manufacturing equipment. In addition to services, about one-third of the incubators in North America provide microloans and revolving credit to assist in financing the business, and many others have indicated interest in providing funds.

And no, incubators did not die during the dot-com bust. Business incubators, which trace their roots back to the 1950s, continue to nurture emerging companies toward business success worldwide. More than 900 of these programs are in operation in the United States alone, the majority of which are nonprofit programs that aim to create jobs, diversify economies, revitalize neighborhoods, or commercialize new technologies.

So, how can you determine if an incubator is right for your business? And how can you decide which incubation program is right for you?

"The bottom line for entrepreneurs is whether their goals are compatible with a prospective incubator's mission and whether a particular incubator is the right tool for helping them achieve success," said Dinah Adkins, president and CEO of the National Business Incubation Association (NBIA), an international membership organization serving incubator professionals; university, government, and economic development officials; consultants; and others. For instance, some incubators have as their mission to serve biotechnology companies, while others focus on serving minority-owned firms. An entrepreneur must consider whether an incubator's mission and array of available services make sense for his or her business.

A 1997 study by the University of Michigan et al. revealed that approximately 87 percent of graduates from the nation's mature incubation programs were still in business. At the time of the study, most of those firms had been in business at least five years, and many considerably longer.

Not all start-up assistance programs that call themselves incubators meet the criteria that experts have found to be key to successful incubation, however. Prospective incubator clients should look for a program that offers customized business assistance services, flexible space and leases to meet changing needs, and programs that facilitate networking among colleagues and mentors.

Some people think of business incubators as a place where entrepreneurs can find inexpensive rent. However, although a facility with appropriate amenities may be a component of a successful incubator, the hallmark of these programs is the array of business support services they provide entrepreneurial clients. "Business incubators are service programs, not buildings," Adkins said. "No building can grow companies, provide mentoring and handholding, and assist an emerging company in meeting the benchmarks necessary for growth." In fact, many incubators charge higher-than-market rental rates because clients receive so much more than just space.

While an incubator's services can be beneficial to many start-up companies, not all emerging ventures are suited to an incubation program. So, who makes a good incubator client?

For starters, many incubator managers agree that entrepreneurs must do their homework before approaching an incubator. The ideal incubator client is an entrepreneur who has a well-developed business idea, a viable market, a business plan, a desire to learn, and a strong entrepreneurial drive. Only then can incubator staff help an entrepreneur develop the business and the skills necessary to make it succeed.

Adele Lyons, executive director of the Gulf Coast Business Technology Center in Biloxi, Mississippi, noted that an entrepreneur also must be willing to roll up his or her sleeves and invest time and energy in the new venture. "An entrepreneur really has to be willing to get in there and do the hard work," she said. "They need to be ready to be the worker bee of the business and realize they are not going to draw a big salary immediately."

An entrepreneur's commitment to his or her business is important, but Lisa Ison, president of the New Century Venture Center in Roanoke, Virginia, said she also looks for clients who are open to suggestions from staff and other entrepreneurs. "We look at not only whether an entrepreneur has a viable idea, but whether he or she is someone who recognizes that they need help to grow their business," Ison said. "An incubator isn't just a place to hang your hat. We encourage our clients to network and interact with each other to learn from the experiences of others."

The benefits to the business can be significant, even for those with a business background. "Being a part of the incubator and working with an advisory team taught me a lot about basic business processes, such as human resources, finance, and customer relations," said Jay Foster, president of SoftSolutions, Inc., a Roanoke, Virginia, information technology company and a recent graduate of the New Century Venture Center. "Even though I had formal training in business [Foster has an MBA] and previous business experience as an independent consultant, I still had much to learn."

That is where an incubator can help. Many business incubation programs offer clients educational seminars covering a variety of business topics, networking events to bring together clients and community leaders, and access to advisory teams comprising business people from a variety of backgrounds. These experts help clients with everything from creating a business plan to troubleshooting technologies to securing patents.

For instance, staff at the incubation program affiliated with Spring- field Technical Community College (STCC) in Massachusetts help clients make contacts with potential funders who might be able to assist in the development of their firms. Incubator clients then practice company pitches with the staff to perfect their presentation skills before making their pitches.

"The incubator environment is focused on sharpening the skills needed to acquire resources," said Fred Andrews, CEO of Fred Andrews Consulting Services and former executive director of the STCC program. Being associated with a successful incubation program sometimes gives clients a leg up on their competition, too. "Local bank presidents have said they are very interested in any of STCC incubator clients because they know they are much more 'bankable' than other small businesses," Andrews said.

Business incubators provide entrepreneurs with many of the tools they need to make their ventures successful, but both incubator managers and clients agree that entrepreneurs must be committed to the process to get the most out of the incubator experience.

"Be a sponge," Andrews advised potential incubator clients. "Keep your eye on what you want to do and seek out mentors within the incubator environment who can help you do it. Network with other entrepreneurs; network with visitors to the incubator. Network, network, network. Incubator managers are constantly looking for ways to create opportunities for their clients, so make sure you're aware of all the opportunities available to you and take them."

Types of Incubators

Incubation programs come in various shapes and sizes and serve a variety of communities and markets. Most North American business incubators (about 90 percent) are nonprofit organizations focused on economic development. About 10 percent of North American incubators are for-profit entities usually set up to obtain returns on shareholders' investments.

  • Forty-seven percent are mixed use, assisting a range of early stage companies.
  • Thirty-seven percent focus on technology businesses.
  • Seven percent serve manufacturing firms.
  • Six percent focus on service businesses.
  • Three percent concentrate on community revitalization projects or serve niche markets.

Today, there are about 1,000 business incubators in North America, up from only 12 in 1980. There are about 4,000 business incubators worldwide. The incubation model has been adapted to meet a variety of needs, from fostering commercialization of university technologies to increasing employment in economically distressed communities to serving as investment vehicles.

Incubator sponsors-organizations or individuals who support an incubation program financially-may serve as the incubator's parent or host organization or may simply make financial contributions to the incubator. About 25 percent of North American business incubators are sponsored by academic institutions, 16 percent are sponsored by government entities, 15 percent are sponsored by economic development organizations, 10 percent are sponsored by for-profit entities, and 10 percent are sponsored by other types of organizations. About 5 percent of business incubators are hybrids with more than one sponsor, and 19 percent of incubators have no sponsor or host organization.

Selecting an Incubator

Just as incubators screen prospective clients, so too should entrepreneurs screen prospective incubators. Here are some questions to ask when considering entering an incubation program:

Track Record

  • How well is the program performing?
  • How long has the program been operating?
  • Does it have any successful graduate companies, and if so, how long have they been in business independent from the incubator?
  • What do other clients and graduates think of the program?

Graduation Policy

  • What is the program's graduation policy-that is, what are the incubator's exit criteria?
  • How flexible is the policy?
  • How long, on average, have clients remained in the program? (Incubators typically graduate companies within three years.)

Qualifications of Manager and Staff

  • How long has the current staff been with the program?
  • How much time does the staff spend on-site?
  • Have they had any entrepreneurial successes of their own?
  • Do they actively engage in professional development activities or are they a member of a professional/trade association to keep them up to date on the latest in incubation best practices?

Does the Incubation Program Offer the Services and Contacts You Need?

What services do you need to make your venture successful? Business plan development, legal and accounting advice, marketing, Internet access, manufacturing facilities? Is access to a particular market critical? Then consider finding an incubator that specializes in that market. Special focus incubators are programs that work with companies within a particular niche, such as gourmet foods, biotechnology, the arts, and software. Be sure the program offers what you need or can connect you to service providers who can meet those needs.

Do You Meet the Incubator's Criteria? Find out the incubator's qualifications for accepting clients before applying. For example, some incubators expect prospective clients to have fully developed business plans, whereas others require a less developed idea and offer business plan development assistance.

Is the Program's Fee Structure Right for You? Most for-profit incubators exchange space and services for an equity share in their client companies, whereas most nonprofits charge fees for space and services. If a large cash infusion and speed to market are essential for your business success, then giving up equity in your company in order to secure quick cash may be right for you. But if you believe you have the skills to raise your own funding (with some assistance), don't want to give up any equity in your venture, and are willing to build your company more slowly, then paying fees for services and space may be a better choice.

Terms and Conditions

The working relationship between the entrepreneurial company and the incubator are typically documented within several agreements. Here is a list of the type agreements that may be entered into, and comments where appropriate: 1

  • Services agreement. The agreement establishes the overall understanding between the parties. It addresses the specific programs and services that the incubator will provide, and rates where applicable. It defines the required reporting and expected meetings, as well as providing for the customary legal protections for each party.
  • Lease agreement. This is a typical facilities lease agreement providing for periodic rent payments and the customary tenant/landlord terms and conditions.
  • Stock option agreement or member interest purchase agreement. These agreements provide the right to purchase a portion of the equity or ownership of the company based on certain terms, conditions, and events.

Community Development Financial Institutions

Community development financial institutions (CDFIs) are financial institutions that have community development as their primary mission and that develop a range of strategies to address that mission. 2 There are five generally recognized CDFI types:

Community Development Banks

These banks provide capital to rebuild economically distressed communities through targeted lending and investment.

Community Development Credit Unions

These credit unions promote ownership of assets and savings and provide affordable credit and retail financial services to low-income people with special outreach to minority communities.

Community Development Loan Funds

These loan funds aggregate capital from individual and institutional social investors at below-market rates and lend this money primarily to nonprofit housing and business developers in economically distressed urban and rural communities.

Community Development Venture Capital Funds

Community development venture capital (CDVC) funds make equity investments in businesses in economically distressed areas in the United States and around the world. They invest in companies in a variety of industries and at different stages of development, from seed to expansion. Utilizing a number of legal structures, from for-profit corporations to not-for-profits to limited liability companies, CDVC funds are mission-driven organizations that benefit low-wealth people and communities while working to earn solid financial returns. Most CDVC funds invest in a focused geographic area. 3

Similar to other institutional investors, CDVC funds are looking to invest in companies with strong management, good ideas, impressive growth potential, and the promise of high financial returns. They also focus on the number and quality of jobs that will be created and the impact their investments will have on low-income communities. Each fund has its own investment criteria and process for submitting business plans. 4

Microenterprise Development Loan Funds

These loan funds foster social and business development through loans and technical assistance to low income people who are involved in very small business or self-employed and unable to access conventional credit.


1. Based partially on information provided by the Nidus Center for Scientific Enterprise, St. Louis, Missouri, www.niduscenter.com.

2. www.communitycapital.org/community_development/index.html, Beth Community Capital 215.320.4315.

3. www.cdvca.org/fund.html.

4. Ibid.

The above material is adapted from The Handbook of Financing Growth: Strategies and Capital Structure by Kenneth H. Marks, Larry E. Robbins, Gonzalo Fernandez, John P. Funkhouser. Copyright ©2005.This material is used by permission of John Wiley & Sons, Inc.