Startups
By Om Malik, Forbes on-line
December 15, 1999
Copyright © 1999 Forbes.com
-------------------------------------
Jeff Levy was 33 years old in 1996 when he started Relevant Knowledge, a
Web-traffic measurement firm in partnership with Tim Cobb. Three years later
the two sold the company to New York-based Media Metrix, a one-time rival.
The combined company went public and the duo were faced with an unusual
predicament: what to do with their time and some $25 million they had each
made from the offering. Earlier this year, Levy ran into Bill Gross the
founder and the force behind Idealab, a Pasadena, Calif.-based incubator
that has hatched such stock market miracles as eToys (nasdaq: ETYS) and some
flops such as Free PC. The two got along famously and Levy ended up spending
the next four weeks in Idealab's sprawling offices.
And then he started eHatchery, an Atlanta-based incubator that is loosely
based on Idealab. Since then, he has been joined by many a few other Net
entrepreneurs who have set up their own Internet incubators. "I think an
Internet incubator is like formalizing the angel investing process," says
Levy. During the past couple of months, the number of new Internet
incubators has shot up dramatically. The latest being Camp 6, a San
Francisco-based incubator started by David Wamsley, the founder of
Ad-Auction, an online advertising marketplace. At last count there were a
dozen or so incubators that had cropped up in places as far apart as
Washington, D.C., Colorado and Atlanta. The current trend of incubators
everywhere is a perfect illustration of the Net economy at work. In the fast
changing Internet economy, it seems the only certainty is that if you have a
smart idea, expect someone to duplicate it in less than a month. And then
raise millions from venture capitalists! Or how else could one explain the
myriad of online pet stores, e-drugstores, and an endless number of
CD-retailers?
If run by a known name with an established track record, an incubator's
offspring can do very well. Take the example of first generation
quasi-incubators such as CMGI (nasdaq: CMGI) or the Internet Capital Group
(nasdaq: ICGE) and their spectacular run on the stock market. Those backing
these incubators are surely thinking about their billion dollar fortunes. As
one industry wag put it, why start one company at a time when you can start
a dozen and profit many times over. Nevertheless, incubators claim that they
are doing both the startups and the venture capital community a favor and
are bringing better companies to the fore front. "What we are doing is
basically acting as a filter for venture capitalists who are finding it hard
to invest the money they have in the startups," says Neil Cohen, chief
marketing officer at Camp 6. Four years ago, a typical first round
investment from a top-tier venture capital firm such as Benchmark Capital or
Kleiner Perkins would be around $3 million. "Today, unless they can invest
$30 million or higher, these VCs do not even bother taking a second look at
the business plans. We are filling a very important need," boasts Cohen. As
a result, he expects to see the number of incubators to increase sharply.
"This is not the end of the new incubators and within a couple of years
there could be maybe 50 or 100 such incubators," says Cohen.
What do these incubators really do?
For starters, they provide office space, technology infrastructure,
seed-capital (mostly about $250,000 or so), and access to some vital talent
such as marketing and financial people, according to Cohen. "Mentoring and
the hands-on approach is what is going to help the companies which are being
incubated get to market faster," says Levy. "It takes about six months for a
startup to get ready before they can face the venture capitalists for the
first round of funding," Cohen adds. "We bring in about 30-35 professionals
that help in everything from brand positioning to public relations to fiscal
management," to get the companies on the fast track and ready for the first
round of funding. But these services do not come cheap. "That's two million
in soft dollars for services and a quarter million in seed capital," says
Cohen. In exchange, an incubator such as Camp 6 would take 30% equity in the
company. No wonder incubators have caught the imagination of the investors
who are pumping in millions of dollars into these untested businesses. Take
the example of eCompanies, which was set up on June 7. By August 30,
Dayton's latest experiment had raised $130 million from the likes of Goldman
Sachs Group, CS First Boston, Sprint (nyse: FON) and Disney (nyse: DIS).
Getting big time investors to fund an Internet startup is relatively easy.
To folks such as Levy it is the type of investors, which is the most
important piece of building up an early stage technology company. A link
with a white shoe venture capital firm makes it easier for the young
companies to attract post seed round financing. In the case of eHatchery,
the backers were Idealab, United Parcel Service (nyse: UPS), Donaldson,
Lufkin & Jenrette (nyse: DLJ) and Botts & Company. These big investors are
counting on Levy and the team he has put together to find the next big
thing. So far eHatchery has taken on two ventures for incubation. The first
is Figleaves, an upscale one-stop-shop featuring an extensive selection of
brand name essential wear (undergarments, socks, hosiery, etc.). The second
is VetExchange, a Web-based marketplace that links veterinarians, suppliers
and animal owners. Both companies are anticipated to launch within the next
90 days. "Speed is the name of the game," says Pete Estler, who recently
launched a Colorado-based incubator firm, iBelay. "We are an incubator on
steroids," says Estler, who started MatchLogic, a direct marketing company
that he sold to Excite@Home for $90 million in 1998. "I like to describe it
as Internet accelerator."
With $100 million under its belt from top net names such as Excite@Home
(nasdaq: ATHM) President George Bell, Scott Beck, cofounder of Reel.com,
IBelay.com will make $500,000 to $1 million investments in startups. And in
exchange for an equity stake, iBelay will provide office space and access to
its data center in Boulder, Colo. Estler says the new incubator will focus
primarily on broadband and Internet-based direct marketing companies based
in the Rocky Mountain region. "It is quite clear that if a startup has a
great idea, you need to bring it to market really fast or someone else
will," Estler adds. "When we started out, it took us a year to get the first
round of financing, but now you cannot afford to take that much time raising
cash. Fast execution is what really counts," adds Levy. Time, as he points
out, is a luxury that has vanished in the Net economy.