Generic Business Incubation Model (Part 1)

Go to the people. Learn from them. Start with what they know. Build with what they have. And with the best leaders, when the work is done, the task accomplished, the people will say, ‘We have done this Ourselves’

– Lao Tsu, China, 700 BC.

Analysis of around 20 business incubation models showed there are still many challenges in the industry and existing models must be improved to better fit entrepreneurs needs. Generic Business Incubation Model was created in order to better understand how the incubation process is organized, what is the structure of the business incubation program, how it interacts with other stakeholders in the innovation industry, how it helps entrepreneur to increase chances for success. That is why the model is a mixture between black and white box descriptions. On the one hand we describe how the program organized inside, what practices are used in order to support entrepreneur. On the other hand we analyzed interactions between players in the innovation industry. The model is also a mixture of the process and structure approaches: three main processes are matched together (venture life cycle, incubation process and funding process of a venture) and main inputs and outcomes of each stage are provided.

Funnel model of incubation

Funnel Structure of the Venture Creation in VC industry

Funnel Structure of the Venture Creation in VC industry

Any business incubator works according to the following process. Entrepreneurs come with their ideas, they participate in the business plan (idea or model) competitions or direct business incubator selection procedures. If entrepreneur fits the requirements of the incubator (s)he become a tenant and accepted to the incubator’s program. Then incubation cycle starts and could take from 3 months to 3-5 years. It depends on the industry, type of the incubator, capabilities of the entrepreneur and business model of a venture. Every successful incubator has certain exit policies which determine the conditions of venture exit from the incubator’s support. Usually incubator define several criteria such as time limits, profitability or revenue, investment rounds. 80% of the incubator’s efforts are dedicated to the incubation stage. However, the success of the incubation program heavily depends on the external factors beyond internal processes and operations. Here comes one of the important contradictions of this model. On the one hand, incubator works with the best projects that have been selected according to its criteria. On the other hand it doesn’t have significant influence on entrepreneurs, ideas and their quality which are sourced as the variables of the external environment. Business incubator’s impact of producing successful ventures (assuming that it have perfect and whole range of support services for entrepreneurs) depends on the inputs of this process. And as far as incubator has no influence on the inputs it becomes a hostage of the innovation ecosystem in which it operates. If the ecosystem is sustainable and produces tremendous amount of ‘stars’ and brilliant entrepreneurs, ideas, ventures, then incubators can be sourced with sufficient flow of deals. However, if we consider efficiency-driven economy (or emerging economy) where innovation ecosystems are undeveloped. The main problem there the deal flow, e.g. number of entrepreneurs and ideas generated by the system. Incubators without sufficient flow of entrepreneurs inside this system will not have the possibility to produce constant flow of successful and viable businesses. This challenge could be addressed by the virtual business incubation program.

Conclusions are:
  • Success of incubation process in general depends on internal (incubator’s resources and processes of selection, mediation, and exit) and external factors (entrepreneurs and ideas flow into the BI) apart many other success factors which are not relevant to the model.
  • If an incubator doesn’t provide sufficient efforts influencing the innovation ecosystem, and the appearance of brilliant talent and ideas, there are less chances to get sufficient deal flow as an input to the incubation process, and incubate more successful startups.
  • This is especially relevant for emerging innovation ecosystems of efficiency-driven countries

Risk and Incubation stages

The Model of Risk Calculation for a New Venture

Venture capitalists as main actor of the innovation ecosystem see incubators as a means to diversify risky investment portfolios, while would-be entrepreneurs approach incubators for start-up support. Venture funds even pay fees for incubators in order to get incubator’s help as the risk reduction tool. Incubators are faced with the challenge and the opportunity of managing both investment risks, as well as entrepreneurial risks.

Degree of risk depends on the stage of a venture cycle and consequently on the incubation stage. The earlier a startup is considered, the higher the risk is. The risk of a venture depends on many variables. Above we provide a model for risk calculation of a venture. The main outcome is that there are many factors which influence the degree of risk of a new venture. Consequently, probability of success on the early stages is very small, and prospectsto earnmoneyratherillusive. That is why early stage entrepreneurs have more problems in comparison with serial or experienced entrepreneurs. According to Ruhnka & Young (Ruhnka J.C., 1987) the risk of investment loss is around 66%, which is very high for a venture investor. Risk associated with a venture according to would be entrepreneurs is connected to the problem of insufficientcapital. In fact there is a huge amount of insufficient capital not only all over the world, but also in America, where the number of venture capital transactions exceeds the world.

Degree of Risk vs. Incubation Stages Diagram

Degree of Risk vs. Incubation Stages Diagram

But what is interesting is that the “valley of death” in the early stages entrepreneurs overcome the problems themselves. Only business angels, government grants and pre-incubation programs are those who help entrepreneurs to overcome the problems in the first stages of venture development. Traditional business incubators usually prefer to support early stage entrepreneurs a bit later when the business model and business plan are already finished. We will propose to shift the incubator support more towards pre-incubation phase in the virtual incubation model.

Conclusions are:
  • The chances for success of a startup depend on many factors, and are extremely high at early stages.
  • Incubators are considered by sponsors and investors as risk reduction tools, which manage both investment risks, as well as entrepreneurial risks.
  • Model shows that the more uncertainty is eliminated the more chances of startup to raise financing. Thus, the earlier entrepreneur will receive support, the better his chances for survival. That is why business incubators should shift their focus towards pre-incubation stages.
  • Incubators rarely support entrepreneurs since the beginning of an endeavor, therefore very few provide pre-incubation support because it is costly and can’t be monetized by existing business models of incubators.
  • Virtual business incubators as cost-effective instruments could shift the focus from incubation stage to pre-incubation, and increase chances for survival of early stage entrepreneurs.

2 thoughts on “Generic Business Incubation Model (Part 1)

  1. Pingback: Generic Business Incubation Model (Part 1) | Entrepreneurship Matters

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