[NYT] Internet Incinerators

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From: Rohit Khare (Rohit@KnowNow.com)
Date: Mon Oct 30 2000 - 12:00:11 PPET

>"There is a method to our madness," Mr. Wetherell said. "There
>aren't a lot of incubators with $1.5 billion in revenue."

Nor with so many billions in losses... but at least I'd like to think
David isn't so stupid as to flush Scout Electromedia...!

Incubator, Stinkubator, as Adam sez...


October 30, 2000
Net Incubators Face Hard Times

Call them instigators. Or catalysts or accelerators. Just please
don't call a company that hatches Internet companies an "incubator"

Now that the fiery crash of Internet stocks has many investors
cursing dot-coms as the devil's spawn, the investment companies that
hatch dot-coms consider incubator a tainted term.

"It's like if your name was Monica before the Clinton scandal, it was
fine; but it's not now," said Bill Gross, chairman and chief
executive of Idealab, a Pasadena, Calif., company that was the first
and best-known, um, I-word.

Mr. Gross knows the ignominy. Twelve days ago, tired and dragged down
by a cold, he canceled a much-anticipated initial public stock
offering for Idealab, warning that tough times were ahead. Two days
later, Eve.com, one of the largest beauty sites on the Web and a
company that Idealab had fostered, said it was shuttering its doors
and laying off most of its 164 employees. And last week, Scout
Electromedia, another company Idealab invested in, went out of

For an entire segment of the technology-financing industry, Idealab's
string of bad news has been a chilling sign of the times. If Mr.
Gross is losing faith in the incubator approach these days, who else
might hope to make it work?

"It's pretty clear by pulling the offering they admitted what
everyone knew all along," said David Dusenbury, a research analyst in
Credit Suisse First Boston's technology group. "There is no market
for incubators right now."

It was five years ago that Mr. Gross, already wealthy from the sale
of his software company Knowledge Adventure, conceived and executed
the idea of a technology incubator. The notion was to offer shelter
and succor for new Internet-related businesses intent on getting
quickly to market. By providing office space and administrative
support, marketing and public relations in return for an equity stake
in each of its wards, Idealab was offering much more than venture
capital firms - which typically dispense only money and advice.

Mr. Gross's concept was widely imitated as other entrepreneurs and
financiers watched fledglings like CitySearch (which later merged
with Ticketmaster Online) emerge from the Idealab hatchery and show
signs of taking flight. In 1999, when Idealab spinoffs produced some
of the year's hottest stock offerings, like the e-tailer eToys and
the Web search company GoTo.com, Mr. Gross seemed to be sitting on a
nest of golden eggs.

Now, though, with the stocks of eToys and GoTo.com trading at a
fraction of last year's highs, the business model that Mr. Gross
cultivated is being called into question. Within two days of
Idealab's Oct. 18 announcement, Garage.com, which provides financing
and other services for high-technology start-ups, announced that it,
too, would delay its initial stock offering.

And publicly traded investment companies like CMGI and the Internet
Capital Group, which have managed and nurtured Internet start-ups but
bristle at the I-word, have seen their own stock prices plummet.
CMGI's shares, which touched a high of $164.75 in January, closed on
Friday at $16.75. Internet Capital, which traded at $212 last
December, ended last week at $12.

CMGI's chairman, David Wetherell, is as insistent that his company
will ride out the current turbulence as he is adamant that CMGI is
not and never has been an incubator. It is, according to the Web
site, a "leading global Internet operating and development company."

"There is a method to our madness," Mr. Wetherell said. "There aren't
a lot of incubators with $1.5 billion in revenue."

In any case, whatever they may be called, there are now some 400
companies, all pursuing a business similar in many ways to Mr.
Gross's Idealab. And some analysts and academics are predicting that
within a year, fully half these companies will be out of business.

"The success of Idealab portfolio companies was noteworthy but was
not proof that the incubator model works," said Dave Witherow, chief
executive of Venture One Economics in San Francisco, which tracks the
venture capital industry. "It proves the challenges and suggests that
the model itself is not so simple."

But like many of his peers, Mr. Gross contends that there is nothing
wrong with the business plan. Idealab has spun off 55 companies over
the years, company executives said. About 50 are still in business,
while the rest have failed. It is currently incubating 12 companies
and will continue to create new ones.

"It's a mistake to read too much over all into this," Mr. Gross said
of the recent gloomy announcements. Investors are now focused on
profitability, he said, and any layoffs at the companies Idealab
backs are simply a reflection of that concern. Besides, he added,
Idealab spends only about $72 million a year and recently raised $1
billion in a round of financing.

"I need to show people I can create value in bad times," he said.
"When people see what we can do, then they will come back."

Of the $1 billion raised, two-thirds has already been spent, said
Howard Lee Morgan, Idealab's vice chairman. Much of that money went
toward buying larger stakes in companies in which Idealab has already
invested, but needed to increase ownership so it could retain
control, including CarsDirect.com. As for the remaining $300 million
or so, "we have enough money for the next two to three years," Mr.
Morgan said.

According to Morten T. Hansen, an assistant professor of business
administration at Harvard Business School, the median first round of
financing for a start-up at an incubator is $690,000. But that does
not take into account the additional money burned if a company has to
stay under incubation longer than planned (say, for a third or fourth
round of financing) or if jittery investors demand that an incubator
commit money of its own as a show of confidence.

"You can go through money quickly," Mr. Hansen said. "For the average
incubator, that is expensive depending on how many ideas fail."

In the old, time-honored approach to starting a business, start-up
expenses used to be paid for by the entrepreneur (remember all those
stories about plucky young companies financed on the founder's credit
card?), or by a venture capitalist.

But after the notion of "Internet time" caught on and made the old
evolutionary approach to entrepreneurship seem as quaint as carbon
paper and Dictaphones, incubators popped up as the sort of place
where entrepreneurs could hatch their embryonic ideas while getting
instant access to technical experts, marketing strategists and
executive recruiters until their businesses matured and could thrive
on their own.

Of course, none of this came free.

Generally, like some venture capitalists, incubators command a 25
percent to 40 percent stake in a company, according to a study
conducted by Mr. Hansen and his colleagues. And many of the
incubators in the study required a fee along with an equity stake.
Idealab, for its part, generates most of its own ideas so it is able
to keep a larger equity stake than in cases where an entrepreneur
brings an idea to the incubator.

Innovative as the concept might have been in the early going, Mr.
Hansen said that by now more than 8 of 10 incubators are providing
the same basic services, like public relations and accounting. "It is
a commodity," he said.

Of the 400 or so incubators in existence today, he said, at least
half have never hatched a company and will probably fail in the next
12 months. "They have no viability," he said, citing inexperience as
a widespread problem.

Another criticism voiced by several analysts is that some incubators
that were formed more recently have focused too much on the Internet
fashion of the moment. Often mentioned in this regard is the Internet
Capital Group, which specializes in the business-to-business
e-commerce market. As that sector has fallen out of favor, so have
the companies that Internet Capital invested in - like Breakaway
Solutions, a provider of e-business products, and Onvia.com, a
marketplace to help small businesses buy and sell services and
products. Shares in both companies have tumbled more than 90 percent
since reaching 52-week highs. And Internet Capital has also suffered
from the collapse of its own share price, making it difficult to use
its stock as currency for acquisitions.

"The size of the opportunity hasn't decreased," said Ken Fox, co-
founder of Internet Capital. "But building companies is hard, and the
Internet didn't make it any easier."

In Idealab's case, it may have focused too much on Internet companies
aiming their products or services at the consumer market.

Idealab's portfolio of companies lets you buy almost anything on the
Web - from pet products and cookware to bridal wear and cosmetics.
But analysts say the failure of the beauty site Eve.com, which had
almost all the makings of a winner - lots of traffic, $1 million in
monthly sales and name recognition, but no profit - could foreshadow
doom for the rest.

"We crushed everyone in the market and it wasn't enough," Mr. Gross
said. He said that in the future, Idealab would not limit the types
of companies it would create or invest in.

Mr. Hansen of Harvard contends that perhaps the most valuable service
incubators can provide start-ups is access to a network of business
relationships with more established companies. Some incubators
already do that, he said, pointing to Hotbank, a Mountain View,
Calif., company managed by Softbank Venture Capital, an affiliate of
the big Japanese investment company Softbank.

Hotbank gives entrepreneurs access not only to the usual incubator
services, he said, but also to Softbank's roster of partners,
including Yahoo and Cisco Systems. But only about one in four
incubators are able to provide this kind of relationship network, Mr.
Hansen said.

In various ways, some incubators have begun to adapt to the new, less
hospitable financial climate. Ecompanies, an incubator set up last
year by Sky Dayton, founder of Earthlink, and Jake Winebaum, the
former chairman of Disney's Internet unit, had trouble last summer
raising a new round of financing. So it has formed a partnership with
Sprint to develop wireless communications ideas. And last month,
Ecompanies sold a stake in itself to Evercore Partners, a
long-established, New York-based investment bank that was an adviser
in the Viacom-CBS merger and has traditionally put money in
old-economy ventures.

In the meantime, Mr. Wetherell's company, CMGI, has put the brakes on
acquisitions and is concentrating on consolidating what it already
owns. In the last few years, CMGI has acquired 34 companies and
started eight others, Mr. Wetherell said. But by next July, he
intends to whittle those holdings down to 15 companies.

Idealab's Mr. Gross acknowledges that he has learned hard lessons
these last few months. "We've become very self-reflective," he said.
"Maybe it was hubris to think it was easy."

He said Idealab would no longer acquire other companies, a strategy
he said had not paid off for his company anyway. But it is
conceivable that, if he regains investor confidence, Mr. Gross would
consider trying to take Idealab public again though he would probably
not call it an incubator.

"I believe I can take an `idea generator' public," he said. "Just not
in this market."

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