The engagement of talented consultants from various professional fields is essential to the success of the company. There are traditional areas, such as economic and legal matters, in which every company customarily hires outside advisors. But there are also professional consultants in other fields who may contribute to the company in its line of business or elsewhere, in order to accelerate the progress of the company and the time-to-market of its products (accelerators). Finally, there are numerous entities who offer companies all consultancy services in one package (incubators).
Financial Advisors and Management Consultants
The functions of economic consultants are very broad and include consultancy and guidance in a variety of areas, such as choosing the optimal channels for raising capital, drafting contacts with investors, and examining different directions of business development. Aside from functioning as independent consultants and strategic consultancy firms, many accounting firms now offer entrepreneurs various economic services. Economic consultants are particularly important for companies whose entrepreneurs have a deep technological background but whose managerial or business experience is lacking, or whose acquaintance with the capital market is sketchy. At times when the number of potential investments with which investors are faced is immeasurably greater than the number of ventures in which they are able to invest, the company’s business design is already essential in the early stages of the venture, and the added value of prudent advice in this area to the venture cannot be overrated.
It is important to engage legal advisors who specialize in startups already in the early stages. Most law firms which work in this field now offer arrangements based on reduced payments (at times through sharing in the company’s equity) that are appropriate for young companies. The role of the company’s attorneys is crucial in determining the optimal form and location of incorporation in domestic and international tax planning, in preparing agreements among the entrepreneurs, employment agreements, employee stock options, and agreements with various suppliers. Naturally, they will also be responsible for the investment agreement with the investors. Finally, attorneys are instrumental in the company’s IPO or sale. Except for legal work, attorneys with experience and contacts can advise the company on business decisions, and introduce it to sources of money or strategic partners.
A veteran entrepreneur who is backed by an experienced team and independent sources of capital or many connections, usually does not require the extensive assistance provided by incubators and accelerators. At the most, he will utilize the connections of the fund who will invest in the company in its early stages. However, many entrepreneurs do not have the know-how, the experience, or the connections required to develop their ideas quickly and enter the market. Several solutions are available for such entrepreneurs.
Incubators are entities which specialize in cultivating the growth of new companies. Incubators provide (or at least profess to provide) much more than money; for instance, they may offer offices for the company, guidance and advice in development (and in some cases also managers), assistance in recruiting manpower, accounting and legal services, assistance in raising capital, contacts with strategic entities, etc. The experienced and well-known managers of an incubator could raise the value of an infant company by exploiting their know-how, and in particular their connections, in the relevant industry. Incubators are not a suitable solution for every company; they are appropriate mainly for young entrepreneurs or entrepreneurs who have no experience in management or project development. It is important to know that incubators demand significant portions of the company, usually between 20% and 50% of its equity, for the services they provide. That said, the entrepreneurs who apply to incubators are usually the ones most likely to significantly increase their chances of success through the added value provided by the incubators.
Many incubators are increasingly aware that focusing on a certain niche, although unwise from the risk-diversification perspective, significantly increases their ability to assist their portfolio companies, mainly due to the accumulation of knowledge and contacts on which the incubator’s companies rely.
Many incubators have been operating in the United States for many years, and more still were established during the prosperous years of Internet startups. In 1999 alone, more than 200 incubators were established in the United States, and a similar number were established in early 2000. The incubator boom spread to Europe and Asia as well, and hundreds of incubators were established around the world during this time; only some of them were led by winning teams of experienced entrepreneurs, financiers, and managers.
Most of the incubators in the United States collapsed during the year 2000, concurrently with the collapse of high tech stock prices. The fundamental problem of most of them was their extensive reliance on the capital market. The incubators were required to make considerable investments within a short time frame in order to finance their high costs, and one of the obvious sources of such financing was the stock market. With the narrowing of the possibilities of raising capital on the stock exchangeâ€”for both the incubator itself and the companies held by itâ€”and of exiting investments by selling held companies, the IPO dreams of some incubators shattered, and the shares of several American incubators which had already gone public, plummeted.
Idealab, for example, a company that focused on cultivating ideas that were born in the company itself, withdrew the prospectus it had filed with the SEC, only a few months after it had raised hundreds of millions of dollars in a private offering based on a value of more than $7 billion. The main problem that confronted the company was that its numerous previous successes (such as the establishment of the companies eToys, Tickets.com, and GoTo, and others, some of which even went public), lost their glamour after their stocks collapsed on the stock market. Although Idealab helped establish approximately forty companies, it stopped “supplying” IPO-worthy companies, at least for awhile, after a feverish period of rapidly taking its companies public. Like Idealab, the shares of other incubators, which were recently offered and already traded on the stock market, such as Divine Interventures, also crashed once the investors’ hopes that the company would manage to take at least some of its investments public, evaporated.
More established companies which were associated with the incubator phenomenon also suffered a plunge in stock prices, even if they were fundamentally investment companies that exercised extensive managerial and operating involvement, such as CMGI and Internet Capital Group (ICG). This blow made it difficult for them to raise more capital on the stock market, and to attract outside investors to invest with them in their portfolio companies.
Although the investments in the incubators have not proven themselves so far on the stock exchange, incubators are beneficial to some entrepreneurs, as they offer an almost complete range of solutions to individual entrepreneurs with no entrepreneurial experience. In any case, before a decision is made to join such an incubator, it is important to check who is behind it and the nature of his experience and connections, and to make inquiries with other companies that have used the incubator’s services. As the frequent establishment of incubators in recent years, and the fact that many of them were shut down, indicate incubators are often no more than startups themselves, and the large portion of equity they demand is often unjustified in view of the results they produce. One needs to remember that more than 80% of incubators do not achieve as much as a single exit.
Accelerators are persons or entities that specialize in technological, business, or financial areas that complement the skills of the company’s internal team, and that share their know-how, experience, or connections with the company in consideration for equity and ongoing financial compensation. This is done with the purpose of accelerating the development of the company, raising its value and facilitating its entry into the market. The defining difference between an incubator and an accelerator is the stage of development of the companies they support and the measure of assistance they require. An accelerator usually works with companies that are slightly more advanced than those that use incubators, and almost always only with companies that already have a management team. Incubators are also prepared to accept projects that are just starting out, even before passing any feasibility tests, and without a proper management team. Furthermore, accelerators often do not provide a full package of services (offices, accounting and legal services, public relations, etc.), but rather focus on the professional issues in which they can assist the company. Also, the payment (in shares) to accelerators is usually not as high as that charged by incubators. The use of accelerators is also recommended for experienced entrepreneurs, if the accelerator’s abilities genuinely complement those of the company. A shorter time-to-market is more important than the percentage in the company’s equity.