Dick Rubin, Managing Partner of Entrepot, has started, profitably operated, and successfully sold several businesses. He and his wife operate a business incubator that has had as many as 20 businesses co-located with them at one time. During a five-year period they saw roughly 70 businesses startup in the incubator. Some of those businesses are now over 10 years old. Only five of the original businesses failed. Several of the ventures have been purchased by much larger firms. Some of the ventures merged and continue to prosper.
Dick agreed to be interviewed by me about what it takes to run a business incubator. Many incubators are now being operated as profit making opportunities, rather than as nonprofit operations linked to a university or state development agency. I was curious to know how one ran an incubator as a profitable business. Here are Dick's answers.
What does it take to set up an incubator? Legally? Financially? The necessary steps?
Setting up an incubator can be a complicated process, especially if the incubator is to be a public entity or a public/private partnership, which typically indicates a "not for profit organization". When we created our incubator the intent was to create a "for profit business". We did so because, our purpose was to create "for profit businesses" with our clients, and we believed that it was the responsibility of the private sector to develop private businesses. From the time we began planning to the point that we opened our doors (in temporary quarters) it was less than 120 days.
Legally, we were able to operate as a proprietorship. Thus, very little legal expense was incurred. Financially, all of the initial capital was privately contributed. However, we already owned most of the furniture, fixtures, and equipment that were to be used as the result of selling other business interests. Thus, our capital requirements were limited to meeting working capital needs, only. If we had purchased the furniture, fixtures, and equipment, I would estimate that the cost would have been $225,000. Working capital requirements were estimated at approximately $100,000.
The greatest effort was in developing a business plan, which included the necessary step of verifying that a valid and workable plan was in place. This meant that for every strategy we developed there were clearly identified and described tactics that would be executed. It also meant that we confirmed that we had the necessary people, skills and other stuff needed to carry out the tactics. This was all done before we committed to a long-term lease on class "A" office space and to the staff that would be needed to support the intended clients.
Our target market was businesses that would have a substantial need for administrative services. The reason was that our research showed that a very large percentage of new/small businesses failed because of weaknesses in administration, marketing, sales, accounting, and finance, while having great strengths in the technical areas that the founders typically had come from.
How does one make money running an incubator?
Making money while running an incubator was not very easy. By selecting clients who really recognized that they have a need for the services being offered and charging for the services that are used by each client we are able to generate income. However, since most of the clients are very small and brand new their needs are also very small, except in the area of planning. In most cases the clients ability to pay for large volumes of services are limited and we have found that it necessary to either accept equity in the businesses or defer collections for extended periods of time.
Some of the deferred income was lost when the clients failed and some of the equity positions taken yielded no return. However, our skill in evaluating new clients grew very quickly. As a result, a very strict selection process was developed. If through the selection process we determine that a prospect had a very low probability of success, we simply never submit a proposal to them to move into the incubator.
How do you choose the businesses?
Choosing the businesses, that we believe would be part of a win/win relationship, is driven by the business plan of that business and the commitment demonstrated by the founders. If no business plan exists, we only propose to assist in the development of the business plan. If a business plan lacks viability, we offer to assist in strengthening of the business plan. If our offers are refused, we simply wait for the delivery of what we believe will be a workable business plan before we submit a proposal for a client to move into the incubator.
Do you have a physical facility?
Over the years, our facilities have changed as our involvement with our clients changed and as the type of client has changed. Originally, we had 22,000 square feet of class "A" office space located at the intersection of two major highways in a city with a population of approximately 350,000 people. One of the highways led to the fastest growing suburban city in the state and the incubator was just a couple of miles from the suburb and the downtown area of the major city. Today, we have a building located in a rural community 35 miles from the downtown area. This building houses only three clients and most of our work is done at the offices and plants that our early clients moved to as they grew out of the space provided at the original incubator. In addition, we serve a couple of small manufacturing clients who are located in buildings that were constructed as incubators by the rural communities that the clients are located in.
Why, or why not, have a physical facility?
In order to function at all some physical facility is needed. It may be a home office that truly can be used to house all the trappings of a business or it may be a separate office suite or building that contains all of the space needed. The answer to this question is really contained in our business plan, which at this point calls for both. Our "in town office" is at our home where we have a meeting/conference facility for our rural clients to meet when they have a need to be in the city and we have a rural industrial building that serves as a high tech industrial service company, a specialty manufacturer, and our administrative support offices.
What happens if a business doesn't work out?
If a business doesn't work out, our first effort is to encourage the owners to re-plan their operations. If the determination that no future exists for the client's business, then the business is closed out, the client goes out and finds a job, and most often we write off the deferred fees and eat the loss on any equity we took. In our case developing detailed selection guidelines has resulted in only a five to eight percent failure rate over a five-year period. Considering that the new business failure rate is well in excess of 80% during the first five years, we have either been really lucky or really good.
What type of contract do you use (typical terms)?
We use a "Consulting Service Agreement" with almost all clients. The agreement contains a description of the services that we will provide to the clients. It also defines the responsibilities that the client has to his/her self and to the consultant and the manner in which fees will be earned and paid. The agreement defines what, if any, fee deferrals will be allowed and what, if any, equity payments will be made. It is this agreement that is signed by all of the principals of the client business and it is usually developed during four to eight separate meetings. The result is that our clients and we get to know each other very well before we enter into an agreement that will most likely go on for many years.
What services do you provide?
Service delivery is the guts of our business. We serve as administrators, planner, marketers, salespeople, systems designers and negotiators for our clients. In short, we do those things that our clients don't want to do, don't know how to do, don't have the time to do, or that we are able to do more efficiently. The results that our clients are looking for are that they are able to focus their time and attention on the things that they do best while they either learn the other things or simply depend on others to make them better business people. We are not a school. We know how to make businesses make money. The more our clients learn from us the better off they will be. But our first obligation is to do those things that will build successful businesses.
A more formal and detailed description of our services can be seen at the Entrepot website.
How do you monitor the businesses?
We monitor the clients' businesses, at the early stages, on a daily basis. As a business develops, the reporting systems that were designed during the planning stage become more meaningful. Since many of our clients are locate in separate facilities and in some cases in different cities the use of cellular phones, fax machines and the Internet have become an integral part of our communications and monitoring operations. All of our clients are able to call a single phone number to reach any staff member. If the consultant is not in at the time of the call, all calls are forwarded to the staff member's cellular phone. Only if the consultant is in a conference are their calls sent to voice mail. The typical response time to a clients call is immediate. In those cases when a voice mail contact is made, the turn around call is normally made in less than one hour.
Any advice you would like to give someone setting up an incubator or looking to start a business in an incubator?
Anyone who would like to set up an incubator should very carefully research the market in order to determine how they will make the incubator pay off. If it is a private for profit incubator then make sure that the market is sufficient to make a profit. Further, make sure that you are able to sell and deliver the services that you are going to offer in sufficient volumes and at high enough margins to insure that your incubator is not a negative statistic. Finally, be patient. Even if you can act as an accelerator, it will most likely take a couple of years before the incubator shows a profit. If you pick the wrong clients, they will fail. If your clients do fail, then the incubator will fail.
For those looking to start a business in an incubator, be selective. If cheap rent is your motivation, then it is the wrong motivation. Look for an incubator operator that has had broad business experience, has a wide sphere of influence, and an accessible contact base. Make sure that the incubator will provide access to the knowledge that you lack and that the knowledge is available to you when you need it, not on some inflexible schedule, that happens to be convenient to the "free advisors". There is nothing more devastating to a new growing business than to have to wait until tomorrow, or next week, to do what needs to be done today.
