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Incubate or incubust

Monday, 21 November 2011 | By Mahesh Sharma
In the past year, mentor-driven incubators have spread like wildfire across the lush Australian start-up landscape. But there are questions over whether this seemingly welcome surge in start-up help is just a flash in the pan for both entrepreneurs and investors.


Originally made popular by Y Combinator in the US, the incubator and seed accelerator model sees a collective of mentors invest a small amount of seed capital for a minority stake in scalable tech idea or very early stage business (usually $25,000 for 7.5%).


The model launched locally last year via Startmate which assembled some of Australia’s best and brightest entrepreneurial talent, and has since been replicated in a range of similar flavours including Pushstart, Melbourne-based Angelcube and the York Butter Factory incubator.


However, can the local start-up scene supply enough talent to give the investors a suitable return on investment? Is it the best way for an entrepreneur to get their idea off the ground? And, crucially, can the industry support this number of incubators?


Making dreams come true


Startmate counts Atlassian’s founders among its 25-odd mentors and after pushing out its first intake of graduates earlier this year, will soon take on another five entrepreneurs to launch web and mobile start-ups.


Among the five alumni, Bugherd and Chorus have since attracted investment from popular US incubator 500startups, while Noosbox and IRL Gaming continue to develop their applications and businesses.


Wollongong start-up Grabble was recently acquired by US retail giant Walmart, and the company's digital receipts technology and team will relocate to Silicon Valley.


Grabble sends receipts to customers' phones, avoiding the need to keep track of paper receipts, and co-founders Stuart Argue and Anthony Marcar praised the Startmate program, which facilitated an introduction to incubator and investor 500startups, a precursor to the Walmart deal.


All businesses credited the program with turning a dream into reality, including Noosbox, an email collaboration tool for small business, which is currently in beta and preparing for a full launch next year.


Co-founder Andrew Jessup says the biggest value was gaining access to the Startmate network which is connected to everyone who knows about start-ups.


One weakness is that the 25-odd mentors are limited in the amount of meaningful support and advice they provide the five start-ups.


“We felt like we were out in the wings a bit, when people came in and spent ten minutes with us and give us some advice, that wasn't particularly useful," he says.


Startmate co-founder Niki Scevak admits there is always be an uneven distribution of mentor resources, and says the goal was to provide two to three meaningful mentor connections, which hopefully could become investors.


This issue is being addressed by providing more specific mentoring, addressing common problems that affected all first-round Startmate start-ups, and the appointment of Startmate alumni as mentors (Grabble’s Marcar and Argue).


“The mentor background is very varied and the connections between the start-up and the mentor depend on the background of mentor, the vision of the start-up and the similarities between the two,” he says.


“One big lesson for me last year was often start-ups don't know what they don't know, it’s hard for mentors to say ‘what do you need help with’ when start-ups aren't equipped to answer that."


Scevak says one of Y Combinator’s biggest achievements is the robust alumni network, which he hopes Startmate will recreate over next five to ten years.


As incubators sprout up across the country, Scevak dismissed the notion that Startmate has a first-mover advantage, and says the mentors will always remain the key differentiators.


“The money, legal, office, discounted services and everything else is just table stakes.”


Incubation validation


A variation on the seed accelerator model such as Startmate, PushStart, and AngelCube is the recently-launched Melbourne incubator and co-working space York Butter Factory, backed by early stage venture capital firm Adventure Capital.


Then there is BlueChilli, a Future Capital-backed project that will open incubators in Melbourne and Sydney, taking on more than 40 start-ups, over the next two months. Suddenly, the market has gone from barren to, potentially, overcrowded.


Darcy Naunton, general partner of Melbourne’s the York Butter Factory, says the incubator and co-working space aims to host businesses that are exciting businesses but aren't mature enough to receive investment from a fund.


The ultimate measure of success of the incubator model will be apparent in the coming years when start-ups exit and attract follow-on funding.


"The proof will be in the pudding when we start to see exits coming through and there's validation for these young seed companies being funded," Naunton says.


"You would say it was unsustainable if we weren't seeing these accelerator programs going on to bigger and better things."


"So ideally you'd either see them flipping up to the US or gaining more traction from angel investors locally, but it would be a problem if the next steps aren't taken and you would get seed accelerators with portfolios of dead companies, which would be a terrible thing to see."


Startmate’s Scevak says it's important for financial returns to validate the accelerator model but mentors enjoy giving back to the community.


“There has to be both a financial return and a passion for start-ups because in the end if there isn't both then it won't be sustainable,” he says.


“Primarily though, the mentors seem to be motivated for the satisfaction of giving back to the community but some have follow on invested in companies and so on.”

Incubate or incubust


Entrepreneur Elias Bizannes has been closely involved in the local start-up community and is now based in Silicon Valley.


He doesn’t believe the incubator model will last and that alternatives such as AngelList, which acts as a virtual “matchmaker” for start-ups and investors, are easier ways to raise funding.


"There has definitely been a boom in incubators, especially the seed accelerator kind,” Bizannes says.


“I think the model of investing will be more sustainable, as the investors have a lower cost of capital to satisfy to generate a return (ie. a Silicon Valley talent acquisition of $2-4 million can give the seed investors of Startmate a 10 times return).


“That said, I don't think all these incubators will last: getting a bunch of random mentors, with dumb capital being invested isn't what makes a successful incubator."


Bizannes emphasises the importance of a mature exit market to nurture companies that have graduated from accelerator and incubator programs.


"It's a hits-based business, and a mature exit market is needed. It's partly for this reason that Silicon Valley has an edge over any other region in the world and why the incubators here are more likely to succeed."


First-timers need apply

Even at this early stage, however, there are success stories to be found. Whether it’s Grabble or 99dresses, backed by the comparative veteran Pollenizer scheme and now headed to the US to join the Y Combinator program, it’s clear that there is plenty of Australian start-up talent to be nurtured.


Bizannes believes there are plenty of benefits that first-time entrepreneurs can gain from incubators.


"Different incubators benefit you differently,” he explains.


“They are great for those who don't have a network, a reputation to raise capital, or validation in their abilities due to lack of experience. Incubators don't make you a guaranteed success, they simply reduce the risk of you failing."


Adventure Capital's Naunton says that both accelerators and incubators are a “self-fulfilling prophecy”.


“By sheer virtue of going through Startmate, AngelCube, Y Combinator, there's a lot of validation in that company even without having the customers on board.”


“It's somewhat of a self-fulfilling prophecy that a level of success will be breed out of the fact that they have gone through an incubator program.”


Startmate's Scevak believes the value of incubators is that they allow a business to accelerate their business development, learning and investing over a matter of months, but he warns that it is definitely not guaranteed to succeed and the default outcome is failure.


“Only a small number will succeed,” he says. “Seed accelerators add to the chances of success but the reality is that still the majority of start-ups fail.”


Noosbox co-founder Andrew Jessup said the program is best suited to technical co-founders, and ideally they have already launched the first version of an application which is ready to be scaled to the next level.


If you don’t fit these criteria, your chances of success are limited. But even if you do tick all of the boxes to join the burgeoning incubator scene, it remains to be seen whether any graduates are set to storm the world stage.