In BRW: How Predatory Incubators are Strangling Our Startups

16 Oct 2014 by Scott Middleton

This article originally appeared on BRW.

The tech incubator boom is on. But the hype is only matched by the number of disillusioned start-ups they leave in their wake. Despite the gag clauses, “anonymous sources” ensure their stories keep on leaking out.

The central misconception that underpins all start-up/incubator relationships is that taking equity aligns the incubator with the start-up’s interests. This fairytale deserves to be categorically busted.

If a start-up is putting money in to pay for the incubator’s services or the incubator is making a margin on these services, then they aren’t aligned with the start-up. They aren’t sharing in the risk of the venture, they aren’t co-founders; they’re a service provider.

Though it is not ideal, there are times when your best option is to provide equity to a service provider. When this is the case, the least risky way to deal with it is to link the cost savings offered by the provider directly to the value of the shares provided. This leaves no room for dispute; it is simple and measurable.

In contrast to the predatory incubator model, accelerators offer capital and mentoring to start-ups. They give a lot and take very little. Y Combinator gives a start-up $US120,000 ($138,000), access to some of the world’s best mentors and great exposure for 7 per cent. Locally, Startmate offers something similarly beneficial.

So why do founders continually fall prey to incubators that take more than 10 per cent equity and make profits charging for their services on top of that? A few reasons repeatedly come up as to why a non-technical founder might be considering such an incubator.

In each case there is a better option.

One of the most common is the question of capital. The founder might have a great idea but they don’t believe they have the money to hire a developer or contract the work out to a development company. A “partnership” with an incubator looks like a pretty good deal. Surprisingly, many make this judgment without even getting an estimated development cost from a potential programming hire or independent development company. Getting an estimate, then trimming back on the idea and funding just enough development to prove the concept to investors or customers will yield a much better result for the founder and their company. This also follows industry best practice, lean start-up thinking.

Another reason start-ups turn to incubators is that they believe they need a technical co-founder to get their ideas off the ground. Too often the desire for a technical co-founder is driven by a fear of the unknown. Founders need to get comfortable with that feeling – it never leaves – and look to build a brains trust of technically minded people who are willing to offer guidance on navigating the technical frontiers because they were once helped the same way.

Still, if a founder feels that they must have a technical co-founder, an incubator is far worse than an individual. Founders need co-founders with the same obsessive focus, someone who is putting the same sweat and tears into their business as they are. Incubators have too many start-ups they’re working with to put this sort of commitment in. But whether it’s an incubator or an individual, when a start-up gives the co-founder equity in the expectation of future work, they are hamstrung if the co-founder turns out to be incapable of delivering or a bad fit.

Incubators that rely on the profit they make through services to start-ups aren’t motivated to help start-ups pay attention to essential market signals which may indicate that a start-up needs to improve. If a start-up isn’t finding traction with individual co-founders or investors, that should tell them that their ideas maybe aren’t ready or just aren’t that great. While incubators will put forward their mentors, who might be useful, the best mentors will be experienced technical and commercial minds who’ll give advice for free over a cup of coffee. No contract required.

From a start-up perspective, it is hard to make a strong argument for incubators that act as technical co-founders as long as they continue to employ this predatory model. The many tales of woe told from start-ups burnt by their contact with incubators should be a warning to non-technical founders looking for a way to get their tech company off the ground to steer clear. There are much better ways to prove your idea and progress it to the next stage, so that it is ready for investment and growth.

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