Home Articles Three red flags to watch out for in an Incubator

Three red flags to watch out for in an Incubator [Attention Start-Ups!]

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My recent story on start-up incubators certainly generated some lively discussion and a large number of emails from people outlining their less-than-ideal experiences.

Mostly, their accounts exposed a really troubling issue. Some start-up founders told me they were entering into agreements with their incubator/accelerator, paying very substantial sums of money and giving up high percentages of their company in return for a place in the program, and the development of a website.

The people who contacted me with these types of agreements were mostly very aggrieved with what was delivered, were self-critical that they had naively agreed to the deals and were now locked into onerous and binding contracts. Some said they were legally obliged to pay more than $100,000 as part of their deal.

Their experiences prompted me to develop a basic checklist to help founders and entrepreneurs do a fundamental assessment of what they are being offered. It should help you to determine when to be wary of what could be an exploitative offer.

But first, some clarification on the differences between a start-up accelerators and incubators is needed. Both offer packages of office space, facilities, mentoring, business networks and VC connections. But that’s often where the similarity ends, though both terms are often used interchangeably.

What exactly is an Incubator?

The US National Business Incubator Association defines an incubator as a “business support process” that promotes the successful development of fledgling companies through resources and services from the incubator and its contacts. They don’t generally have a limit on the time a business can spend in the program and graduation can occur any time from about six to 48 months.

Incubators are more likely to prefer an existing business that wants to grow and develop over time, with “graduation” from the program taking up to four years.. They will often charge a monthly fee for their package of services and don’t usually seek an equity position.

And… an Accelarator?

Accelerators aim for the same overall goal of helping to improve the odds of success for start-ups, but unlike the incubator, accelerators generally make an investment in the companies enrolled in their programs.

Accelerator programs are designed to be concise and generally take three to four months to complete, culminating in a “pitch” or “demo day”.

The Three Warning Signs

There are three very important signs to watch out for when you’re assessing your options. An incubator or accelerator that exhibits any of these should raise a red flag. You should proceed with extreme caution and, at an absolute minimum, seek objective third-party advice before signing binding agreements.

1. “Use Our Expensive In-House Developers!”

The incubator/accelerator proposes a turnkey solution, including building you a sophisticated website or other using in-house services and charging thousands of dollars.

An incubator where the business model is to use their in-house “dev” team for a fee and/or equity has, in my opinion, a clear conflict of interest. Ethical incubators/accelerators focus on getting you established with minimal cost and that would rarely involve using expensive in-house developers.

A related warning sign is a complex and one-sided contract that contains clauses binding you to an accelerator well beyond the formal program period.

2. Advisors don’t have a track record of success

The program’s advisors don’t have a discernible track record of success working with start-ups.

One of the truly critical means to a successful outcome is the quality of the management team, including the board, chief executive, chief operating officers, advisors and mentors. You absolutely must do careful and detailed due diligence on them.

Don’t be fooled by a cool office and location, it’s the team that is critical. Each of these people has a very important role to play in getting you to a point where your business is operational and attractive investment opportunity.

3. The program’s success stories are… not that great.

While you might think that this is an absolute no-brainer, I list it because once again, there is no substitute for thorough due diligence.

It is truly time consuming, but you simply have to talk to as many of the past graduates of the program as you can, and not just the ones suggested by the program. If the program you are considering has graduated 40 or 50 businesses, then plan to talk to 80 per cent of them.

Don’t shortcut this aspect of your due diligence. Feedback may range from ecstatic satisfaction to “I’m taking legal action”. A handful of past graduates is just not enough to verify the program’s claims.

And, a final parting advice

A final consideration is to be alert to the program that has one objective: to extract the maximum amount of funds and equity from you.

Many reputable programs focus on working to qualify the potential of your idea and getting you to an investment-ready status as quickly and with as little cost as possible.  Unfortunately, it is very much a case of caveat emptor when it comes to signing a contract with an accelerator or incubator.

Don’t sign agreements until you have done your homework. A formal legal opinion may well cost a few thousand dollars, but that is petty cash compared to signing an exploitative contract.

But wait, you may not even need an Incubator/Accelerator.

It’s also a good idea to firstly decide whether you really do need to approach either an incubator or accelerator.If you have a killer idea that you truly believe has the potential to become a business, there is a growing number of services designed to quickly help you do basic testing to determine whether your business is something worthy of investment.

Good examples of such services are Javelin’s QuickMVP and Experiment Board, which are super useful for both start-ups and more mature businesses. If you use them, you might be in a much better position to pitch to investors.

Whether you are bootstrapping a new venture, revitalizing an existing company or working on an exit strategy, you need at least a sounding board and more usually you need wisdom, experience and business smarts. Advise, consult, strategize, devise, implement, manage, mentor – that’s my niche and what I do everyday.  

Greg Twemlow is a Sydney-based business consultant. Find him on LinkedIn at http://www.linkedin.com/in/ gregtwemlow

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