Technology Incubators: Has Their Time Past?

As a home for startups, the state-sponsored network has proved itself over two decades. But critics say big firms and rich investors are exploiting the program.

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Israeli high-tech workers. Rare is the Ethiopian-Israeli among them.
Israeli high-tech workers. Rare is the Ethiopian-Israeli among them.Credit: Alon Ron

The technology incubator project is a government program 23 years old. In the old days the goal was clear: to provide funding for young, inexperienced entrepreneurs having a hard time raising funds to turn their ideas into businesses.

The state took on most of the risk and funded 85% of the investment in startups requiring heavy spending on research and development. The rest of the financing came from private groups that won the concession to operate and manage the incubators.

Even today, long after the Startup Nation matured, the government provides entrepreneurs with around 160 million shekels ($46 million) a year through the program.

On Monday, the Economy Ministry’s Chief Scientist’s Office announced the winners of the tenders to run two new technology incubators. Strauss Group will develop a food technology incubator in Ashkelon, to be called Food-Tech Hub, while Teva Pharmaceutical Industries and Dutch company Philips will specialize in pharmaceuticals and medical devices. Their outfit will be called Inspire Healthcare Innovations.

No one was chosen to operate the third planned incubator in the Golan Heights, for which a tender will be issued in six months.

Unlike during the previous tender process two years ago, people in the high-tech sector are asking whether technology incubators remain relevant when it’s easier than ever for startups to raise money. Do startups in the mobile phone and Internet industries need government help at all to raise seed funding? Do the large companies that run incubators really invest the public’s money efficiently and in a way that meets the incubator program’s goals?

Run by the Chief Scientist’s Office, the network of state-supported incubators was meant to turn technology developed at research institutions into commercial products, while creating a culture of technological entrepreneurship and investment opportunities for venture capital. It would also develop a high-tech industry in the country’s outskirts.

Another goal was to coax venture capital funds into investing in the riskiest, earliest-stage startups. By the end of 2013, the program had helped launch more than 1,800 companies with $730 million of government money. The incubator portfolio companies raised another $4 billion from the private sector, including so-called angel investors and venture capital funds.

In other words, for every dollar the government put in, private investors put in $5, with most of this raised after the companies left the incubators. In fact, about half the companies that completed the incubator period raised at least $500,000 within a year.

Yossi Smoler, the previous head of the incubator program, overhauled the program to let large corporations manage incubators, too. The assumption was that they could add value, not just inject money. In the previous tender, multinationals such as Johnson & Johnson and Nielsen won, as did Israeli defense contractor Elbit Systems.

In addition, Smoler and Economy Ministry officials concluded that they didn’t have to work in hot areas such as the Internet and mobile applications. For the incubator, they focused on areas such as life sciences and medical devices, where funding is more difficult to obtain.

Long development cycles

Smoler’s decision has proved correct. Since the incubator program was privatized in 2002, 836 companies have taken part, half in the life sciences. These companies raised a combined $1.5 billion, compared with $580 million for information technology and communications startups.

In the past five years, some 70% of Israeli startups in the life sciences have been part of the incubator program at some stage. Today half are in the life sciences, where incubators have become a critical resource in an industry characterized by long development cycles, heavy capital spending and high risk.

For more traditional high-tech startups in areas such as the Internet and mobile applications, there are many other routes besides incubators. These companies usually need much less funding because they rely on open-source code and use cloud computing resources at the outset.

There are no less than 40 programs in Israel that call themselves accelerators for such startups; the young companies are assigned mentors and support depending on their products. Many are under the auspices of big companies such as Microsoft, IBM, AOL and Citigroup.

Another incubator success has been Trendlines Medical, an incubator based in Misgav in the Galilee that was named the outstanding incubator of 2013. The Trendlines Group, which operates the incubator, said last week it had filed a prospectus for an initial public offering; the shares will trade on the Toronto Stock Exchange.

The recent changes in the incubator program were designed to bring in operators with deep pockets who could help firms find funding in the future or a buyer, but critics complain about the policy for choosing incubator operators and the quality of the companies they have taken on.

The program still suffers the reputation of a refuge for lesser-quality startups. Many suffer from what the industry calls Death Valley — an inability to raise capital after leaving the incubator. According to one startup investor, it’s an open secret that investors shun incubator startups because they use their capital poorly.

According to the investor, another problem is that when incubator startups try to raise funds after leaving the incubator, the founders and early investors find their holdings severely diluted.

In addition, the government lets incubators take too large a percentage of startups’ shares, often between 30% to 50%, says the investor. In most cases they take the maximum. All this dampens an entrepreneur’s incentive to make a company a success, he says.

Critics say another problem is that life for incubator operators is too comfortable. They put up very little of their own money and the government takes most of the risk, making the upside sizable. It’s no wonder so many big companies and wealthy investors want in. There’s a suspicion that big companies use the incubators as an R&D arm at the public’s expense.

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