Startup support organizations—especially incubators—are notoriously fragile. Of the 122 incubators and accelerators that Xconomy profiles in the 2012 Guide to Venture Incubators, almost three-fourths of them were founded after 2006, and more than 95 percent since 2000. Only two of the Xconomy Venture incubators have had sustained operations for more than 15 years. The longest established of these—the Austin Technology Incubator (ATI)—turned 25 this week. So it may be worth examining ATI for lessons on incubator sustainability.
First, some background on us. ATI is the startup incubator of the University of Texas at Austin and works with early stage companies, helping prepare these businesses for commercial success, with a particular focus on helping startups compete in the capital markets. We have operated since 1989 with a dual mission: create jobs and wealth in Central Texas through technology entrepreneurship, and provide distinctive teaching and research opportunities to the UT-Austin community.
ATI is a “classic” incubator. We work with our member companies for a sustained period, usually 12 to 36 months. We surround members with talent they otherwise could not afford to access, including our own staff, faculty and students at UT-Austin, and area mentors and advisors. We operate across multiple tech sectors, currently with a focus on IT/wireless, healthcare/life sciences, and energy and clean tech. Admissions are selective: less than 10 percent who apply become members of ATI.
We have a track record of success:
• Since our founding in 1989, some 150 companies have “graduated” from ATI.
• More than 40 of these have exited via an IPO or M&A, and an additional 55 continue to operate as going concerns.
• Many ATI founders go on to create other companies, which themselves often end up with us at ATI. Exterprise begat Webify; Evity begat Savara Pharmaceuticals; Phurnace Software begat Datical.
• According to independent analysis performed by UT-Austin’s Bureau of Business Research, over the past 10 years alone, ATI graduates have contributed almost $1 billion in economic output to the Austin area and created more than 6,000 jobs.
• Since 1989, the total economic impact of ATI companies in Central Texas is about $2 billion.
• Over the past 5 years, ATI companies have raised more than $350 million dollars in investor capital.
Even a program as established and successful as ATI, however, faces real sustainability challenges. An incubator’s primary clients – the startups being incubated – do not have much money. They therefore cannot pay fully for the value the incubator delivers. This means an incubator needs to find other sources of revenue to sustain its operations. And we have.
Most incubators rely on two sources of revenue: charging rent for office space, and/or taking equity in incubated companies. Although ATI does charge rent, and indirectly takes equity, those sources were not sufficient to make us sustainable. Here’s why, and what we did about it.
Rental income is insufficient because there is just not a lot of margin in being the middleman in a real estate transaction. Even in situations where the incubator’s space is subsidized or even cost-free, it is rare that rent will provide enough revenue to hire the people and build the service lines required to create value for startups. Also, relying on rental income creates incentives to “keep the incubator full” regardless of applicant quality. Good incubators need to be able to say “no” and run at less than capacity if doing so is necessary to preserve the quality of their portfolio. That is hard to do when rent is what pays the bills.
Taking equity in incubated companies should allow incubators to participate directly in the downstream value they helped to create. However, for most incubators, equity will have only a small economic impact and will almost never contribute to sustainability. First, dilution kills you, unless you have the financial wherewithal to protect your equity interest through subsequent financing rounds. As an example, ATI recently witnessed an approximately $50 million exit for one of our companies, but the equity “pop” to us was only worth about $30,000.
Second, there’s a timing issue. We can’t sustain ourselves while we wait for a big equity pop. We are a business that needs cash flow to survive.
So what has been our key to long-term sustainability? Our 25-year history suggests three strategies that we think have been critical for ATI’s longevity.
First, find the right institutional sponsor, one who brings value and is committed to the long term. For ATI, that is the University of Texas at Austin. UT provides us access to space, facilities, and resources such as the university libraries. All of our back office, compliance, sponsored research, and other admin is performed through UT, which significantly lowers both our cost and our risk. We have UT talent—student associates—working with our companies, as well as UT faculty who help solve problems, validate potential solutions, and bring innovations to commercialize.
Second, early on at ATI, we identified entities that benefit “downstream” from the value we create “upstream” and asked them to help pay for it. In our case, this has meant relationships with economic development organizations, large corporations, and professional service providers.
• ATI’s founding support came from the city of Austin and Travis County, each of which invested for economic development reasons.
• Today the city and the state of Texas each support ATI financially in return for economic development results verified via annual impact studies.
• We partner with corporations interested in early access to our portfolio and pipeline, both to understand the evolution of the startup landscape in their sectors, and to identify potential acquisitions. IBM, for example, has been a longtime partner with the Incubator, and since 2006 has bought three ATI graduates, BuildForge, Webify, and Lombardi Software.
• Local professional service providers provide support because our portfolio is highly curated and we have a track record of helping member companies achieve funding, grow, and succeed.
The third key to our longterm success, we think, is diversifying our product offering. Earning revenue from incubation activities is challenging—the primary beneficiaries, the incubated companies, have very little money – but good incubators have built other capabilities that have value in the marketplace.
In our case, a significant portion of ATI’s early revenue, came from a contract with NASA where ATI was paid to identify commercially promising technologies in NASA’s portfolio and build businesses around them. Today, ATI has relationships with several governmental and private sector organizations who ask ATI to support or perform research on various topics related to startups and technology commercialization.
All together, likely through a combination of strategic design and luck, our approach has helped ATI be successful and stay relevant for 25 years. We have evolved an economic model beyond rent and equity. The future certainly will introduce changes and modifications—such as, potentially, partnering more closely with capital providers. But our approach to building and sustaining successful operations for a quarter of a century has provided a solid foundation on which to build.
