What's wrong with incubators?

Incubators seem to be among the latest darlings of the business world, and to a lesser extent, the health IT industry.

Extremely rare just a few decades ago, there are now more than 1,200 incubators in the U.S., Entrepreneur.com reported.

While the vast majority of these incubators don’t cater specifically to healthcare, several prominent incubators do, including: Blueprint Health, Rock Health, HealthBox and Startup Health.

The logic behind incubators is that they can help inexperienced entrepreneurs by providing the mentoring, business advice, networking opportunities, facilities and funding they need to get their businesses off the ground.

Kendall Wouters, CEO of Reach Ventures in Cleveland, doesn’t buy much of that logic. Wouters believes the model most incubators operate on is fundamentally flawed. Most importantly, incubators fail to do the up-front diligence in assessing the market potential of ideas that entrepreneurs bring to them, meaning the vast, vast majority of companies that enter incubators are doomed to failure and won’t make it through the “valley of death.”

“Most incubators are cultivating a garden of startups that are dead on arrival,” he said.

To understand Wouters’ thinking, it’s important to understand his definition of the “valley of death.” For Wouters, it’s not the commonly understood definition of the term — the time period between idea and commercialization when many startups have a difficult time accessing capital.

Rather, in Wouters’ vernacular, the valley of the death is the period of time from idea to the point at which a company identifies a sustainable and repeatable business model. Crossing that valley requires a serious amount of scrutiny — a couple months to conduct a formal market assessment and develop an understanding of the market’s incumbent players, plus acquire a detailed understanding of how and why a product will cause its target customers’ behaviors to change.

“If you’re going into a market and you don’t have a fundamental way to disrupt, substitute or complement existing innovation enough for the customer’s behavior to change, you are wasting time,” Wouters said.

Most incubators are “puppy mills gambling with people’s dreams,” investing in startups despite not having a clue whether those companies actually have any chance of achieving that disruption, according to Wouters. Most incubators based their decision on a “gut feeling” about an incoming startup rather than on a deep assessment of the entrepreneur and his or her idea. And that’s the essence of the problem with most incubators, according to Wouters.

And then there’s the type of entrepreneurs that incubators attract — typically high-energy people with high-risk tolerances who don’t have the responsibilities that would prevent them from leaving their existing jobs to devote themselves full time to their new ideas. Those qualities don’t necessarily have much bearing on whether a person has the wide array of skills to be a quality entrepreneur, manage difficult people or see a company through the lean times when it’s constantly struggling to make payroll, Wouters said.

“Just because you think you have an idea doesn’t mean you have what it takes,” he said. “Just like the book “E Myth” says, because you’re willing to take the risk to quit your day job doesn’t mean you’re an entrepreneur.”

“Fine,” an executive with an incubator might say, “but we know that only 10 percent of the companies we invest in will exist in five years, and we tell that to every entrepreneur who steps through our door. Everyone involved knows what they’re getting into.”

The consequence, according to Wouters, is that so many snowball’s-chance-in-hell companies get funded when they shouldn’t, incubators are “killing the entrepreneurial spirit in these people because they’re gambling with their lives.”

In other words, don’t encourage these would-be entrepreneurs to quit their day jobs until they can confidently make it through the valley of death. “I feel sorry for them because I know they don’t have the proper recipe to keep their dreams alive,” Wouters said.

Wouters’ company Reach takes a much different approach to starting companies. Reach’s model is to find an idea, assess it, build it quickly and see it through Wouters’ valley of death — identifying a sustainable and repeatable business model. Then, Reach gets out of the way by handing off the idea to a follow-on funding group, like a private equity firm, to build a company.

“We go out and look for a gap in the market, then look for ideas on how to fix it and test them,” Wouters said. “Our goal is kill the idea quickly. The faster we kill it, the fewer resources we spend.”

Wouters said Reach is working on several possibilities now but isn’t ready to get into specifics. All take a big data approach to solving market problems, he said.

“With our approach, there’s a much higher likelihood of creating sustainable businesses that have a chance because the ideas are fully assessed,” Wouters said. “We have execution, clear positioning and market validation. And we’re not trying to build the next Facebook.”

[Photo by flickr user AlishaV]