WSJ India Chief Mentor has an interesting article on incubators being an important engine of growth of entrepreneurship. It is an interesting observation, and makes me think about what will make these successful.

Incubators have been known before to have an adverse selection problem. Simply stated, if an entrepreneur has an option to either get cash investment or incubator support, what are they likely to choose. Incubator “money” is likely to be at a far higher cost than investment, and hence unlikely to attract the best ideas/teams.

There are a few things that can still offer an interesting opportunity for incubators:

  • Lower cost in startup phase: Web 2.0 has reduced the cost of internet startups in the west. If incubators can help achieve more with lesser money, or entrepreneurs can achieve more “under the radar” (with much less money than is typically supported through angels/VCs), they might be better off on a net basis being with an incubator. In a market like India, it remains to be demonstrated how much can be achieved (without compromising value) with 5 lakhs of cash.
  • Dramatic shortage of cash investments: If the ecosystem is too weak to support the top tier ideas/teams, than incubators may land up getting some of those as well. I do not believe that is the case in India though – the key gap might be in offering the adequate investor diversity, and in that scenario the screening skills of incubators become critical. From what I have seen of some of these incubators, that is not necessarily the strongest point in their favor.
  • Value beyond: In my mind, this is the most important element if an incubator has to succeed on a sustained basis. It has to provide value beyond money. That could be access to highly capable technical/scientific personnel (think IITs, or in a mature model, Israel). Or perhaps market access through a corporate incubator. I have heard claims that networking between incubator participants itself could be a key value, but am not sure of that one. Access to high quality mentorship at early stages – would the best teams get access to this anyway?
  • Own the idea factory: If ideas are generated in the incubator itself (such as a company, or a university setting, though in India most university incubators are tapping outside ideas) then the adverse selection issue might be avoided.

I would love to get thoughts on the merits of such an initiative. One can justify the government programs as a developmental initiative, but I would ask the question if they should operate as independent selection entities, or double down to increase probability of success of companies that have gone through a high quality selection process. Another key success factor will be the length of time for which an incubator supports the company – if business building is taking a few years, can an incubator effectively influence the outcome through a 3-6 month involvement? An interesting article here which outlines some similar thoughts.