Small business incubation

As the whole world looks at how (and if) the United States can stimulate our national economy, I contend that we should place more focus on small business incubation. I mean "incubation" in a specific sense very different from the funding for Small Business Administration loans that are in the current version of the bill. These are good, but target a very different business model than what I have in mind.

Below, I lay out a vision for a business incubator that I would very much like to see happen in economically challenged urban areas around the country (places like Memphis, Cleveland, St. Louis, Detroit, etc). I strongly believe that there is an opportunity for software-focused business models to thrive in non-traditional areas of the country and have an enormous positive impact on these regional economies. Silicon Valley is great (I've lived there), but we need to pollinate other parts of America with the same entrepreneurial focus and brilliant innovation that has made Northern California the wonderfully affluent place that it is today.

The type of businesses I see being incubated by this system are small, lucrative software products such as commercial applications, websites and web services.  This business model was presented very succinctly by David Heinemeir Hansson at Startup School 08.

So, here's my outline for a small business incubator: 

1. Targeted at early stage software/web-based business ideas
• Can be launched by very small teams (1-5 people)
  
• Low capex/startup costs ($50k-$200k)
2. The incubator is managed by a well-balanced board of technologists and entrepreneurs with expertise in software, electronic commerce, business development and legal.
   
3. Stage 1: Apply for proof-of-concept grant (~$10K)
• Establish the project's viability within 4-6 weeks (the shorter, the better) by using these funds to:
  
• Refine the business plan
• Create a technology roadmap
• Design and build a prototype
• This initial $10K is not a grant or funding round: it is a promissory note tied to the applicant's active participation in the project. 
4. Stage 2: Present the business plan and demo the prototype.  A review board decides go or no-go.
   
5. Stage 3: Iterative, quarterly funding cycles (~$25K-$100K) covering operating costs
   
• Provide shared office space and resources (like a traditional tech incubator)
• Each team works regularly with a team of mentors: one technology expert, one product expert.  Mentors provide guidance to their respective team members and work together to help the group manage the project
• Regular status updates every 30 days to the review board
• Demo of new product development (required)
  
• Progress plan update and estimation of progress milestones for next status update
• Review board assesses previous estimates and current updates to gauge the team's success, foresee problems and commit to next quarterly round of funding
• Each funding round gives another slice of equity to the incubator, in accordance with a predefined schedule
  
6. Stage 4: Launch or scrub within 6 months (the shorter, the better)
   
7. If the project is scrubbed, this is okay; promote idea of failure as a learning opportunity
• Require "drop outs" to participate in a post-mortem activity (participation in this final stage will satisfy the terms of the stage 1 loan)
• Use feedback gained in these post-mortems to guide future activity (both for reviewing new business proposals and managing ongoing projects)
  
8. Inactive, ineffective or disruptive mentors or board members can be censured or ejected, as necessary
   

This process is designed to fail fast.  Unlike traditional investment banking and venture capital models, the goal is to quickly incubate lots of small businesses with an expectation to get several multi-million dollar successes.  Rather than pour millions of dollars into a handful of businesses in the hopes that one will be a billion-dollar lottery ticket, this model is designed to give birth to many small, successful businesses that can have a long lifespan.

There's certainly nothing wrong with the traditional VC model -- especially from the investor's perspective.  A big win using the conventional model will almost certainly generate more wealth for the venture firm.  The small business incubator, though, will have a much broader impact on a community scale.  Imagine the turnaround that could happen in a depressed local economy if 30-40 small businesses could be established over the course of a couple of years, each one employing 10-20 people and earning some millions of dollars of annual revenue.  Now compound that success over several annual cycles and you begin to see a picture of robust economic growth.