How Tech Incubators Work

Let's use the example of Innovation Depot in Birmingham, Alabama, to help us better understand the tech incubator process and why a company would want to use one.

The first step to joining a tech incubator like Innovation Depot is to apply online. In 2014, the incubator housed 99 different companies. Twenty-three of those companies were new in 2014, and those lucky companies were chosen from 122 applicants [source: Innovation Depot]. Competition is fierce at the most successful incubators — admission to Innovation Depot is based on the strength of the applicant's business plan and an in-person interview.

Admitted companies move into offices inside Innovation Depot, which are leased by the month. In 2014, the building held nearly 700 employees [source: Innovation Depot]. In addition to offering the conventional office amenities like conference rooms, WiFi, copiers, kitchens and (of course) ping-pong tables, Innovation Depot devotes a portion of its second-floor real estate to cutting-edge "wet labs," where biotech companies can research and develop new products and services. Members pay rent for their office space, which provides most of Innovation Depot's revenue.

Once inside the incubator, Innovation Depot offers a suite of customized services for growing companies, many of them provided by other companies in the incubator. Let's say you have a great product idea, but you need help developing a marketing plan. Lucky for you, there are a half-dozen strategic marketing and branding firms right inside Innovation Depot.

The same is true for other business-critical services like accounting, public relations, intellectual property protection, payroll management, distribution logistics and custom software development. Not only are all of these companies physically close, but they are co-members of the tight-knit Innovation Depot community. This is one of the biggest advantages of working within an incubator, instant access to like-minded entrepreneurs offering helpful services. There are also on-site business coaches to help with strategy and planning.

To foster this sense of community and enhance the incubator experience, Innovation Depot hosts regular community-wide events. There are the traditional mixers and happy hours, but also "hackathons" and twice-monthly seminars on strategic topics in startup development and management [source: Innovation Depot]. Innovation Depot also hosts regular, weekly "Depot Connect" mixers just for member startup companies as a way to foster culture and collaboration among the entrepreneurs.

And let's not forget about funding. Tech companies need capital to fuel growth and innovation. The board of directors at an incubator like the Innovation Depot includes regional business leaders representing banks, investment funds, economic development agencies and more sources of potential venture capital. In 2014, Innovation Depot companies raised $20 million, with 87 percent coming from venture capital firms and angel investors [source: Innovation Depot].

It's not an accident that Innovation Depot is only a block from the UAB campus. Colleges and universities are some of the most ardent backers of emerging technology. Major research universities have the luxury of easy access to brilliant young minds, a ready supply of research-focused faculty, and loads of expensive toys like engineering labs and supercomputers on which to test the best ideas. Thanks to bulging endowments, they also have lots of money to invest in promising ideas.

In addition to hosting traditional startup residencies on campus, university-based incubators also throw wildly popular startup competitions. The Rice Alliance for Technology and Entrepreneurship at Rice University in Texas hosts an annual Business Plan Competition that gives away nearly $1.5 million in startup funding to graduate-level entrepreneurs, with more than $500,000 going to the first-place team [source: Rice Alliance].

Established tech companies and corporations also have a vested interest in supporting high-tech entrepreneurship and innovation. Larger tech companies often buy up smaller, nimbler startups that have developed a game-changing new product or process.

To ensure a steady supply of new ideas, these corporations might invest in the creation of new incubators like Matter in Chicago. The nonprofit health-technology incubator received $4.4 million in private funding from 20 Chicago-area companies in 2014, including several large pharmaceutical companies [source: Carpenter].

Idealab, arguably the most famous tech incubator, has a completely different business model. The California-based incubator is a private, for-profit company founded in 1996 by serial entrepreneur Bill Gross. Unlike most incubators, which accept applications from established startups, Idealab generates its own business ideas and then recruits in-house teams to grow them into viable startups [source: Idealab].

As you research tech incubators online, you might find that some are referred to as accelerators and vice versa. It's true that some incubators have become accelerators, or offer those services but the two entities are quite different.

Tech incubators are a great way for fledgling tech companies to develop their business plan and connect with investors. But there's also something called a tech accelerator. In both tech incubators and tech accelerators, small teams of founders are mentored by experienced tech entrepreneurs and provided with critical services.

The terms "incubator" and "accelerator" are often used interchangeably, but the two business development models are actually significantly different.

Let's start with the clients served by incubators and accelerators. An important characteristic of tech incubators is that they are open to companies in all stages of growth and development, from the earliest-stage ideas to established companies looking to rebrand or develop a new product or service.

For example, one of the biggest success stories at Innovation Depot is Atlas RFID Solutions, an established company that moved its offices there after taking a hit during the Great Recession. With the help of Innovation Depot's in-house legal and accounting resources, plus its connections to investors, Atlas RFID Solutions re-emerged stronger than ever, boosting revenue from $200,000 in 2007 to $7.2 million in 2012 [source: NBIA].

Tech accelerators, on the other hand, target only the earliest stage companies, often nothing more than a pair of smart 20-somethings with a bright idea. Y Combinator, one of the most successful tech accelerators, puts more weight on the talent of the founders than the actual idea, which it expects will change considerably during the accelerator process. You also don't need a business plan to apply to Y Combinator.

The next big difference is the length of the development process. In an incubator, member companies expect to spend several years with the organization and treat the space like a permanent office. With most tech accelerator programs, prospective members compete for a limited amount of residencies that last only three to five months.

The final, and perhaps most important difference between tech incubators and tech accelerators is the overall mission of the organization. Incubators are mostly nonprofit ventures with a goal of kick-starting innovation in the regional economy. Incubators rarely provide upfront seed money to member companies, and they don't take a percentage of profits earned by companies they help to launch.

Accelerators, on the other hand, are often for-profit businesses founded by teams of venture capitalists and angel investors. They award $100,000 or more upfront to founders in exchange for an equity stake — between 6 to 10 percent — in their companies [source: TechStars].

That said, there are plenty of examples of hybrid incubators/accelerators. There are three-month accelerator programs run by nonprofit universities. Some incubators award money upfront. And certain companies that started out as incubators switched to an accelerator model, all adding to the confusion. In fact, Innovation Depot is launching an in-house accelerator program with the goal of providing funding to participants in key sectors.