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  • 1. file:///A:/94sbi090.txt Page 1 of 8 THE BUSINESS INCUBATOR: RETHINKING ITS APPLICATION TO SMALL FIRM FINANCIAL STRATEGY DAVID B. NEWTON, WESTMONT COLLEGE ABSTRACT Business incubators provide operational assistance at one loca- tion to newly launched businesses. These shared arrangements provide generic operational support at an elementary level of sophistication. Incubator finance and accounting services include basic data entry, bookkeeping, and end-of-month state- ments. This paper addresses the lack of strategic value in incubator accounting and finance support functions. A previously published model of unmet tenant needs is further developed to segregate operational and strategic financial reporting requirements. A financial strategy model is proposed where incubator firms proceed through increasing strategic requirements over time. A channel of incubator-support stages is recommended to provide internally-graduated financial strategy support as tenant firms progress through the incubation process. INTRODUCTION The incubator, an often reviewed concept within the entrepreneurship and small business literature, has been hailed as a revolutionary concept for enterprise development and job creation (1) (2) (3). In reality, incubators do provide very basic support services for new ventures, including reception, meeting and office space, data entry, word processing, copying, printing, and management advice. They also assist with bookkeeping, inventory accounting, and generic end-of- month financial summaries for newly launched small businesses (4). The Problem Small businesses tend to utilize generic "off-the-shelf" software for their accounting and finance functions (5), yet want financial reports which are useful for their own unique decision- making (6). Incubators generally lack the resources sophis- tication necessary to address firmspecific financial reporting requirements of tenant firms (7), yet evidence shows that a firm- specific, strategy-driven objective should be employed when setting up a small firm financial information system (8). The generic nature of these incubator accounting and finance functions may not be altogether beneficial or value-adding to a small firm's financial strategy and positioning needs. HYPOTHESES A primarily operational managerial resource, incubators may not meet the strategic needs of tenants. Three questions must be asked. First, are tenant firms aware of any strategic deficiencies that may exist in incubator-provided accounting and finance services? Second, is there a point at which tenant firms might recognize the need to first augment their incubator- provided accounting services? And third, is it possible for incubator-based new ventures to develop timely and reliable financial strategic information? It could be argued that the development of incubator services aimed at specific financial file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 2. file:///A:/94sbi090.txt Page 2 of 8 strategic capabilities might not be conducive to the contemporary incubator model, where services have broad applications. Objective This paper reviews the characteristics and empirical evidence of incubators, and the nature of incubator-provided accounting and finance services. The "management advising" component of incubators is then examined relative to the fundamental tenets of operational management and strategic management relative to new venture financial reporting requirements. Finally, potential detriments of incubator services are delineated in light of the differentiation between operational and strategic financial orientations. A model is proposed that could serve to locate the most appropriate time(s) for a new venture to utilize an incubator, and at what specific point it might be beneficial to abandon the generic incubator concept from a firm's operations in favor of developing specific financial strategic information resources. Discussion addresses the model's impact on incubator use, and ideas for further research are proposed. BUSINESS INCUBATORS Networking and shared resources are essential elements of successful entrepreneurial ventures (9). Incubators provide generic shared business management support functions, with access for numerous small firms at one location (10). They are often located in converted warehouses and abandoned factories where inexpensive support services are offered for nascent enterprises and where tenants generally remain for between 18 and 24 months (11). The number of business incubators in the United States grew from ten in 1979 to over 350 by 1989 (12). Reports were that there would be well over one thousand incubators by the early 1990's and that four out of five existing incubators were successful (13). Incubators are an essential component of a larger model for enterprise development, but are merely one type of small business resource along with venture capital exchanges, intrapreneurship and innovation centers, small business development centers (SBDC's) and student education/entrepreneurial development (14). Some incubators organized and geared toward a niche of new ventures that exhibited common profiles of business success factors (15). Specific criteria that should be employed when small firms are choosing an incubator, including a match of industry firm type with certain support and technology services (16) (17). Incubator Empirical Studies Incubated businesses have success rates of between 80 and 90 percent, while nonincubated firms have failure rates near 60 percent (18). One study examined a large incubator over a nine year period and found that only 23 of 143 (16%) new ventures failed (19). Incubators in smaller cities tend to be more successful than those established in metropolitan areas, and incubator tenants believe the services provided are important for the continued survival of the business (20). New entrepreneurs enter incubators only when they believe that some benefit will be derived from file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 3. file:///A:/94sbi090.txt Page 3 of 8 their tenancy, and that these expectations vary considerably (21). Incubator tenants primarily seek inexpensive space, with shared and incubator-provided services, and such services are extremely generic in nature rela- tive to business type (22) (23). Four measures of successful incubators have been suggested, including a relatively large number of tenants, a large number of jobs created, a high level of graduated firms (firms that leave the incubator), and a tenant equity position (24). Incubator Finance and Accounting Business incubators generally offer a basic package of finance and accounting services (bookkeeping, data entry, and ex post end-of-month financial statements). Very little of this is customized to the unique objectives and concerns of tenant firms. This paper contends that the majority of tenants probably do not recognize the generic shortcomings of these reports. Incubator Management Advising The primary function of an incubator is to provide management ad- vice, networking for ideas, and operational support (1) (10) (11) (12) (16) (25). Incubators offer noticeably generic support (management advice included) in an effort to provide widely-used applications for all tenant firms. This "expertise" exhibits some breadth, but no firm-specific depth of knowledge for specific strategic ideas and goals of particular small firm tenants. Operational Management The studies cited in the prior section found that the advising available through incubators is almost strictly operational management support (i.e. directly related to day-to-day firm operations). This type of "planning" is myopic by nature, and often ex post in terms of developing firm perspective. Strategic Management Strategic management is distinguished from operational management in that it takes a longer-term view of the business, and is ex ante in its perspective. Potential changes in the external environment and the relative appropriateness of the firm's internal capabilities are managerial concerns far more sophis- ticated in nature than coordinating daily operations. The firm specificity required to analyze and take action on strategic issues goes far beyond the capabilities of the operational advice offered through business incubators. Small Firm Strategy Strategic planning is positively related to small firm performance (26), but strategic management for small business needs to be specific and dynamic in its implementation. Firm- specific strategies are necessary for small businesses to be successful, and certain small-firm strategies are more profitable than others (27). Little benefit accrues to small firms that utilize a highly formalized strategic planning process (28). Small firms should know the difference between a written business plan and on-going company planning, because small firms rarely use their stated business plans for managing on-going operations (29). file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 4. file:///A:/94sbi090.txt Page 4 of 8 A FINANCIAL STRATEGY MODEL A previous model of incubator-tenant interactions was developed (23) where sponsor-managers of the incubator decided that some services were unneeded offerings, tenants recognized that some needs were unmet, and an overlap occurred where sponsor offerings met tenant needs (Figure 1). This serves as a basis for examining where the operational finance components of the incubator end, and the strategic requirements of the many tenant firms begin. Figure 1 INCUBATOR-TENANT INTERACTIONS ________ Sponsors|-----------> Unneeded and |-----------> offerings Managers| ________ ________|<----------------------->| |Tenants Unmet <-----------| Needs <-- ---------|________ From: Spitzer and Ford, 1990. Journal of Business and Entrepreneurship, (October), p. 32. Figure 2 outlines three basic accounting and finance needs that are met by most incubators, and recognizes that the resources to address the tenants, financial strategic needs develop outside most incubator capabilities. Much of what incubators offer is often limited in scope relative to the tenant firms (30). An incubator financial strategy model would address those specific unmet needs of tenants, and could eventually require incubator manager/sponsors to consider firm-specific financial strategy as a necessary service offering. There is little agreement as to which incubator services have the greatest value for tenants (25). Figure 3 outlines nine types of firm-specific strategic oriented financial reporting requirements. Each of these documents exhibit ex ante financial forecasting perspectives that are directly related to strategic issues that impact small business capabilities. Figure 2 INCUBATOR-TENANT STRATEGIC INTERACTION ________ _________ Sponsors|---------------->| Tenants and | Data Entry | Managers|---------------->| Opera- | Bookkeeping | ational ________|---------------->| Needs End-of-Month |_________ Financials _________ __________ ? |----------------->| Strategic|----------------->|Strategic Resource |---------------- ->| Needs _________| |__________ Figure 3 (Incubator) (Tenant) Sponsors| | and |<---------------------------->| Operational Managers| | Needs _________| |___________ |----------------------------->| | Pro Forma Income Statement | | Pro Forma Balence Sheet | ? |Cash Budget Scenario Forecast | Strategic| Capital Budgeting Forecast |Strategic Resource | Sources & Uses of Funds | Needs |Pro Forma Receivables Aging | | Pro Forma Payables Aging | | Financial Ratio Analyis | | Cost Accounting Analysis | _________|----------------------------- >|___________ file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 5. file:///A:/94sbi090.txt Page 5 of 8 Financial management as both operational and strategic components. Posting receivables and payables, and monitoring working capital are fundamental financial operations easily offered by incubators. The higher quality of sophistication and expertise necessary to generate timely and useful financial strategy requirements (eg. pro formas, scenario analyses, forecasts) is directly related to firm posture and positioning, so that small businesses can address external threats and opportunities, internal capabilities and resources, and other strategic issues. Figure 4 proposes a financial strategy model for incubator tenant small firms where line B represents a fixed level of operational finance support from the incubator, and line A represents some scheme of additional graduated firm-specific financial reporting. (Line A assumes that financial reporting increasingly develops at discrete points in time as the business grows.) Line 1 depicts a newly launched incubator firm that displays erratic changes in financial reporting needs. Early on, the firm derives sufficient utility from the incubator financial support up to time period lb (their financial reporting needs do not exceed the incubator's data entry and bookkeeping services up to that point in time), after which they then require other firm-specific services not offered by the incubator. Figure 4. Line 2 traces a second firm type that has more predictable and uniform reporting requirements. It quickly outgrows the incubator at point 2b. These requirements remain within the general parameters of the growth in expected discrete additions to financial reporting. Line 3 traces a third firm type that is also predictable and uniform in financial reporting growth, but which successfully utilizes the incubator finance supports for a relatively long time (point 3b). DISCUSSION It would be inappropriate to assume that any small firm still housed in an incubator is not a candidate for sophisticated, firmspecific, strategic financial requirements, just as it cannot be said that firms requiring strategic-oriented financial reporting should not be located in an incubator. Location of the business operations is exclusive of strategic financial needs. It would be worthwhile to locate any discrete points in time where newly launched firms would require additional financial strategy- oriented reporting, and whether incubator firms understand their need for these increasingly sophisticated support functions. Business incubators might need to establish a continuum of categorical support (from purely operational levels through various stages of strategic tools) aimed at a complete range of tenant firm types, each with differing strategic financial reporting requirements. Once graded support levels are in place, newly admitted tenants could be tracked across a series of variables. Incubators could support separate classes of firms with distinct financial and accounting service groups, and pro- vide an intra- incubator graduation process through well-defined stages of financial support. Figure 5 outlines how Stage 1 tenant firms require only basic (Level 1) financial support (up to point a). Firms at Stage 2 require the first adjustment in strategic reporting requirements up to Level 3 (this adjustment could be the addition of some portion of the financial reporting summarized in Figure 3). Stage 3 requires further strategic- oriented sophistication to Level 3 (point c), while Stage 4 could file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 6. file:///A:/94sbi090.txt Page 6 of 8 describe some remaining financial strategy reporting capability to some comprehensive arrangement (to Level 4, point c). Figure 5 IDEAS FOR FURTHER RESEARCH Prior work recommends longitudinal studies be developed when examining entrepreneurial ventures, in that repeated measures over time provide much clearer results compared to studies that employ retrospective designs (31). Researchers could measure tenant firms from their first day in the incubator to the day they graduate and see if firm profiles could be developed to describe whether distinct firm types exist (see Figure 4). It would be interesting to see what measures (if any) might prove useful in classifying incubator tenant stages of strategic financial reporting requirements. A Data Envelopment Model was previously developed to analyze the efficiency of SBDC's that provide incubator-comparable services (32). This could be extended to examine incubator new ventures that are deemed homogeneous across several criteria, distinguishing these on an input-output basis (those that utilize firm-specific financial reporting versus those that do not). Perhaps the concept of an incubator is more descriptive of the physical arrangement, rather than the nature and quality of the support services. REFERENCES (1) Carroll, R., 1986. "The Small Business Incubator as a Regional Economic Development Tool: Concept and Practice", Northeast Journal of Business & Economics, (Spring/Summer), 24-43. (2) "Small Business: Incubate and Flourish" Economist, 1985, (November 30), 34. (3) "Economy's Incubator", U.S. News & World Report, 1986, (May 19), 19-21 (4) Ellenis, M. and J. Innace, 1985. "Business Incubators", Nation's Business,(November), 48 A-H. (5) Broida, M. and D. Flora, 1990. "The Status of Computerized Accounting Software in Small American Businesses", Journal of Small Business Strategy, (February), 44-51. (6) Singleton, L.G. and B. Swindle, 1992. "Preparing Decision Useful Financial Reports: A Challenge for Small Businesses", Journal of Small Business Strategy, (Spring), 59-66. (7) Udell, G.G., 1987. Sources of Incubator, Financial, Management, and Technical Assistance for Inventors and Innovators. (Rockville, MD: Mohawk Research Corporation) (8) Lin, B. and J.A. Vassar, 1990. "Issues in Managing Small Business Information Systems", Journal of Small Business Strategy, (February), 37-43. (9) Birley, S., 1985. "The Role of Networks in the Entrepreneurial Process", Journal of Business Venturing, (Spring), 107-118. file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 7. file:///A:/94sbi090.txt Page 7 of 8 (10) Allen, D.N. and S. Rhaman, 1985. "Small Business Incubators: A Positive Environment for Entrepreneurship", Journal of Small Business Management, (July), 12-22. (11) Goldstein, M.L., 1987. "Hatching Companies: Business Incubators Improve Their Chances", Industry Week, (July 13), 20-23. (12) Woolley, S., 1990. "Feathered Nests for Your Fledgling Business", Business Week, (February 19), 139-140. (13) "Business Incubators: A Booming Business", Journal of Accountancy, 1988, (June), 18-19. (14) Hisrich, R.D., 1988. "New Business Formation Through the Enterprise Development Center: A Model for New Venture Creation", I.E.E.E. Transaction Engineer Management, (November), 221-231. (15) Lumpkin, J.R. and R.D. Ireland, 1988. "Screening Practices of New Business Incubators: The Evolution of Critical Success Factors", American Journal of Small Business, (Spring), 59-81. (16) Nelton, S., 1984. "Incubators for Baby Businesses", Nation's Business, (November), 40-42. (17) Demuth, J., 1984. "What Can Incubators Offer?", Venture, (November), 78-84. (18) Dobler, B., 1989. "Right From the Start", Savvy Woman, (November), 87-88. (19) Mamis, R. A., 1989. "Mother of Invention", INC., (October), 119-128. (20) Reed, D., 1991. "Incubator Program: Factors in a Profile of Success", Journal of Business & Entrepreneurship, (March), 61-71. (21) Spitzer, D. and R. Ford, 1989a. "Essence of Business Incubators: The Manager-Tenant Interaction", Journal of Business & Entrepreneurship, (March), 37-48. (22) Spitzer, D. and R. Ford, 1989b. "Business Incubators: Do We Really Understand Them?", Babson Conference on Entrepreneurship Research, St. Louis University, (April). (23) Spitzer, D. and R. Ford, 1990. "Business Incubators: Manager-Tenant Interaction Revisited", Journal of Business and Entrepreneurship, (October), 31-39. (24) Smilor, R.W., 1987. "Managing the Incubator System: Critical Success Factors to Accelerate New Company Development", I.E.E.E. Transaction Engineering Management, (August), 146-155. (25) Fry, F.L., 1987. "The Role of Incubators in Small Business Planning", American Journal of Small Business, (Summer), 51- 61. (26) Watts, L.R. and J.G. Ormsby, 1990. "The Effect of Operational and Strategic Planning on Small Firm Performance", Journal of Small Business Strategy, (October), 27-35. file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04
  • 8. file:///A:/94sbi090.txt Page 8 of 8 (27) Ibrahim, A.B., 1993. "Strategy Types and Small Firms' Performance: An Empirical Investigation", Journal of Small Business Strategy, (Spring), 13-22. (28) Robinson, R. and J. Pearce, 1983. "The Impact of Formalized Strategic Planning on Financial Performance in Small Organizations", Strategic Management Journal, (Volume 4), 197-207. (29) Parks, B.; Olson, P. and D. Bokor, 1991. "Don't Mistake Business Plans for Planning", Journal of Small Business Strategy, (February), 15-24. (30) Udell, G., 1988. "Strategies for Stimulating Home-Grown Technology-Based Economic Development, Business Horizons, (November/December), 60-64. (31) McNeil, R. and P. Burgar, 1991. "Entrepreneurship Success or Failure: Can We Identify the Causes?", Journal of Business and Entrepreneurship, (March), 35-46. (32) Lang, J.R. and P.A. Golden, 1989. "Evaluating the Efficiency of SBDC's with Data Envelopment Analysis: A Longitudinal Approach", Journal of Small Business Management, (April), 42-49. file://C:WINDOWSDesktop1994SBIDA94sbi090.htm 5/19/04