Broadly speaking there are 3 revenue models for business incubation environments: revenue from incubated enterprises; revenue from equity; and external donors. Most business incubation environments will combine elements of each, and this article highlights the pros and cons of each and provides guidance in choosing the right mix.
| Revenue Model |
Key Features |
| 1. Revenue from tenants and other clients:
Rent (40 to 60+ %) is the most common, but fees for the business support offered (business incubation fees) and other fees for use of facilities and services can be just as important. Hot desking fees (renting a desk and on-line computer by the hour can be important for broader incubation models) |
Financially self sufficient, given:
- "free" buildings
- Minimum economies of scale
- Often with anchor tenants
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| 2. Revenue from sharing in client success by way of small equity positions or royalty agreements on gross sales and brokerage fees on raising finance. |
- Stakeholders with deep and patient pockets – it takes up to 10 years to develop the revenue streams in a way that they can sustain operations into the future.
- At the leading edge of business incubation environment development and relatively rare.
- Needs management sophistication, a well developed business environment (so as to be able protect and to from an investment) and, for brokerage fees on finance raised, capital markets.
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| 3. On-going government or donor funding |
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The first two models may be expected to be self-sufficient over time, perhaps with the only ongoing support for the first model being ‘free buildings’. A proportion of ongoing government funding is likely to be particularly relevant for SIDS, especially if the social and economic return on investment is greater than for other BDS-like activities. The indebtedness of many SIDS however, may make it very difficult for Governments to afford long term funding or necessitateor necessitate rigorous cost benefit analyses to compare incubation to BDS and other business development support mechanisms before committing to long term support.
Taking a small proportion of equity, or a royalty on gross sales for a period can be a very good way to receive payment for a business incubation environment’s value-adding services once the company being assisted has succeeded, rather than up front when the company is short of cash; sharing in success and aligning the business incubator’s mission with that of its clients. More and more technology business incubation environments take a small equity position, or negotiate royalty agreements as a condition of entry to the business incubation environment. Taking equity only realistically applies to high growth and generally IP driven companies, in situations where there are clear exit mechanisms (e.g. IPO or trade sale) and does not make much sense with most service companies or where exit mechanisms are not clear, where royalties may be a better approach.
Business models reliant upon success sharing with client companies have proven to be somewhat problematic, if returns from the equity position, royalties and brokerage on finance are to be relied upon for financial sustainability in the short term, because it takes up to 10 years to realize returns and a portfolio of at least 20 companies is required to spread the risk, not to mention the high level of management expertise that is required. New Zealand is a good example where this model is being followed, in a strategic way. The Government provides annual funding for a 10 year period, after which the business incubators are expected to replace this financial support with returns from small equity positions (up to 5% typically), royalty arrangements on gross sales for a negotiated period (typically 2% for a 3 year period) and finance brokerage (only possible if there are capital markets, although government funds are applicable as well). Other business incubators, which rely upon rent and other revenue streams for their self sufficiency, still enter into these arrangements as a way of sharing in the success of the companies they assist, but not as the main strategy for financial self sufficiency.
Business incubation environments reliant upon rent and client fees as their main revenue sources cannot, as a general rule, be financially self sustainable in commercially leased accommodation or where they pay the capital costs of a building, without other forms of substantial ongoing support. Generally this is ongoing financial subsidies by a third party, which can be unreliable and unpredictable. It is very hard for a business incubation environment to achieve adequate margins in commercially rented accommodation and business incubation environments that attempt this run the risk of either failing financially, or having to cut costs so that they end up as nothing more than real estate operations. More commonly, business incubation environments access buildings at a ‘peppercorn’ rental (e.g. $1.00 per annum), or secure funds to purchase or construct their own facilities, both of which are more reliable ways of securing ongoing support. With these models there are minimum economies of scale that allow financial self sufficiency, ranging from 1,500m2 in countries like Australia to 3-4,000m2 in Europe and the USA and more than 10,000m2 in China.
Some of the best business incubation environments combine elements of all three of the models outlined above; arguably the best strategy.
Another strategy used is to generate revenue from non-business incubation activities such as consulting. This runs the risk of taking time and focus from the important task of assisting client companies, but on the other hand leads to an entrepreneurial approach. The Jamaican Technology Innovation Centre is an example of an entrepreneurial approach, generating additional revenue from consulting, training, facility rental, ID services, document processing for businesses and study tours. As the business incubator is repaying the substantial loan for construction of the building they have little choice.
Busy Internet in Ghana is an innovative example of a very different business model which involves revenue from ‘hot desking’, internet café, ISP, training facilities and restaurant, as well as the more traditional income streams.