From eggs to equity Featured

9:38am EDT July 22, 2002
Wrong turns and backsliding occur from time to time, but the arrow of evolution flies toward the pioneering.

Thomas Petzinger Jr. used those words as the grand finale for his latest book, "The New Pioneers." Petzinger, a well-known Wall Street Journal columnist who recently left the publishing world to co-found a business incubator called LaunchCyte in Pittsburgh, was researching the benefits of incubation long before dot-com companies ever became popular.

Incubators have been around for decades, he says, helping young businesses get off the ground, typically by providing for them shared office space and services. And it's no coincidence that the influx of dot-com companies across the country the past few years has gone hand in hand with an increase in the number of incubators, particularly a number of new high-tech-oriented firms in Pittsburgh. But don't call them incubators.

"Some people are averse to the term incubator because the dot-com space has deflated," Petzinger says. "The valuation of dot-coms on Wall Street has been punctured, and since incubation was more closely identified with dot-coms, people are opposed to the term."

Call them what you want, but it doesn't change the latest incarnation of this age-old concept.

"Although they may not always go by that name, incubators are here to stay," Petzinger says. "Big organizations are losing their best talent to the new economy, and incubators will be out there to catch the talent that's fleeing. Individual entrepreneurs will come together to work on projects, and there will be a need for physical space, services and capital. Incubators will always be there to support them."

Petzinger, who serves as LaunchCyte's chief executive officer, doesn't mind if you refer to this start-up as an incubator, an accelerator, a network or even an early-stage fund. The most important thing to remember, he says, is what his company hopes to accomplish by providing seed money and business services to a highly targeted group of early-stage companies.

Breathing life into biotech

LaunchCyte, started in May by Petzinger and long-time high-tech consultant Babs Carryer, is not your typical incubator aimed at helping information technology companies. instead, the focus is on supporting companies that have both an IT component and a biological connection.

Its unique niche gave rise to the LaunchCyte slogan, "Where Life and Computing Converge."

"Health and medicine are becoming increasingly digital, and, at the same time, computer sciences are being informed by biologists," Petzinger says of his market niche. "So we're trying to support companies that have a biological component and an IT component. We think the future of biology, medicine and biotechnology will be digital, and we have a lot of medical industries and digital technology right here in Pittsburgh. We're trying to open the space to support both of them."

LaunchCyte's name and logo were carefully created to convey what the company is trying to accomplish and who it wants to help. The inclusion of "Cyte" in the name makes it clear the incubator has an interest cytology, the study of cells. The logo, designed by chief design officer Tim Carryer, husband of Babs Carryer, shows a strand of DNA connected to a computer cable.

Chucking their careers

Petzinger and Carryer were strangers a little more than a year ago, but a mutual friend felt confident they shared similar ideas which could be turned into a successful business. While Petzinger admits their ideas were not identical, they were close enough. They have spent the past year working on the business plan, developing their ideas and deciding what market space to target.

Concentrating on LaunchCyte meant, Petzinger says, "chucking our careers." He had spent 22 years as a reporter, editor and columnist for The Wall Street Journal and authored three best-selling business books. Carryer, LaunchCyte's president, had founded Carryer Consulting, which developed growth strategies for start-up companies such as Hells Kitchen Systems, SneakerLabs, jobsite.com and MediaSite. Her success as a business strategist was recently featured in Red Herring magazine.

Carryer says that having a sense of humor helped the company over some rough spots in the beginning.

"We're in the process now of learning how to place our priorities and knowing when to listen and what people to listen to in terms of advice," Carryer says. "Timing is crucial. Sometimes we've rushed the timing because we were trying to meet a deadline, and we actually missed the boat."

Petzinger says company players have made mistakes, but are always ready to learn and move on to something better.

"We've been too preoccupied with space issues and we've been too slow about some of our decision-making," he says. "We've seen opportunities slip away. We've agonized about decisions that we should have made quicker. As with everything in life, the good ones do get away sometimes."

Joining the co-founders in trying to make LaunchCyte a success is a group of professionals, including medical practitioners, field experts, experienced entrepreneurs and scientific authorities. Others are being sought to fill the positions of chief science officer, research associates and a deal person experienced in structuring venture capital deals.

An advisory board consisting of business leaders and distinguished scientists is in place to help LaunchCyte evaluate technologies and business opportunities.

Cash and equity

LaunchCyte's initial funding came from the co-founders' pockets and the generous contributions of family members. Petzinger says the company is in the process of raising $2 million strictly from high-net-worth individuals.

They plan to seek an additional $3.5 million in the fall from individual investors not necessarily from the area, and a third round of financing, totaling about $5.5 million, at a later date.

The substantial funding, Carryer says, is necessary early on because the company will not be accepting cash or its services. Instead, its business model calls for payment in what has become the chief currency in this New Economy: shares of company stock. Therein lies the core of New Economy incubators such as LaunchCyte. It's a model which will prove extremely risky on the front end, but the company hopes to hit pay dirt as at least some of its start-up clients score major successes.

"Cash is only cash," Petzinger says. "Were not in this to be consultants. We're in this to be investors. The upside of a high-risk investment is much more appealing to us than the certainty of a small amount of cash. The equity model seems to be the norm for incubators lately.

"The dot-com space popularized for-profit incubators that tend to work exclusively on the equity model. Now, the dot-com incubator model has deflated, but it's no reflection on incubators. It's a reflection on dot-coms. We don't think the demand for medical science is going to diminish any time soon."

Marketing efforts have been negligible up to this point, and the founders say they will not invest heavily in advertising in the future. Word-of-mouth marketing seems to be working well for LaunchCyte, which is generating interest while pursuing capital.

"Future marketing will be word of mouth in the technology community," Petzinger says. "We will try to accelerate word of mouth with Web site promotions, event sponsorships, conducting conferences and summits and possibly some advertising. If you give something to the community, that's the best form of marketing."

Of course, active fund-raising hasn't hurt its cause.

"We think we have the product, the contacts and the story to tell," he says. "Our fund-raising has been a source of marketing and brand building. We're generating some buzz in our attempts to generate funds, and that buzz is causing scientists to bring us their technology and employees to seek us out.

"You can build a dot-com incubator or company anywhere, but you can't build a highly sophisticated biotechnology company anywhere. In order to do that, you need medical science and computer science together, and Pittsburgh is globally ranked in both of these categories."

Carryer says that emphasizing what Pittsburgh has to offer is important when telling the LaunchCyte story to potential investors. The region, she says, is in a unique position to offer untapped resources to companies that are trying to form in the convergence space where medical science and computer science come together.

These companies encounter challenges that don't confront the typical IT start-up and must be addressed with a network of resources.

Maintaining a focus

LaunchCyte officials have talked to representatives from about 20 companies, including a handful from communities as far away as Seattle. Petzinger says, however, that his company's specialized niche will make it impossible to help every company that requests assistance. He says one of the biggest challenges will be sifting through the many opportunities and selecting which companies to help.

"We know that genomics and proteomics software tools are places we want to be in," he says. "For every company we incubate, there will be 100 that we haven't, and choosing one out of 100 will be a challenge."

The criteria, Petzinger says, include whether the technology is protected by patents, how neatly it dovetails with the trajectories of the marketplace, how neatly it dovetails with LaunchCyte's portfolio companies and whether it is beneficial to medicine and human health.

"We want to know if it has an impact because we want to make an impact," he says. "We will work with all early-stage companies, but that's a fairly wide category. We talk about companies including one guy and an idea as one category, five guys and a patent as another category, and then there are companies that we will form ourselves.

"For example, we may see a small company or individual researchers who has the pieces of a larger puzzle, and if we spot the opportunity to put those pieces together, we can create a company of our own design."

Petzinger and Carryer are talking to companies that are developing software tools to apply information about the human genome, companies that are developing tools to study how proteins work, robotics companies that are creating medical applications and medical technologies being used in high-tech imaging projects.

"We are more focused than most incubators in terms of the market segment, but even within that market segment, there are a half dozen subsegments, and we may choose to focus on only several of those," Carryer says. "We are strategizing about this on a daily basis."

Who benefits?

The advisory board and other staff members will play a key role in helping to decide which projects are pursued. Petzinger and Carryer hope to bring about 68 companies into the incubator over the next seven years, working with each for an average of 18 months.

LaunchCyte will provide the selected companies or entrepreneurs with strategic counsel, networking opportunities, seed money and introductions to vendors and funding sources, which may include venture capitalists, individual investors or pharmaceutical companies.

"We will have to spend a lot of time and resources evaluating even the best opportunities using our experts and advisory board," Petzinger says. "Once they are in the incubator, we will provide seed capital in the hundreds of thousands of dollars. In typical cases, the seed money will amount to about $500,000 plus an additional $100,000 in services. We will also introduce them to premium service providers who will be offering discounted rates."

According to LaunchCyte's business model, the amount of seed money could range from $300,000 to $1 million. In exchange for the assistance, LaunchCyte will receive equity interests averaging 40 percent in its portfolio companies. The 40 percent figure is based on LaunchCyte's flexible "deal model" of owning smaller pieces of larger companies, larger pieces of smaller companies and as much as 100 percent of the companies that it will create from scratch.

Petzinger says he is willing to work with firms from outside the region, as well, because having access to their technologies and networks could enhance the companies being supported on a local level.

Not your ordinary incubator

Petzinger is quick to point out that while LaunchCyte clearly is a business incubator, it takes its mission much further than other incubators in the region. For Petzinger and Carryer, it's all about networks.

"One distinguishing trait is our emphasis on the network aspect," Petzinger says. "Good friends can come together and create more of a sum of their parts. The greater the scope of the network, the greater the value of each part of the network. We're not just building an incubator, we're building a network that includes staff, portfolio companies, directors, advisers and strategic partners both in Pittsburgh and all around the United States.

"We think that network will generate so much knowledge, value and creativity that the whole will exceed the sum of the parts."

Another distinguishing characteristic, he says, is the company's reciprocal ownership arrangements with portfolio companies and others.

"We will award a very small piece of equity in LaunchCyte to companies from whom we're also receiving equity, so every member of the incubator will have a stake in everyone else's success," Petzinger explains. "We're not talking about a huge stake of equity, though, because it will never be more than a few percentage points of LaunchCyte's total equity.

"We have a lot of great technology in Pittsburgh, but we need to open the space for the technology to come together and add value to each other's work. I remember thinking what a privilege it would be to be a person who was in that space." How to reach: LaunchCyte, (412) 201-7238

Tracy Carbasho is a Wellsburg, W.Va.-based freelance writer.


An incubator network

LaunchCyte CEO Tom Petzinger says he is familiar with the other incubators in the Pittsburgh area, and he supports the work they are doing.

His company has referred business to other incubators which were more suited for a particular project, and officials from other incubators have sent clients his way.

Zlingshot, operated by Casey Smith, is among them. Smith is just as new to the incubator market as Petzinger and Carryer are. He began his company in May to help early-stage technology firms and already has several potential clients in the pipeline.

"We're part incubator, part investment company and part operating company," Smith says. "We will provide seed capital, assistance with strategic planning and the marketing plan, IT and Web development, recruiting, finding office space and seeking venture capital. We have more of a hands-on approach where we expect to be working with entrepreneurs 50 to 60 hours per week."

Smith says Zlingshot can provide companies with seed funds of up to $200,000. In return for the start-up money and services, Zlingshot will charge a fee which consists of a cash payment, deferred until the company gets its first round of funding, and part equity, which usually amounts to between 5 and 10 percent ownership in the start-up.

"We've been funded internally to date, but we're talking to outside investors, and we have raised some investment money already," Smith says. "Our goal is to work with 10 to 12 start-ups per year, and we will have a chunk in all of the companies we help."

Since May, Smith says he has received business plans from more than 200 companies, with about 60 percent of the inquiries being from local entrepreneurs. Other requests for assistance have come from as far away as Europe.

"We're looking at companies that are way too early-stage for venture capital," he says. "We're bridging the gap from the idea stage to the time when the company can go for venture capital. Venture capital firms are more willing to fund companies that have been screened by incubators."

Smith estimates there are 12 to 14 companies in the Pittsburgh area that serve as incubators or venture capital firms that fund early-stage companies. He predicts that some of the incubators will make poor choices of which ideas to fund and will go out of business.

Iventurelab, formed in 1998 by Tommy Wang, his brother, Henry, and friend Anthony Ma, so far isn't among such firms. To date, the incubator apparently is doing well, with nine start-ups in its portfolio. It helps Internet and software companies move from square one and get to the point where they can raise their first rounds of venture capital.

The Wangs' company offers software development, graphic design, human resources, legal and accounting services, office space, fund-raising assistance and recruiting help. Tommy Wang says its core competencies are strategy, technology and design.

Iventurelab takes part of its fee in cash and the other part in stock, which ranges from 15 to 35 percent ownership in portfolio companies. The fee ranges from a few hundred thousand dollars to millions, depending on the project.

"There are so many incubators that provide office space," Tommy Wang says. "We're more like a think tank with a 50-man development staff that includes some of the top people from the Carnegie Mellon University engineering school. We hope to do 12 to 15 projects per year."

Wang has his own prediction on the future of incubators. He says some of the more powerful ones in areas such as Boston are doing so well that others are trying to imitate them. He expects a Chicago-based incubator to go public in the near future -- an action that likely would determine what happens with many others.

Jeryl Rauluk, vice president of Discovery Entrepreneur Resources Inc., says her company is similar in some ways to an incubator. The firm, with offices in Oakdale and Murrysville, was incorporated in 1999 to provide consulting, staff augmentation and strategic planning.

She says her firm has helped about 20 technology companies, including one in South Carolina. Rauluk says companies can spend time perfecting their product while her firm concentrates on the business plan and obtaining necessary funding. For companies that have already perfected a product, DER can put together an appropriate marketing strategy.

"With start-ups, we take a combination of cash and equity," Rauluk says. "We like to work with established companies because they pay cash which, in turn, gives us more equity to work with start-ups. The companies we've worked with so far have been software firms and dot-coms. We concentrate on product management, project management and marketing, so I don't think we're considered an incubator, but we're a good complement.

"For example, incubators can offer four walls and technical support, but sometimes they don't have the expertise in strategic marketing and sales support. We try to maintain relationships with venture capital companies, and when we see something that matches a company's portfolio, we'll pass the information along to them."

How to reach: Zlingshot, (412) 512-0090 or www.zlingshot.com; Iventurelab.com, (412) 621-4050 or www.iventurelab.com; Discovery Entrepreneur Resources Inc, (412) 334-1760 or www.discoveryentrepreneur.com