Flip the Incubator Part 2: Job Creation Outlook

By Lauren A. Burnhill aka @LaurenOPV

Last week I promised some numbers and this week, I’ll try to deliver. In order to model job creation for incubators and alternatives, I had to make a lot of assumptions and I tried to keep these as simple and conservative as possible. The two tables below are intended to provide a job creation “guesstimate” for a traditional incubator model and for my “flip the incubator” proposal. My apologies for the clunky formatting – this is my first attempt at importing tables into WordPress.

In all honesty, the Flip Model assumes the existence of long-term social investors (foundations, family offices and HNWIs willing to provide patient capital) and/or government sponsors looking to provide lasting job creation and economic development. Ideally, a public-private partnership would form around each Flip Model, but that’s putting the cart way ahead of the horse.

If you are running a private incubator, I don’t suggest trying to flip your model unless you have patient sponsors with deep pockets. Flip won’t be sustainable in two or three years. My guess is that we need 7 to 10 years to reach break-even. Why? The answer is that we’re maximizing sustainable job creation rather than financial returns, which means slower growth, lower repayment “quotas” and longer-term relationships with Flip participants.

To get started, I’ve assumed that the incubator model produces four types of companies: home-runs, doubles, singles and failures (“dogs”). Half of the incubator supported companies were treated as dogs and half distributed across the three profitable categories. As you can see in the table below, this model created 2,450 jobs at a direct cost of US$81.63 per job. Indirect cost is higher because somebody has to run the incubator! The direct cost is only what is invested in incubator portfolio companies. Excellent cost per job, but a fairly low number of jobs created, given how many we need to be creating on a monthly basis.

Incubator Model
10 companies per cycle X 2 cycles = 20 companies
$10,000 per company; $200,000 investment over two cycles

Pct

Direct Jobs

Indirect Jobs

# Cos

Total Jobs

Home-run companies

10%

1000

100

2

2200

Double companies

20%

50

5

4

220

Single companies

30%

5

0

6

30

Dogs

50%

0

0

10

0

Total direct Job Creation

2,450

Cost per job

$81.63

For the Flip Model, I assumed only three types of companies: Stars, which grow from micro to small (or small to medium, depending on what market you’re looking at) and account for only 5% of the portfolio; Sustainable Ventures that produce consistent low to moderate level profits (70% of the portfolio) and Failed Ventures that represent a quarter of the portfolio. Note that fewer companies “fail” in this model because the definition of success includes small businesses that return a stable single digit return and not just businesses that can scale up. The cost per job created, US$ 443, is higher for the Flip Model, but the upside is that we’ve created 79,000 jobs instead of 2, 450!

Flip Model
5,000 companies per cycle X 2 cycles = 10,000 companies
Consulting per company = $2,500, $25 million investment over 2 cycles
Seed Capital per company = $1,000; $10 million investment over 2 cycles

Pct

Direct Jobs

Indirect Jobs

# Cos

Jobs

Star Ventures

5%

50

10

     500        30,000
Sustainable Ventures

70%

5

2

   7,000        49,000
Failed Ventures

25%

0

0

   2,500                      –
Total Jobs Created

          79,000

Cost per Job

    $443

It cost us US$ 443 to create each of 79,000 jobs using the Flip Model, which is five times what it cost to create a job in our notional incubator. On the other hand, we have 32 times as many people employed at the end of two Flip cycles.

I can’t even pretend that I have reasonable assumptions around tax payments, but let’s assume that each ongoing business pays some nominal amount of business tax and each employee also pays personal taxes. The table below shows that even if all Incubator and Flip businesses and employees are paying very low levels of income tax, the differential between the two models is signficant. Even assuming that Incubator companies pay twice as much in taxes as Flip companies (assuming the former are larger or more successful), the Incubator is throwing off $7.4 million in tax payments and the Flip is throwing off $158 million or 21 times that amount. In other words, the $35 million invested in Flip is generating $158 million in tax revenues on an annual basis while enabling 79,000 to enjoy a sustainable livelihood.

Incubator

Flip

Business Taxes Paid

 $                  2,000

 $              1,000

Personal Taxes Paid

 $                  1,000

 $              1,000

Total Taxes Paid

 $           7,350,000

 $   158,000,000

Even if you argue that Incubator companies will be much more successful and should pay five times more in business taxes (ie $10,000 per year instead of $2000), the Flip still generates almost 6 times more revenue for the public sector. We’d have to bump business taxes up to over $60,000 per company in order for incubator contributions to economic development to equal those of the Flip model.

Should we abandon the incubator model? Of course not! Can we create other models that nurture sustainable social enterprises and local economic development? I sure hope so!!

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3 responses to “Flip the Incubator Part 2: Job Creation Outlook

  1. Have read both these posts now and am very enthused by this idea. I see several issues that may need to be, or could be, addressed within such a plan: (1) Many people don’t know how to create their own self-employment business or have only limited expertise/skills in certain areas. The umbrella organization you posit could have a template + checklists that entrepreneurs can adopt, giving them a lot of the basic starters on how to create and run their business from actual operational issues to regulatory compliance and include warning signs about when to get outside advice (eg. whether about operating issues or biz admin such as cost accounting, legal /regulatory compliance, employees, taxation…). A focus on creating a replicable process – much like franchisors provide to franchisees – could also make the cost of providing the consulting services more predictable and manageable. (An additional, but perhaps problematic support, could be in buying business inputs through a co-op under the umbrella group.) I’ll call this the Franchise aspect. (2) Some additional partners or funders for the Flip model could be successful niche industry businesses, or professional organizations/unions, that are philanthropic-minded and wish to promote professionalism for new entrants, whether organic produce growers/distributors (WholeFoods), engine mechanics, brewers, bee-keepers, skills teachers or birth-counsellors. They could contribute to the Franchise template, assist with sourcing or providing the biz-ops consulting, and possibly with lobbying for government funding for the umbrella group. New “Franchises” would have a support group to network with. (3) From experience within a charitable organization, I see a lot of need for back office or admin services in addition to the group insurance plans that you mention they might benefit from within the umbrella org. Charities, non-profits and small businesses tend to be unable to afford, but still need, accounting/bookkeeping, computer/tech support, advice about legal and human resources issues (whether day-to-day stuff or urgent), strategic advice, liability insurance, buying groups…the list goes on. Almost none of them have time to source these inputs adequately, know how to get cost-effective service or know when they are not being served well.

    I would love to be involved with something like this in my home city, Toronto.

    • I really like your ideas, especially the different angles of how we can help entrepreneurs get started (in very practical terms) and what kinds of things might work “under the umbrella”. Lots of good “food for thought” in your suggestions!

      I don’t know any initiatives of this type in Toronto right now, but that doesn’t mean they aren’t out there. The MaRS Center seems to roll out new programs and ideas very frequently, so that might be the best bet today. Vancouver has a couple of interesting programs/start-ups that look at some of these things.

      BTW, I agree on the need for back office/admin support – seems to be universal for non-profits and small businesses alike. I think I have to start plaguing my colleagues with more questions. Is the lack of third party back office the problem? Or is it cost, or trust or size that creates the obstacle? I know VC and PE firms that require common back office for portfolio companies, but I imagine its easier to force the issue when you have investment dollars to offer (or to buy the service provider first).

      Thanks for sharing your ideas. If I hear of any Flip type models in Toronto, I’ll send you a note!

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