Venture capital increasingly incubates its own startups

Venture capitalists are known for spotting and investing in promising upstarts, but an alternative approach is growing in popularity: incubating.

Why it matters: With startup investments pricier and competition stiffer, some investors are setting up startup studios or incubating companies — a trend that’s expected to continue accelerating.

The big picture: The recent public listings of companies like Snowflake and Hims have put incubation and startup studios back in the spotlight.

• Startup studios have evolved since Idealab’s founding in 1996 — from offering shared office space and servers to providing efficient systems for quickly testing (and rejecting) ideas.
• They tend to combine deep market research, networks with potential entrepreneurs and other would-be early employees, and capital to seed promising ideas.

What they’re saying: “In general, the studio structure is really smart in a world where there’s a lot of capital coming into the market downstream,” says Heather Hartnett, Human Ventures CEO. “And the return profile of being in there early is great.”

Between the lines: It’s all about getting sizable equity stakes at a low price.

• “Our goals include proprietary deal flow, which yields meaningful ownership in great businesses, without paying frothy prices,” explains Brian Schechter, who heads Primary Venture Partners’ incubation program. He adds that the NYC firm’s first three incubated companies will return its first fund “many times over.”

In New York City, which appears to have more startup studios than any other region, this model can fill in some resource gaps and turbocharge startup formation. (Yes, NYC’s startup scene is now robust, but that wasn’t always the case.)

• Startup studio Atomic’s arrival last year in Miami is likely to have a similar effect.
• And the studios can act as their own business clusters, especially when focusing on a particular sector like fintech or health tech. “If you have founders building [companies] together, it’s not 1+1=2 — it’s 1+1=10,” says Hartnett.

Yes, but: Not all startup studios and incubation is created equal.

• The top criticism is that some studios take too much equity (sometimes upward of 50%-60%), leaving founders with stakes not meaningful enough to put in the grueling work. Ditto with board control.

The bottom line: VCs will go to great lengths to find great investments — and it increasingly means helping to hatch companies themselves.