Incubators Providing a Helping Hand to Internet Start-Ups

Peter Dolch, the president of Thaumaturgix Inc., a five-year-old Internet technology consultant, and his staff. Mr. Dolch finds that offering office space to start-up companies cements the consulting relationship.

JOHN HOLUSHA
03/05/00

THE proliferation of new-media and other Internet-related companies in New York and the scarcity of available office space are creating a new type of business: incubators that provide prebuilt space to start-up companies, often in return for the right to obtain stock at favorable prices.

Real estate executives say this approach mirrors the tactic of venture-capital companies that make investments in many small, underfinanced companies   —   knowing that many of them will fail   —   in return for the opportunity to share the rewards of those that succeed.

"Incubators are hot now   —   everybody's trying to get into it," said William Brodsky, a senior managing director at Insignia/ESG, the real estate services company. He said traditional suppliers of temporary office space in the city, like Vantas and HQ Business Centers, have been joined by companies like TechSpace and IdeaLab, which specialize in Internet-related ventures.

"Even S. L. Green and Vornado are trying to get in on it by building out a few of the floors of their buildings," Mr. Brodsky said, referring to two large real estate investment trusts that own office properties in Manhattan.

Some of the venture-capital companies backing the dot-com start-ups are getting into the incubator business in hopes of nurturing the companies they have invested in, said David Falk, an executive managing director of Newmark & Company Real Estate, a services company. "General Atlantic Partners and others have leased 100,000 square feet at 601 West 26th Street, the Starrett-Lehigh Building, as an incubator for finance-related start-ups," he said. "The idea is to create an environment where they can interact with each other."

He said the incubator will be called Efinanceworks.

He added that companies that had developed incubator businesses on the West Coast   —   E-companies is one   —   were known to be looking for space in New York. One such California company, IdeaLab, recently leased 94,000 square feet at 675 Avenue of the Americas, at 21st Street, for use as an incubator.

Before the coming of the Internet, the practice of providing offices for small temporary tenants was called fractional office space business. A company would rent space from a landlord on a long-term lease, build and equip offices and then rent the space to companies that needed a place for its employees to work temporarily. The fractional space operator rented the space at a considerably higher rate to the temporary tenant and made more money by providing communications and secretarial services, as well. Real estate executives said it has not been unusual for operators to rent space at $40 a square foot annually and to rerent it at $90 to $120 a square foot.

The risk, of course, was that the operator could not find enough temporary tenants to cover its long-term lease obligation to the landlord.

INTERNET start-ups represent a considerable challenge for landlords. Most of them are staffed by young people with limited business experience. Many have financing from venture capitalists so they can afford the rent, but the question is, will they be around long enough to complete the lease?

It is generally expected that many of these companies will fail or that they will be absorbed by more successful ventures. And because the whole e-commerce industry has developed in only the last few years, few of them have much of a credit history.

Some landlords are taking a traditional approach and requiring hefty security deposits, as much as three years. But tying up that much capital can hinder a company's growth, and most dot-com managers are convinced they must grow quickly or die.

The ones that are successful grow at a phenomenal rate. Eric Granowski, a senior managing director of Murray Hill Properties, recently helped negotiate a deal to move Bigfoot Interactive, an e-mail direct-marketing company, into a building at 531 Fifth Avenue, at 43rd Street.

"Within 30 days of signing a lease for 20,000 square feet, we had to go back to do an additional 16,475 square feet to accommodate the growth," Mr. Granowski said.

He said the decision by the landlord, RFR Holdings, to rent space to Bigfoot was a recognition that the opportunity for renting more space at least partly outweighed the risk of signing a deal with a company that has not yet sold stock to the public. "A year ago I don't think they would have done this deal," he said.

The lure of making a killing in the stock market by establishing links with dot-coms early in their existence is beginning to distort the real estate business, said James Meiskin, the president of Plymouth Partners, a broker who represents tenants.

"I'm competing for a 150,000-square-foot block of space on the West Side," he said. "My client is a multibillion-dollar company that has been around for at least 50 years."

ALSO bidding for the space, he said, is a technology company with almost no history and considerable credit risk. But that technology company is offering the landlord warrants to buy stock at a favorable price if it goes public.

"The landlord is considering doing that deal rather than with my client, and that says a lot," Mr. Meiskin said. "This has happened overnight."

One company that got into the incubator business almost by accident is Thaumaturgix Inc., a five-year-old Internet technology consultant. Peter Dolch, the president of the company, provided space for dot-com clients as an informal service.

He said a typical Internet start-up is a few people with a business plan and a couple of million dollars in financing from venture capitalists. "They don't know how to get a T-1 line installed and don't want to waste the time doing it," he said, referring to the high-capacity telephone connection that most Internet companies require.

Mr. Dolch said offering office space to start-up companies helps solidify the consulting relationship and takes one more burden away from young executives trying to build a business. "We'll provide you with a place to sit for three months until you staff up," he said. "It's not a long-term solution, but we can help get you started instead of operating out of spare bedrooms, the way we did."

Helping these new companies succeed is in his own self-interest, Mr. Dolch said, since failed companies can't buy consulting services.

But he said one problem with the incubator business is that his own company is expanding so rapidly that it often has no spare space for clients. The company is occupying the entire 18th floor at 19 West 44th Street and is preparing to add another 16,000 square feet on the 17th floor.

He said the company is in negotiations to lease the 16th floor, too, so that it will have some space to spare. "The intention is to devote several thousand square feet for incubation," he said.

One e-commerce company that benefited from incubation at Thaumaturgix was actBig.com, which arranges group- buying discounts. Stephen Tsai, the chief executive, said some of his technical people moved into Thaumaturgix's space while the Web site was being developed.

"It was more than a client-agency relationship," he said. "They carved out some space near their technology team, and we worked at integrating the technology and the business."

Mr. Brodsky of Insignia/ESG said some Wall Street firms have become interested in the incubator business as an opportunity to get a look at promising Internet businesses at an early stage, when small investments can lead to big payoffs when stock is sold to the public.

"Goldman, Sachs has taken an interest in TechSpace so it can get a look at the company that's going to become the next Yahoo," he said, referring to the company that started out as a project by two graduate students and has since become an important player in e-commerce.

"Some landlords are viewing their buildings as the equivalent of venture capital," he said. "The key to incubation is to make contact with these new companies and get in at an early stage."