A Real Options-Driven Theory of Business Incubation Sean M. Hackett 1 David M. Dilts 2 ABSTRACT. This article employs real options-theoretic reasoning to develop a theory of business incubation. This theory seeks to predict and explain how business incubators and the process of business incubation increase the likelihood that new ventures will survive the early stages of development. It conceptualizes the incubator as an entrepreneurial firm that sources and macro-manages the innovation process within emerging organizations, infusing these organizations with resources at various developmental stage-gates while containing the cost of their potential failure. The incubator is the unit of analysis while incubation outcomes—measured in terms of incubatee growth and financial performance at the time of incubator exit—provide indicators of success. Our model of the incubation process and specification of the range of possible incubation outcomes offer implications for managerial practice and policy-making vis-a `-vis incubator management and good entrepreneurial failure. JEL Classification: M13, O2, O31, O32, O38 1. Introduction The failure of new ventures in their early stages of development is a common occurrence (Watson et al. , 1998; Zacharakis et al. , 1999). Evolutionary theorists contend that the forces of selection that eliminate uncompetitive firms are a necessary phenomena that contribute to the maintenance of healthy populations of organizations (Aldrich, 1999). The continuing growth, since 1980, in the number of business incubators operating in North America, however, suggests that many govern- ments, local communities and private investors believe that it is desirable to try to help ‘‘weak-but- promising’’ firms to avoid failure by incubating them until they have developed self-sustaining business structures. 1 We define business incubator as a shared office- space facility that seeks to provide its incubatees (i.e. ‘‘portfolio-’’ or ‘‘client-’’ or ‘‘tenant-compa- nies’’) with a strategic, value-adding intervention system (i.e. business incubation) of monitoring and business assistance. This system controls and links resources with the objective of facilitating the successful new venture development of the incu- batees while simultaneously containing the cost of their potential failure (Hackett and Dilts, 2004). Although much of the literature centers on incubator facilities, it is important to also recog- nize the key role that the entire incubator network plays in incubating new ventures. This network typically includes the incubator manager and staff, incubator advisory board, fellow incubatee com- panies and employees, local universities and university community members, industry contacts, and professional services providers such as law- yers, accountants, consultants, marketing special- ists, venture capitalists, angel investors, and volunteers.
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