In a city that plays it safe, incubator has a tough job
Azuki Systems Inc. and Tsumobi Inc. are two start-ups with big plans to extend your cellphone's capabilities. But the differences between the two companies, based in Acton and Cambridge, respectively, highlight a serious glitch in the way Boston's innovation economy works.
Right now, it's far easier for veteran entrepreneurs like those at Azuki to find support and funding for a new idea in Boston than it is for first-timers. So young entrepreneurs like Tsumobi's founders tend to get pulled out to Silicon Valley, where investors seem more willing to take a risk on companies started by eager youngsters.
One initiative, Y Combinator, is trying to change that dynamic - futilely, so far. YC, as it is known, is a blend of boot camp, commune, and mini-university designed to help start-up companies such as Tsumobi get off the ground.
YC, which operates out of two industrial-style buildings in Cambridge and Mountain View, Calif., was founded by three friends who studied computer science at Harvard and later started a pioneering e-commerce company, Viaweb. (Cambridge-based Viaweb allowed anyone to set up an online store, and it was acquired by Yahoo in 1998 for $49 million.) The trio of hackers was joined by Jessica Livingston, who had run marketing at the Boston investment bank Adams, Harkness & Hill.
Every summer, YC invites a crop of fledgling companies to Cambridge for a three-month program. YC makes a tiny investment in each company - usually less than $20,000 - and takes between 2 and 10 percent of the equity in return. No office space is provided, so most of the companies work out of apartments and coffee shops. Most have never started a company before.
This summer's batch of 22 start-ups will convene in Cambridge this week. Every winter, the Y Combinator program moves to Silicon Valley. (Tsumobi took part in the West Coast program last year.)
The companies are expected to build a prototype of their product - if not actually launch it - by the end of the three months. The YC motto, emblazoned on basic gray T-shirts, is straightforward: "Make something people want."
Toward the end of the program, Y Combinator hosts a "Demo Day," when angel investors and venture capitalists pack the building to see what each company has created. Paul Graham, one of the YC founders, says that about 85 percent of the companies eventually receive further funding, and at least six have been acquired for small sums by companies like Amazon.com and Google.
Investors like David Hornik say that "if you're smart, the demo day is a must-attend event."
Hornik, a partner at Menlo Park, Calif.-based August Capital, says Graham has "a very good sense of people, and which people will be interesting entrepreneurs." David Beisel, a partner at the Cambridge office of Venrock, writes in an e-mail that the demo day is "a great showcase of fresh thinking about new and old problems."
"Y Combinator is filling a big gap," says Microsoft business development executive Don Dodge, who is based in New Hampshire. "There's a tremendous leap from the idea stage to having something that you can present to a VC or angel."
But the problem is that of the 80 companies that have come through the program, not one has yet received money from a Massachusetts investor. "There have been three cases where a Boston VC was talking to one of our companies, and they had the sandwich ripped right out of their hands" by a West Coast investor, Graham says. "The Boston VCs were so slow and timid."
Of the Y Combinator alumni, only two have chosen to stick around in Boston - Tsumobi and a shopping site called Bountii. Dodge says, "We just have to do better."
Graham says that Boston venture capitalists prefer making "safe investments" in companies with experienced executives at the helm. As a result, he says, "They miss the Googles - the ones that have the really extreme returns."
Azuki, formerly PeerMeta, could be considered one of those so-called safe investments. It's the sort of start-up that gets Massachusetts investors salivating. The company is run by fortysomethings and fiftysomethings with stellar resumes. Chief executive Jim Ricotta sold his last two companies to IBM and Cisco for $100 million and $800 million.
Chairman and cofounder Cheng Wu has had a series of successes, all with companies that begin with the letter A. In 2000, Cisco bought one of them, ArrowPoint Communications, for $5.7 billion just after its initial public offering.
Their goal with Azuki (another "A" company, for good luck) is to make it easier for media companies to deliver video to cellphones, and also bring Facebook-like community features to the mobile device, such as sharing and commenting on photos. They hope to build a business by charging media companies a per-user fee for the service, and potentially splitting ad revenues with them.
Raising money wasn't terrifically difficult for Azuki. Last August, "Cheng was having discussions with a few investors," Ricotta says. Ricotta went on vacation, and when he came back 10 days later, "it was a done deal." Two Waltham-based firms, Kepha Partners and Sigma Partners, agreed to put $6 million into Azuki last September.
Tsumobi, based out of an apartment in Harvard Square, is thinking about some of the same problems as Azuki, like how to make it simpler to share a photo you've just taken on your cellphone with friends.
The company also aims to allow members of a social cluster to share information among their cellphones, like someone's phone number or the date and location of a party. Tsumobi's founders, 24-year old Josh Wilson and 23-year old Adam Bouhenguel, are MIT undergrads on leaves of absence.
Tsumobi has yet to raise a dime from a traditional Massachusetts venture capital firm, though it did get an important assist from Y Combinator.
And coincidentally, one of the investors who has handed Tsumobi a few hundred grand in seed funding is Ron Conway, who was an early investor in Google - another company founded by a pair of twentysomethings who'd never started a business before.
It's too early to tell whether Tsumobi, or Azuki, or both will be successful at changing the way we interact with our cellphones. But the way the two companies evolve will inevitably say a lot about the innovation economy here.
As Wilson and Bouhenguel grow their company, they say that Boston is an attractive place to be, as a source of programming talent. But Wilson acknowledges in an e-mail that "there is a definite pull to San Francisco from multiple places: investors, friends, and Y Combinator founders."
Last week, he was in the Bay area, meeting with investors and arranging for a temporary apartment.
Scott Kirsner can be reached at kirsner@pobox.com.
