Idealab Puts Net Concepts to Work

Bill Gross had a problem. It was the kind of problem most entrepreneurs would welcome, and Gross wasn’t missing any meals as a result, but it was a problem nonetheless: too many ideas.

They poured forth constantly from the Caltech graduate’s peripatetic mind, ideas for new high-tech companies, for the products and services they might sell and for the business strategies they should employ. He couldn’t act on most of them, though, because he had to run one of the companies he’d already started: children’s software maker Knowledge Adventure.

So last year, Gross ceded management of Knowledge Adventure to his brother, and agreed to sell the firm to CUC International. That cleared the way for him to launch Idealab, an unusual incubator for Internet businesses that enables the 38-year-old to put many more of his concepts into action.

After just nine months in operation, Idealab already has 18 companies in various stages of development. And even though the venture is a very personal expression of Gross’ unique talents, it also points to some larger trends in the way start-up companies are financed and nurtured in the age of the Internet.

“What companies need are intelligence and business smarts,” Gross says. “How do you get knowledge into companies as quickly as possible? It used to be that the main thing you needed was money to start a company, but you don’t need that anymore.”

You don’t need so much of it at the outset, anyway. Idealab does provide its companies with seed capital, anywhere from $50,000 to $250,000 in exchange for an equity stake of up to 49%.

But its most important contributions are ideas and expertise--from Gross; from other Idealab investors (director Steven Spielberg, actor Michael Douglas and Compaq Computer Chairman Ben Rosen among them); from a team of in-house computer programmers; and from a group of advisors that includes MIT cybersociologist Sherry Turkle, information design guru Richard Saul Wurzman and advertising innovator Arthur Einstein.

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With that kind of knowledge base, Gross reasons, Idealab companies can quickly do things that would be out of the reach of conventional start-ups.

Idealab also provides its companies with routine services such as payroll, and there will soon be a shared office space in a renovated warehouse in Old Town Pasadena. All employees of the start-ups have an ownership stake in their firms--giving them the incentive to undertake the “heroic” measures that Gross views as critical to any new company’s success--and the Idealab affiliation should enable them to raise additional capital as needed.

Gross says Idealab is patterned after an old East Coast engineering company called Thermo-Electron, which has grown into a multibillion-dollar firm largely by starting new enterprises, taking an equity stake and spinning them off.

But even though there don’t appear to be any high-tech ventures with precisely the same structure as Idealab, there are all kinds of efforts underway to build new mechanisms for supporting entrepreneurial activity. That’s because the incredible growth of the high-tech sector in recent years has created so many different types of opportunities that traditional institutions simply can’t handle them all.

Some of the things Idealab does--providing start-up capital, for example, and help with recruiting executive talent--are the kinds of things that venture capital firms have always done. The very success of the venture capital business in recent years, though, has caused a huge inflow of money into venture funds, and that in turn has made it difficult for many of them to deal with early-stage companies that don’t need a lot of cash.

“It takes every bit as much time to manage a $100,000 investment as a $10-million investment,” explains Richard Shaffer, principal of Technologic Partners, a New York company that provides high-tech investment information. “The better-known venture capital funds have been able to raise so much money that they have to use it as efficiently as possible.”

At the same time, the insatiable demand for technology and the roaring stock market that have made the venture capitalists so successful have also created a new class of wealthy entrepreneurs--like Bill Gross--who are looking for new things to do with their money.

Many of them have become “angel” investors, providing start-ups with funding in the $50,000 to $250,000 range and sharing the knowledge they’ve gained through their own entrepreneurial efforts.

Others have been more ambitious. Microsoft co-founder Paul Allen three years ago launched Interval Research, promising $10 million a year in funding to a group of highly regarded researchers in the hope of finding some big ideas that could be spun off into companies. Interval announced its first three spinoffs last month.

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The inevitable flip side of all this, however, is that there is an awful lot of money and talent chasing a finite set of opportunities. Lower capital requirements for Internet businesses mean lower barriers to entry, and that means more competition--especially in the so-called content businesses that don’t rely on a unique technology.

At Idealab, some of the new companies are indeed counting on specific breakthroughs. Bandwidth+, for example, promises to double the speed of Web browsing with proprietary compression technology. I-Map aims to develop a completely new way to visualize large amounts of information.

Many of the Idealab ventures, though, are anything but original. CareerSearch will enter a very crowded market for online job searching, and HomeSearch will do the same in the real estate arena.

Gross thinks his companies can win by doing it better. With all those extra-smart people on staff, and rigorous attention to the recruitment of solid management for each of the companies, Idealab firms might indeed have an edge.

The danger, though, is that even a polymath like Bill Gross can pay only so much attention to 18 companies at the same time.

Gross counters that the leverage of a small number of great people is huge. “Really strong intellectual property does not take a lot of time,” he says. In other words, even a half-hour with Spielberg could give a game company a big leg up.

That may be. But the other part of the equation is more harshly Darwinian. Because the barriers to entry in the Internet business are low but the rewards for success are potentially very high, it makes sense to start a bunch of companies for relatively little money with the expectation that the success of a few will more than make up for the failure of the many. And managing through the failures may end up being the biggest challenge of all.