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As seen in
March 5, 2000
Providing a Helping Hand to Internet
Start-Ups
The trade-off: ready-to-go space for a piece of the stock action
by JOHN HOLUSHA
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 service
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 require
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 530 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 S. Meiskin, the President of
Plymouth Partners, Ltd., 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 firm. 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 businesses 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 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 place to share. "The intention
is to devote several thousand square feet for incubation,"
he said.
One e-commerce company that benefited from incubation at Thaumaturgix
was act-Big.com, which arranges group-buying discounts. Stephen
Tsai, the Chief Executive said some of his technical people
moved into Thaumaturgix's space while the website 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 Tech-Space 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."
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