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In the summer of 2007, Highland Capital Partners welcomed eight teams of fresh-faced college grads into its first business incubator program. Victoria Ransom and Alain Chuard worked together on tools for marketers to measure the effectiveness of their campaigns on Facebook (FB), Twitter, and other social networks. In July, Google (GOOG) agreed to pay $250 million plus performance incentives to acquire their company, called Wildfire. That brought the final price tag to $350 million, according to a person familiar with the transaction.
For most venture capital firms this would have meant a big payday and a bottle of Champagne. But Highland didn’t make any money on the deal—the firm never invested in Wildfire. “It kind of caught us by surprise,” says Michael Gaiss, who had run the incubator program since its inception. (Gaiss left his job as a Highland senior vice president in August but says he may still help out with next summer’s class.) “We had a look and talked to the team. I wish we would have invested.”
Dozens of niche incubators, catering to hardware and business software, have emerged in the last few years. They typically give startups a few thousand dollars in exchange for a percentage of equity. Most of the companies fail, but the ones that hit it big or get acquired can mean big returns.
The model for Summer@Highland, as the firm’s program is called, is different. Each team gets at least $15,000 with practically no strings attached. Highland doesn’t take equity or require that the young companies give the firm first dibs in fundraising rounds. It only asks that at least one member be a recent graduate and that groups work and attend events at its offices in Cambridge, Mass., and Menlo Park, Calif. Senior executives from Amazon.com (AMZN) and Square have given talks to participants. “Besides giving us resources, it was very educational,” says Chuard, the Wildfire co-founder. “In return, they didn’t really ask for much.”
Highland, a firm with $3 billion in committed capital that has made investments in MapQuest (later acquired by AOL) and Quattro Wireless (later acquired by Apple (AAPL)), says its incubator is a way to establish a greater presence in the entrepreneurial community in Silicon Valley. The firm has won entree into competitive financing rounds for companies including Leap Motion, which makes an inexpensive motion-control gadget, and Violin Memory, which makes flash memory for data centers and is preparing for an initial public offering.
The firm also wants to use Summer@Highland to build relationships with promising young entrepreneurs so that it might be positioned to fund their companies after they mature or when the founders move on to create other businesses. When they developed the incubator, the venture capitalists decided that demanding equity would sour the relationships. “When we go out and meet with entrepreneurs and buy them coffee, we don’t send them a bill and ask for equity in return,” says Sean Dalton, a general partner who has worked with the incubator since its start. “We think we’re providing a great opportunity for us and for the entrepreneurs by getting to know them.”
Highland has missed out on funding other promising startups besides Wildfire. One member of this past summer’s class was Anchovi Labs, which develops photography software. According to a person familiar with the matter, the company was acquired by cloud-storage provider Dropbox in September in a deal that made its investors, which didn’t include Highland, a healthy profit.
Then there’s CloudFlare, a fast-growing San Francisco-based Web services company started by members of the incubator’s 2009 class. CloudFlare has attracted big customers, such as link-sharing service StumbleUpon, and has raised more than $22 million from venture capitalists who took equity stakes. Highland Capital Partners was not among them. The firm had the chance to invest but passed because at the time it was cautious about investing in small companies located far from most of its partners in Cambridge, says Michelle Zatlyn, a co-founder of CloudFlare. “There’s no hard feelings,” she says.
Zatlyn and Wildfire’s Chuard suggest that Highland’s get-in-the-door strategy could yet pay dividends, saying they’re closer with the company that incubated them than most other venture-capital outfits. “If we ever were to do another company in the future, they would definitely be one of the first ones we’d be in touch with,” Chuard says.
Notable whiffs aside, Highland has made some potentially lucrative investments in companies it incubated. The online jewelry retailer Gemvara now has about 25,000 customers and raised $25 million in June (including an undisclosed amount from Highland), bringing its total funding to $52 million. “For every CloudFlare, hopefully we have a Gemvara as well,” Dalton says. “If you’re not missing some great opportunities, then you’re not working hard enough. That’s just a part of venture.”
The bottom line: Highland’s incubator program has produced successful new businesses, but the VC firm hasn’t always reaped immediate benefits.