The answer really depends on your current startup structure, both from an ownership perspective and how it handles its financials. In the simple case where you own the current company completely, and you are not billing overhead on contracts to outside parties (like the Federal government), then incubating the new startup inside the existing company doesn't really have many downsides as long as you keep separate bank accounts and books. Watch out for snares like credit card processors though, they almost ALWAYS have something in their terms of service that prohibits you piggy-backing transactions for an unrelated company through the established merchant account.
So, here are some potential downside considerations:
- Liability issues. Mixing resources and blurring the line between entities can potentially allow someone that is suing one company to go after the other. Incorporating helps this, but beware conditions that allow 'piercing the corporate veil'. I am not a lawyer, so a few minutes of legal advice would be good on this point
- Blurring of overhead cost structure. This becomes serious if you have contracts that you're billing overhead rates under because technically some of that overhead (lights, office space, office supplies, etc) is being consumed by the unrelated entity. If you have a Federal contract that requires certain financial controls, this is especially thorny.
- If ownership is shared in the existing company, get a waiver on any claims to the new entity from existing shareholders. They should be kept 100% in the loop that this is new entity is going to be incubated. Check employment agreements to be sure you can create IP that is outside the rights of the existing company. Again, if you have a simple situation where you wholly own the existing company, this is probably a non-issue, but in all other cases, tread carefully!
- Diluting efforts from the main company. This isn't really an incubate/don't incubate argument, but it is a consideration. Time you spend on the new startup is time not spent building the existing business. What impact will that have on the existing company, both from your own output, and also the output of others in the company... this can be a morale issue that cuts productivity.
- Mixed records and resources - If you are not diligent about keeping files, paperwork, etc in a separable manner, you may have trouble when it is time to 'graduate' the new startup from it's incubation phase.
Advantages to incubating:
- Minimizes the effects of #4 above in some ways by allowing you to minimize time on wrangling the basic needs of the new startup.
- Shares resources which lowers costs and also gets things up and running faster. Efficiencies in terms of space, basic utilities, office equipment, even administrative staffing can make it cheap to get something new off the ground.