Winter is coming, warned Y Combinator, one of the world’s leading start-up accelerators, in mid-2022. Plan for the worst, cut costs and extend your runway was the precise advice to start-ups. The funding winter extended through 2023, with investments from major venture capital (VC) funds in India witnessing a massive decline of 85 per cent that year. This capital shock left several start-ups in the ecosystem struggling for survival, with almost 35,000 shutting down in 2023, up 93 per cent from 2022, according to Tracxn.

As a result, there has been a welcome move back to the basics, with start-ups and investors focusing on profits and financial viability. The India Startup Outlook report by InnoVen Capital said that more than 60 per cent of start-up founders prioritised profitability over growth in 2023. The last two years have brought several lessons about surviving and flourishing not only for start-up founders but also for other organisations in India’s start-up ecosystem.

India has emerged as one of the world’s most vibrant and dynamic start-up ecosystems, characterised by a surge in entrepreneurial activity and innovation across various sectors. Within this ecosystem, start-up incubators play a crucial role in nurturing and supporting early-stage ventures by providing them with resources, mentorship and networking opportunities. Today, India has more than 1,000 incubators spanning the length and breadth of the country.

Since incubators have become a key component of India’s entrepreneurship and innovation ecosystem, it is important to ensure that they become financially sustainable within a reasonable period of time. Typically, incubators receive seed funding at inception from the government, philanthropic foundations or their host organisations. It is critical for incubators to create stable revenue streams which end their dependence on external financing, especially for operational expenses. A financially self-sustaining incubator can survive funding winters, create long-term impact, provide high-quality services and contribute to a resilient ecosystem.

In this article, we outline various revenue streams accessible to incubators in order to achieve financial sustainability. We focus on how incubators can generate revenue from four key stakeholders in the ecosystem: incubatee start-ups, industry partners, government and other entrepreneurial support organisations (ESOs).

Incubatee start-ups

The relationship between an incubatee and an incubator is symbiotic, characterised by mutual support and collaboration. Incubators provide essential resources, mentorship, and networking opportunities to start-ups, guiding them through the early stages of development. In return, start-ups contribute to the ecosystem by innovating and creating value. There are four ways in which incubators can partake in this value creation and generate revenue for themselves: incubation fees, equity stake, revenue share and success fees for additional support.

Incubators can charge incubatee start-ups monthly fees for providing a package of tangible and intangible support which includes working space, shared facilities, product development support, upfront seed grants, mentoring, legal and accounting expertise, guidance for intellectual property protection, access to networks, and much more. It is essential to ensure that incubation fees are affordable for early-stage start-ups.

To reduce upfront cash costs for start-ups, incubators can take an equity stake in lieu of incubation fees and sell it at a higher valuation to follow-on investors like angels and venture capitalists. While this involves significant upfront risk, it also opens up the possibility of disproportionate returns, albeit several years down the road. Equity stakes for early-stage start-ups can range from 3 to 5 per cent, although this can vary based on specific circumstances and negotiations.

A similar alternative for incubators is to take a share of the start-up’s revenue instead of an equity stake. Incubators can charge 3-4 per cent of annual revenue for a limited period of time, say 2-4 years, depending on the duration of incubation.

In order to make it a win-win agreement, the annual revenue to be shared with the incubator is capped at a pre-decided maximum and revenue sharing is only done in years where the start-up’s revenue exceeds a certain minimum amount, so that the incubator’s downside risk is managed.

Finally, incubators can charge success fees for facilitating significant transactions like follow-on funding, large customer orders and successful exits via acquisitions. Seeking contingent fees for successful exits is particularly important for incubators which do not hold an equity stake in their incubatees.

Industry partners

To enable better industry-start-up collaboration, incubators can undertake and execute partnership programmes with corporations. These could be in the form of accelerators, corporate social responsibility initiatives, demo days and events like hackathons.

Incubators can earn programme management fees from corporations for organising and spearheading these initiatives. They can also earn success fees from start-ups which experience favourable outcomes like receiving orders or funds from the industry partner.

Government channel

Most incubators in India have started their initial activities with the help of grants received from government agencies. While such grants cannot be considered as revenue, they help finance the initial cost of setting up an incubator.

In addition, incubators can earn programme management fees for administering government programmes for proof-of-concept and prototype funding, like the Department of Science and Technology’s NIDHI PRAYAS scheme and the BIRAC Biotechnology Ignition Grant scheme.

Other ESOs

Start-up incubators can also earn revenue by providing a range of services to other ESOs like other incubators, accelerators, innovation labs, research parks and universities. These can be in the form of consulting, training and workshops, partnership programmes, resource sharing, incubator-in- residence programmes, data and research services, accreditation and certification programmes and network access, to name a few.

The road towards financial sustainability is beset with several challenges. However, several incubators in India have been operating effectively for close to two decades and have achieved financial sustainability, and proven models have emerged to learn from. Incubators need to invest heavily in developing and improving sound processes and practices which allow them to select high-quality start-ups. If start-ups succeed, this will naturally translate into the flourishing of incubators. At the same time, mature incubators can enable the success of more start-ups. India’s entrepreneurship and innovation ecosystem relies significantly on the success of this symbiotic relationship.

Chinchwadkar is an Assistant Professor (Finance, Entrepreneurship) at IIT-Bombay, Bhatt is the former CEO of SINE, IIT-Bombay, and Vaishnav is the Mission Director of Atal Innovation Mission, NITI Aayog

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