Incubators and the Perennial Challenges of Fundraising

As part of my board responsibilities and interactions, I have analyzed startups originating from incubators, particularly student-led ventures, and their fundraising challenges. While some of the points I highlight here also apply to acquisitions, I plan to write a separate piece on that topic in the coming days.

For startups, fundraising is essential for several reasons: ensuring resource availability, enabling faster growth, validating their ideas, and establishing general credibility. For incubators, it is crucial to demonstrate the success of their portfolio companies and generate some returns through liquidity.

However, fundraising often presents significant challenges, some of which I’ve outlined below. This list is by no means exhaustive, so feel free to share additional thoughts or reasons.

Key Challenges in Fundraising for Incubator Startups

1. Lack of a Single Scalable Use Case

Many startups focus on multiple revenue models and use cases, which makes their business complex and difficult to scale. A contributing factor could be the influence of multiple mentors and customers advising startups based on what they believe constitutes an ideal solution( & not necessarily with a view of scale/fundrais). Early-stage venture financing is typically driven by niche, deep solutions with reasonably large market opportunities. It is not margin-focused but rather depends on scalable unit economics.

Often, mentors and customers approach problems from a market perspective, which may not align with the scalability and funding requirements of a startup. It is essential for startups to experiment with 2-3 models, select one scalable use case, and avoid adding complexity or making drastic changes to their business model thereafter.

2. Lack of Differentiation

Contrary to expectations, many incubator and student startups lack genuine differentiation. A visit to 10 incubators will often reveal at least 50% overlap in ideas. Investors seek differentiation that creates entry barriers for competitors and demonstrates scalability due to the uniqueness of the solution.

The involvement of multiple mentors can result in an extensive list of feature-based differentiators but without any substantial depth. Startups must focus on creating a clear, defensible advantage in their offering.

3. Lack of a Fundable Team

Team composition is a critical challenge for early-stage startups. For incubator startups, specific issues include energy, commitment, and coherence among team members. Investors expect full-time commitment from founders, with most equity held by team members (typically, full-time startup founders and ESOPs should account for at least 80-85% of the equity at the stage where there are pilot customers).

Additional red flags include:

• Single founders.
• Founders with only technical backgrounds.
• Founders lacking startup experience.

Incubators play a crucial role in identifying and addressing these issues early on.

4. Unreasonable Expectations for Traction

Unfortunately, venture capitalists (VCs) often demand significant proof points for startups, especially those based on new technologies or business models. They also require evidence of the team’s execution capabilities, particularly for first-time founders (which is often the case for incubator startups).

While this expectation can be unfair to bright talent, the reality is that startups need substantial resources and capital to achieve the kind of traction that generates investor FOMO (Fear of Missing Out).

5. Time Efficiency

Time management is a unique challenge for startups in Indian incubators. Many depend heavily on grants, leading them to build more than necessary and take more time than required. Startups that spend 3-4 years identifying their first customers, or worse, survive without scaling for 2-3 years, face significant red flags from investors.

Startups thrive on pace, focus, and execution. Delays in validating customers or proving the market fit pose significant risks, as they hinder the necessary uptake of revenue.

6. Hardware and Deep Tech Challenges

Hardware and deep tech startups face the unfortunate challenge of limited funding opportunities. Few investors understand these domains, and there is a general lack of capital available for inventory, hardware certification, and other capital-intensive requirements.

Entrepreneurs in this space must adopt smarter approaches, such as positioning their offerings to reduce the emphasis on capital expenditure, to improve their chances of success.

Conclusion

While there are additional challenges that I plan to address in subsequent write-ups, I’d love to hear your comments and feedback in the meantime. Let’s continue the conversation on how to tackle these issues and build stronger startups in incubators.

#incubators #startupfundraise #studentstartups #deeptechfunding