Start-up accelerators and cohort-based investing: Is this the future?

After spending over 20 years helping multinational financial firms set up captive centres in India, Ashish Bhatia felt his job was getting too comfortable and it was time for a change. Seeing the start-up fever sweeping the country, Bhatia jumped in. Like most entrepreneurs in their early days, he too struggled and was frantically looking for support when he chanced upon the concept of accelerators. That’s when he started looking at how they operated. “When I launched a start-up, I didn’t know who to talk to. I thought, if someone like me, in spite of a fairly successful corporate career, is struggling so much while doing a start-up, spare a thought for the young founders out there,” says Bhatia.

His thesis was simple. India’s start-up ecosystem was expected to grow and it would need a strong ecosystem of enablers and partners. On that thesis, Bhatia launched India Accelerator (IA) in 2017. Over 100 start-ups applied for its first cohort. “The number of start-ups gave us the belief that this [the accelerator programme] is a required solution for a real problem,” he says.

IA is among a crop of incubators and accelerators that have mushroomed in India post the e-commerce boom. Per a report by consulting firm Primus Partners, the number of accelerator programmes in India grew from 585 in 2017 to 900 in 2021. However, the concept of start-up accelerators has forever changed from the time Bhatia launched IA. As the ecosystem has matured, the quality of ideas and founders have improved too, resulting in start-ups raising around $24.7 billion in India between January and November 2022, per data platform Tracxn. Also, the country has over 100 unicorns today. A visible outcome of this maturing ecosystem is the changing dynamics of how founders and VCs (venture capitalists) approach accelerators.

A start-up accelerator isn’t cheap to run. It constantly needs capital to hire quality talent to run the programmes, fund an office space and offer early-stage capital to portfolio companies. Traditionally, accelerators take a small, single-digit equity share in their portfolio start-ups with a promise to help them in everything from connecting with domain mentors and go-to-market strategies to assistance in raising future capital. But relying on the returns from early-stage start-ups for their own cash flows is proving to be unviable for accelerators. VCs, start-ups or accelerators have a common but vital thread—all of them need a good deal of time before they figure out what works and what doesn’t. Odds are that 80-90 per cent of the start-ups will not give a viable return in a five- to six-year timeline.

A majority of accelerators in India are funded by government grants or corporate social responsibility programmes. The generalist, equity-based programmes suffer from an adverse selection problem as they attract founders who could not raise capital from pure-play angels or early-stage investors. That leaves accelerators with a set of start-ups that have a lower probability of success, a majority of which may not reach a stage where they could give meaningful returns.

Meanwhile, start-ups today have a plethora of avenues to find early-stage capital and build a mentor network. “Good start-ups do not need to go to an accelerator and give up equity. They can still get seed funding on their own. Besides, the primary source of capital for 80-90 per cent of accelerators comes from programmes run by government institutions such as DST, DPIIT, MeitY, and iDEX. That capital is not necessarily aligned with a return,” says Shyam Menon, Chief Growth Officer at IIM Ahmedabad’s accelerator, CIIE.CO.

Which brings us to the fact that accelerators are now shifting to a pure-play VC model that invests in cohorts. Accelerators have realised that unless commercial capital with management fee and return expectations is involved, their current model cannot sustain.

Y Combinator (YC), the largest start-up accelerator in the world, now invests $500,000 in each start-up in its cohorts. Its business model is to invest in all the start-ups in its programme. YC’s programmes funded 750 companies in 2021. Today, 150 of its portfolio firms are valued at $150 million or more, and 60 are valued at $1 billion or more. Its growth-stage fund, YC Continuity, invests in its most successful companies.

Rajesh Sawhney, Founder and CEO of GSF India—that began as an accelerator in 2012 and added early-stage investments later—says YC has transformed the game into one of scale. “Our business has changed. Either you become extremely niche, or create scale. Our winter batch will have 200 founders. Our goal for 2023 is to have 500 founders coming out of our academy and our Demo Day will have 2,000+ investors,” he says. GSF—boasting of a 10x multiple on invested capital so far—aims to invest in 20-25 start-ups in a year.

Techstars, a Colorado-based accelerator running several VC funds, is reportedly raising a $300- million fund for early-stage investments. Another global accelerator, 500 Startups, rebranded itself as 500 Global recently to focus on its early- and later-stage investments. Both 500 Global and Techstars run programmes in India while YC picks Indian start-ups for its Silicon Valley-based programmes.

Integrated incubator Venture Catalysts runs a $150-million accelerator fund, a $200-million fintech-focussed fund, and a $200-million growth-stage fund besides an angel fund and a proptech (tech used in the real estate space) fund.

IA too has pivoted to a fund-led model. Today, it operates two active VC funds of Rs 350 crore each, and has partially exited from a third of its investments (about 40 exits from 150 investments) to generate cash flow for its programmes.

I n most cases, start-ups complete generalist programmes without accruing any significant learning or support. Prasanna Krishnamoorthy, Managing Partner at SaaS accelerator Upekkha, says sector-agnostic programmes lack the critical component of a domain-specific founder community. He adds that when accelerators work with all kinds of start-ups, founders fail to garner support and feedback in their core domains. “They can help each other on co-founder conflicts, investor relationships or HR issues. But from a domain perspective, they can’t help each other,” he says.

Krishnamoorthy, with close to a decade of experience in building and operating accelerators, says Upekkha decided to build an accelerator first to prove its mettle and then get to a fund model. Launched in 2017, Upekkha initially worked on a revenue-share model, and then raised $9 million from WestBridge Capital in 2022. Although the cost of running a start-up has come down, he says, founders still need some funds to operate. But from an accelerator’s perspective, if they can offer capital, it gets easier for founders to choose their programmes, he adds.

IA—that ran domain-agnostic programmes in its initial two years—pivoted to a domain-focussed model in 2019, and currently runs domain-specific programmes for nine verticals such as cybersecurity, fintech, health-tech, social impact, agri-tech, deep-tech, etc.

Meanwhile, corporate accelerators continue to attract start-ups due to their ability to offer unique tech capabilities, add value, and provide better business opportunities. Their sector-focussed niche programmes help start-ups navigate the ecosystem better and prepare them to position better.

For instance, Google for Startups is helping start-ups focus on key business and technical challenges and reduce the time-to-market and success of the product, says Paul Ravindranath, Head of Google Accelerator at Google India. “Our mission is to provide young start-ups with information and lessons acquired from Google’s two decades of creating corporate and consumer products,” he says.

Just as the expectations from accelerators have grown, investor interest in early-stage start-ups has intensified, too. A tangible outcome of this is the arrival of large late-stage funds into the early-stage market with dedicated funds. For instance, Sequoia Capital launched an early-stage fund called Surge in 2019 that combines up to $3 million of seed capital with company-building workshops, global immersion trips and support from the founder community. Accel’s early-stage programme, Atoms, offers 100 days of learning and development workshops, setting objectives and key results, building a peer community, dedicated mentorship and an uncapped convertible—financing where the investments translate into equity during the next round—investment of $250,000.

Prayank Swaroop, Partner at Accel, says early-stage start-ups need easier access to funding without giving up equity. “They need mentorship on how to build a company, and a community to learn from,” he says. Launched in August 2021, Atoms has invested in 23 start-ups across its two cohorts, which have collectively raised $80 million till now while Sequoia’s Surge has invested in over 127 start-ups and helped them raise over $1.7 billion till now.

Upekkha’s Prasanna says it is critical that accelerators find long-term investors who understand that one needs to be patient while investing in start-ups and accelerators. Upekkha’s lead investor, WestBridge, invests out of an evergreen fund with a life cycle of 20 years that can be extended by 10 years or more, while most VC funds have a life cycle of 10 years. Sumir Chadha, Co-founder and Managing Partner of WestBridge Capital, says that since it takes 8 to 12 years for start-ups to give outcomes, building a business working with them could take between 12 and 15 years. “What is needed is patient capital to allow the business model to play out,” he says.

The success of an accelerator programme also depends on the strength of its mentor pool. As mentorship opportunities are compensated through equity, accelerators with a good track record of exits and follow-on funding attract the best mentors. And a good mentor pool attracts the best start-ups. But in the early stages, start-ups are not very sure about the value an accelerator programme brings to the table, says Apoorv Sharma, former lead of market strategy for South Asia at 500 Global. “It is imperative to have a structured ecosystem where mentors and programme managers have global exposure. Today, start-ups have a global vision from day one. Therefore, mentors should be able to guide start-ups with a global outlook,” he says.

The evolving nature of accelerators is only natural for an industry that is still growing. Just as the start-ups are evolving, accelerators are also transforming to find a sustainable balance. VCs have existed in the US for about three-four decades before the first large, meaningful accelerator came up there, says CIIE’s Menon, adding, if accelerators can figure out a way to create a sustainable model, they will see relatively quicker exits and faster turnarounds for their investments. “We will get there over time and our accelerators will be able to attract start-ups without the adverse selection problem,” adds Menon.

@binu_t_paul