Poyni Bhatt is a founding team member and former Chief Executive Officer of SINE, the technology business incubator at IIT Bombay until October 2023. She has an experience of 38 years in industry and academia of which she spent nearly 20 years with SINE. Poyni is a qualified legal and compliance professional- Fellow member of the Institute of Company Secretaries of India.
Startup incubators typically operate with very limited resources, making competitive compensation for incubator managers a long-term challenge. Consequently, incubator leaders often question how strong performance by the incubator team can be appropriately rewarded. The most obvious answer to this question is that incubators may consider a certain percentage of their annual profit paying towards performance bonus to their high performing team or certain members who have taken extraordinary load of incubation and investment activities. In this profit-based method, certain percentage of surplus after deducting entire expenditure (including failed investment) from an incubator’s aggregated income may be earmarked for those who have contributed significantly in generating this surplus on an annual basis. This will be a fair claim for their share of contribution in generating this surplus. There is also a question whether the concept of carry, commonly used in the Venture Capital (VC) industry, is relevant or suitable for incentivizing performance in a business incubator context.
Carry is a performance-based reward mechanism in the VC industry, introduced to compensate fund managers who deliver returns in excess of their commitments to investors (referred to as Limited Partners, or LPs). It represents a share of the profits generated above a predefined hurdle rate and is distributed to fund managers only upon achieving this out performance. Carry is thus a performance fee rather than an entitlement. The decision to grant carry rests with LPs, who evaluate it in the context of overall fund economics- treating management fees and carry as costs as against their returns. LPs balance the fees paid to fund managers against the share of profits they permit managers to retain. Importantly, carry is a concept very specific to VC funds and does not extend even to other investment categories such as angel networks.
Another aspect is that the fund life of VC fund remains fixed, and the carry is typically paid towards closer to the end of the fund life. (In exceptional cases, it could be paid during the fund life, however, with a clawback clause). Payment of carry also accounts for all investment failures. Fund management team, specially, partners who have managed the fund and investments remain the same during a fund life.
Incubation investments and equity are somewhat different in their nature. Incubators come on cap-table of a startup in different capacity- as an incubator and/or an incubator-investor. Incubation equity is typically against the incubation support extended to startups at subsidized cost. The cost of intangible support is difficult to arrive at in case of incubation support. In case of incubator-investment, an incubator hold equity against specific amount invested typically out of free grants/ donations received by incubators. There is no obligation to return proceeds of investments to the granting agency or donor unlike the VC funds where the committed returns are to be paid back to the fund investors. There is no fixed life of such grants/ donation funds; they remain rolling by its character. Also, tenure of the team in incubators are not aligned to the investment-to-exit timeline.
1. Carry as a concept
Carry from a fund is typically towards closer to the end of the fund life (in exceptional performance it could be earlier). It also accounts for all investment failures. Fund management team, specially, partners who manage the fund and investments remain the same during a fund life. Compare this with incubation investment: The assumption is to distribute profit on every exit. Team is floating, equity character and cost are different, and tenure is rolling.
2. Equity Character and cost of an Incubator’s equity in a startup
Incubators typically have different classes of equity in an incubated/ supported company. Each class has different character and cost structure.
i. Incubation equity: Incubation equity is typically in lieu of the subsidy for operational cost. The investment cost in this case is near zero. It is difficult to quantify operational cost. So, while the entire liquidation proceed may be assumed as an earning, actual operational cost in form of subsidy is ignored.
ii. Investment equity: This is against actual money invested out of various grants. Each grant has different condition for dealing with proceeds of investment. Some are required to be ploughed back to the grant fund in entirety, some have condition to plough back after 50% paying back to the grant agency. Some grant conditions permit a small portion of liquidation profits to be used for administrative costs.
iii. Investment facilitation for a third-party investor: In some cases, state-owned funds leverage the expertise and close engagement of incubators with startups. In such arrangements, incubators support and facilitate investment decision-making on behalf of these funds, while the actual investments are made in the name of the state-owned entities. In return for their role, incubators receive an administration fee and a predetermined share of carry for the incubator at the time of exit or liquidation.
Thus, there is no uniformity in character and costs of equity. Hence the question would be- how one would consider actual profit and consequent % of carry against each of these separate set of equity.
3. Fund Tenure
Each fund operates with a fixed tenure, and carry is distributed only after the fund achieves certain performance thresholds, considering both successful and failed investments of the entire fund at the end of its tenure. In the incubator context, this structure may not work given rolling cycle of investment and differing policies of exits. This in fact, introduction of carry at every exit may create an incentive to delay write-offs in case of incubators’ equity.
4. Periodicity and Eligibility to receive carry
In a VC fund, its investment partner team typically remains in place for the duration of the fund, managing the full cycle from investment through exit. In contrast, incubators do not operate time-bound funds; investments are generally made from grants, and incubator teams experience ongoing churn without fixed tenures. Given the long-time horizons for startup exits, it is common that individuals who sourced deals, incubated companies, and provided mentoring and value addition will no longer be with the incubator when an exit eventually occurs. By that time, they are often replaced by new team members who were not involved with the invested companies. This raises a fundamental question: how should an incubator determine entitlement to carry for a given liquidation? Such situations are not exceptions but part of a continuous ones, as the life cycles of portfolio companies and the tenures of incubator team rarely align.
Given the fundamental difference in the nature of the VC Fund and the investments by incubators our of grant, the concept of carry of carry is not relevant for an incubator’s equity performance. Thus, the practice of the carry does not extend beyond VC Funds. Furthermore, introducing carry could divert attention from the core objective of incubation, where investment is only one of several support components. It may incentivise the team to maximise financial returns rather than maintain a neutral, developmental approach. For instance, this creates a risk of bias towards startups with higher return potential, leading to a “betting on winning horses” mindset instead of nurturing and preparing all startups for the race.