Making Sense of Accelerator Terms
Accelerator season is upon us!
Last week, I was in Montreal for the launch of FounderFuel, which is making a return to Montreal after a 4-year hiatus. We’re also only a few weeks away from the start of YC’s S23 batch and the launch of many other summer accelerators. As founders around the world contemplate joining accelerators and incubators, the inevitable question comes up: is it worth it?
The Basics
In general, accelerators “cost” between 5-10% of a company’s equity. In exchange, founders receive the benefits of the program, along with a nominal investment.
Here are some example terms from well-known accelerators:
Y-Combinator: USD $125K for 7%
Techstars: USD $120K for 6%
500 Startups: USD $112.5K for 6% ($150K - $37.5K “Program Fee”)
Entrepreneur First (UK): £80K + ~£6K/founder stipend for 10%
FounderFuel (Canada): CAD $120K for ~8%
Alchemist (Enterprise Software): USD $25K for 5%
HAX (Hardware): USD $150K for 14%
The Fine Print
I won’t go into the details of each and every permutation of accelerator fine print (I would have to write a series of novels in order to do so). Suffice to say, there are many nuances to the terms offered by accelerators around the world. While the terms aren’t generally meant to be misleading, it’s incredibly important that you understand the fine print before you sign on.
Covering an entire topic is hard
Here are a few examples of accelerator fine print:
Y Combinator
Y Combinator makes an initial investment of USD $125K for 7% of the company, but they also have the right to an additional USD $375K investment on “Most-Favored Nation” terms. This means that they have the right to invest an additional USD $375K at the best SAFE terms that occur between the time you start the program and your next equity round. On the one hand, this ensures that you have $375K already committed to your next round. On the other hand, depending on how your post-YC fundraising goes, they could end up owning a lot more than 7% of your company.
500 Startups
500 Startups advertises a USD $150K investment, but subtracts from that a USD $37.5K “Program Fee”. This type of clawback is a fairly common (and relatively benign) practice amongst accelerators. It’s simply a means for them to transfer money from their investment fund to their balance sheet in order to fund operations (i.e. pay the salaries of all of the people who run the accelerator). Bottom line: they’re actually giving you USD $112.5K as opposed to $150K.
Entrepreneur First
Entrepreneur First focuses on helping train individuals to become entrepreneurs. The program starts by offering individuals a £2K/month stipend to participate in the program. If, at the end of the program, you end up founding a company, they have the right to invest £80K for 10%. The thing is, they have no obligation to do so. So, even if you do found a company during the program, you might end up finishing with £80K in the bank and EF owning 10% of your company. Or you might end up with a shiny new company that you (and your cofounders) own 100% of, but no money in the bank.
FounderFuel
FounderFuel invests CAD $120K, but does so in two parts:
CAD $20K for 5% of the company in common shares
CAD $100K on a SAFE with a CAD $3.5M valuation cap and a 20% discount
Assuming that you raise your next round at or above a valuation of CAD $3.5M, FounderFuel will own ~7.9% of your company. However, if your next round occurs below the cap, then the 20% discount comes into play and they could end up with a higher ownership percentage.
The Investment
The #1 thing that most founders get hung up on when comparing accelerators is the investment amount.
The thing is: that’s not actually the main benefit.
When you join an accelerator, you’re committing to spending 3 - 6 months of your life in the program. That’s a huge time commitment when you’re a founder. Not only that, you’re giving up 5 - 10% of your company for that privilege.
The investment amount? It’s actually a rounding error in the big picture.
Now, don’t get me wrong — $100K or $200K is a significant amount of money when you’re an early-stage founder. But it’s honestly not a large amount of money to raise if you’re running a high-velocity fundraising process. In fact, the investment amount was never meant to be the primary focus.
The financial investment from accelerators was originally meant to serve two purposes:
To provide you with operational capital while you’re in the accelerator
To provide a mechanism for the accelerator to obtain equity without tax implications
Funding as Operational Capital
When Y Combinator, 500 Startups and Techstars were founded, each of them realized that for their programs to succeed, they needed to provide founders with operational capital to keep the lights on while they were participating in the program. The concept was similar to scholarships for university: if you don’t have to worry about paying the bills (i.e. getting a part-time job), then you can better focus on the educational content of the program.
If you look at accelerators and incubators around the world, you’ll find that the amount of capital invested typically equates to 4 - 6 months of runway for a company of 3 - 5 people. This is absolutely by design (and why accelerators in cities with lower costs typically invest far less than those based in major tech ecosystems).
Funding as a Means to Transfer Equity
It may surprise you to learn that U.S. tax law contributed significantly to the precedent set by the original startup accelerators when they provided companies with funding in exchange for equity. In the U.S., there is no way for a startup to simply “give” an accelerator equity without a taxable event occurring. Absent an exchange of cash-for-equity, accelerators would have pay taxes on the receipt of equity and both the startup and the accelerator would need to jump through hoops in order to ensure that the calculations were correct (e.g. 409A valuations). Mistakes could lead to lots of problems down the road, including a degree of outcome variability for the accelerators that simply wasn’t worth it.
Exchanging funding for equity results in a clean, simple transaction for both sides.
Do Accelerator Valuations Matter?
In short: no.
Many founders worry that they could be setting a precedent for future funding rounds if the valuation implied by an accelerator’s terms is too low. In reality, no investor takes into account accelerator valuations when thinking about a company (if an investor ever tries to use this as a negotiation point, you should run the other way).
It’s also quite common for startups to join accelerators with implied terms that are lower than the terms that they have already raised on. Generally, this isn’t an issue — although if your early investors have “Most-Favored Nation” terms, then you’ll need to go back to them and negotiate an exemption before signing onto the accelerator (something that any good investor will generally agree to).
How Do You Decide?
When I was a founder, I never participated in an accelerator (although Brad Feld and David Cohen, two of the cofounders of Techstars, were investors in DataHero through their respective funds), so I can’t speak from personal experience as a founder.
However, my first role in VC was at 500 Startups, where I helped to run the firm’s flagship San Francisco accelerator. After that, I helped launch and operate accelerators on five continents and founded one (San Francisco-based Commonwealth Ventures). In short, I believe that the right accelerator can have a massive positive impact for many first-time founders. But you have to choose carefully.
Where’s Chris?
After seeing the inside of so many accelerators, my perspective is simple: if the money wasn’t part of the equation, would you trade X% of equity to participate in the program?
Like any important decision, you need to do your research. What companies have gone through the program and what outcomes did they achieve? What do the founders who participated in the accelerator have to say about it? What areas do you need help in and does the program focus on those?
If the answer is yes, then it’s probably a good deal, regardless of how much the accelerator invests. If the answer is no, then — absent a desperate need for funding — you probably shouldn’t do it.
It really is that simple.