Categories
Uncategorized

Investment Structure

Many accelerator programs offer investment alongside the program they run. The dirty secret of the accelerator business is that running programs is actually not very profitable. Quite the opposite actually! Most programs are run at a loss with the returns being wholly dependent on the investments in startups themselves. If you’re launching an accelerator program to build a big profitable business you’re not likely to find it.

Whether your program includes investment is up to you and depends on your own situation and business goals. There are many programs out there, especially corporate ones, that for example don’t invest for equity in the companies they work with. One reason for this is that it’s actually rather challenging to manage the sheer volume of investments an accelerator can make during its lifetime. Not to mention the longer-term legal maintenance needs. If your program does not have a venture fund attached to it, or if your backing is corporate it might not make sense to make investments with each program. Additionally, some programs are run as a public service (government-backed) or for corporate branding and marketing. They are not returns-driven and there ain’t nothing wrong with that.

That being said, the quality of startups you can attract will dramatically increase when an investment is available. It is, of course, a big decision for a startup to spend several months with you, so for the startups, the investment helps to cover costs incurred and time lost working on other things. The general thinking is that you’ll also work harder for them in trying to increase their company’s value. As we say in our industry, it’s all about having skin in the game.

There are many great books written on the subject of startup funding. If this is all new to you I would recommend ‘Venture Deals’ by Brad Feld and ‘Angel’ by Jason Calacanis to get started. In this book, ‘The Accelerator Startup Guide’ we won’t be going into such depth of investment structure and terms. However, I’ll share a few things I’ve learned over the years with programs that included a financial investment made into the companies.

What are the terms?

As you interview startups and build your pipeline this question will come up again and again. Startups who are talking to accelerators are particularly sensitive about this topic, specifically with what valuation a program invests at. Of course, if a startup was killing it and growing rapidly they would be getting lots of great offers from venture funds. However, if they’re talking to you this is likely not the case. Still, they are programmed to try to get as much money for as little equity as possible. Herein lies the problem.

Startup accelerators don’t invest at typical startup terms and there’s a reason for that. An angel investor may write a check but they are usually not very active in the company. An accelerator program, on the other hand, will spend weeks and months hands-on with a company, in addition to longer-term alumni support. An accelerator’s contribution is different from an angel’s, and in some cases, their contribution is even more hands-on than a venture fund. Accelerators are also typically investing very early. This means that they are accepting much higher risk and therefore warrant a lower valuation. Much to the dismay of the young founders, this is sometimes hard for them to understand.

 Sample Program Investment Terms

ProgramInvestment AmountEquity
Y Combinator$150K7%
500 Startups$150K6%
Techstars$120K6%

As we can see in the table above, most of the well-known programs are investing at a roughly $2M valuation. For the markets in which YC, 500 and Techstars operate (like Silicon Valley), this is actually considered a really good deal for a good startup with traction. For comparison, a seed round for a similar company in Silicon Valley might value the startup at more like $4M-$5M, so the accelerator is getting a significant discount here. As every startup ecosystem and region is different in terms of valuation, you can use as a general rule that an accelerator program should be entering a company at about 50% of the valuation a local venture fund would invest at. Your ability to convince a startup you’re worth such a deal will be critical to closing the best companies for your program.

As part of that convincing, you’re going to run into a few roadblocks. First, for the founders, you want to show them that doing your program is a path to a *more* successful fundraise. Along with that, you’ll help them attract better investors and get them the valuation they believe they are worth. It also helps if you can get them to understand that fundraising is a difficult and nebulous process with no guarantees. However, with your program, you can take something very murky and misunderstood and provide some clear direction. I’ve used the below image in welcome materials for several programs and feel it encapsulates this all very well.

Another challenge you might face with regard to investment terms is getting buy-in from the startup’s previous investors, board members, and advisors. I have in several cases been able to convince the founder to accept a program’s terms, only to have a board member try to completely shut it down. Your best bet in this scenario is to talk directly to the concerned party and continue to sell the value offered by your program, explaining how the company will have a greater chance for success by attending your program. Sometimes this works but other times these parties are an unmovable object and unwilling to consider it. In that case, I go back to the founder and simply ask them, “Do you run your company or does someone else?”, hoping to inspire some boldness in them to push the deal through. From my qualitative experience, early startups that have already ceded control to their boards are doomed to fail anyway, so perhaps you’re saving yourself some trouble by having them opt-out.

Program Fees

There’s one part of accelerator investment terms that’s a bit controversial and that is charging startups a program fee for attending. Y Combinator does not do it, and they go as far as to publicly call it “bad behavior”. 500 Startups, on the other hand, have always charged a program fee and defended its use. Often the fee is deducted at the time of wiring the money. Effectively allowing the program to buy more equity for less. Here’s how 500 Startups explains it in their FAQ:

Yes – We charge $37,500 per company to participate, but these fees can be deducted from our investment amount so you don’t have to pay out of pocket. As mentioned above, our gross investment is $150,000. Once program fees are deducted, you would receive $112,500. These program fees help to cover basic costs of running the Seed Program, paying outside speakers and should be viewed like tuition.

I’ve worked in programs that do both and I don’t have any strong convictions against charging a fee. In fact, I think for new programs where your operation budget might be limited it’s your best way to get a financial boost. I’ve worked on several programs that just would not be able to operate without the program fee. Just be mindful that some founders will push back on this or decline a deal due to the program fee. I recommend a ratio of roughly 3:1 in terms of investment size to the program fee. Anything more and you’re perhaps being a bit too greedy and may scare away good startups.