Getting into an accelerator program is a great opportunity to jumpstart a startup by allowing it to gain access to excellent mentorship and exposure. However, apart from the accelerator services themselves, it is crucial to pay close attention to the terms contained within the accelerator investment documents, as there are various issues to be on the lookout for from a legal standpoint. In this post, we will discuss some of the main terms for startups and accelerators to consider when contracting with one another, as well as issues that come up prior to and after the investment itself.
Structuring the investment
One, if not the main issue surrounding accelerator investments is determining how the investment itself should be structured. At this point in time, there is no universal or standard type of investment instrument used by all accelerators. Each accelerator uses its own documents and the terms differ, not only between accelerators in the U.S. and Europe, but also among Silicon Valley accelerators themselves. We have found that many non-U.S. accelerators/incubators operate as funds, which in turn affects the terms they offer when contracting with startups. The more the accelerator operates as a fund, the more the investment terms begin to look like a venture capital, rather than a seed, financing.
Generally, the instruments used to structure investments have varied from acquiring common stock, preferred stock, convertible notes, warrants or other convertible securities. Each choice comes with its own set of provisions to be negotiated and legal implications to be agreed upon by the parties.
Another aspect of the investment that greatly varies is the percentage of ownership an accelerator acquires in the startup. The range is mostly between 2-8% ownership, but can go up to 10% or above. The investment amount itself also differs: higher-tier accelerators tend to invest in the range of $100-$120 thousand, whereas smaller-tier accelerators are willing to spend around $20-$25 thousand.
In the case of an accelerator purchasing common stock, the accelerator will often acquire higher ownership of the company in lieu of investors’ rights. Such a situation may seem like a best case scenario for the founders in the short run, however, may result in an upward valuation of the common stock too soon. This may be problematic for the startup down the line in terms of the future development of the company and when choosing stock option plans for the company’s employees.
An accelerator will frequently opt to acquire preferred stock for its protective provisions, which may include the requirement to seek its permission for the company to issue additional equity, or to create a subsidiary. Other times, accelerators seek to set up an option pool. Here, it is important to realize that the option pool will result in a lower pre-money valuation of the company, as it reduces the effective valuation of the company.
Frequently, a convertible security will be used with a preemptive right attached. The preemptive right allows the accelerator to purchase its pro-rata share (meaning essentially, its percentage of ownership) in any future financing, on its as-converted basis. Accelerators will usually also seek anti-dilution provisions that allow them to maintain their ownership percentage. Problems for the company that may arise with both preemptive and anti-dilution provisions involve allowing those rights to last beyond a Series A financing, leading to the need to acquire accelerator waivers and approvals beyond a reasonable time frame.
Representations and warranties
Another aspect of the investment instrument are the representations and warranties the company must make to the accelerator. It is important that the startup has acquired all approvals for the investment as well as has a current cap table. Furthermore, it is important that the company is well aware of all of its obligations under the instrument. Although not common, we have come across investment documents that imposed a contractual penalty to the company if it was in breach its contractual obligations and involved certain personal liability of the founders.
Apart from the legal terms themselves, it is important for a company to do its research on the particular offers of the accelerators. For instance, certain accelerators offer more structure and some tend to prefer a more hands-off approach. Most accelerators, apart from general mentorship and guidance to the startup and assistance in negotiating with investors, also offer as part of their program assistance in the marketing and sales sphere, an office space, and help the startup prepare for its demo day presentation. In the case of a U.S. accelerator, the startup must take into account that fact that it will likely need to move to Silicon Valley for the duration of the program.
Signing the investment instrument with an accelerator does not mean the end of legal and corporate governance issues for a startup. It is important for the company to make sure its organizational documents and minutes are kept organized and updated. Furthermore, it is crucial to obtain all necessary signatures and approvals going forward, as failure to do so will result in liability and will steer away future investors. Similarly, the company must be sure to maintain a current cap table, to make sure all equity is accounted for, especially in preparation for any future financings.
In the next post, we will present a table which compares the different approaches of leading U.S. and European accelerators in structuring their investments, including what type of instruments they use and the terms contained therein.
We do not endorse any particular accelerator and the information herein has been found online from publicly available sources.