Giving that you are at the “accepting offer” stage, I assume you have done diligence on the accelerator and their key people. Here are the terms you should look out for and understand.
- Investment – Understand how much money you will get and when. For example, if you’ve decided to invest in the nz stock market you will understand when the return on investment will occur and how much you will get. You can then see whether this will be an effective long-term investment or short-term investment. There are tools such as a stock market calculator to provide rough estimate of your investment.
- Dilution – Know how much % of your company you give up. A good way to understand dilution is to run a model with this excellent (and free) Cap Table & Exit Waterfall Tool.
- Program Cost – Some accelerators ask participants to “pay” for the program. 500 Startups for example, invests $150k, but then asks the company to pay $38k for the program , making the investment effectively $112k. While this looks strange, it is due to internal accounting and is generally ok. Just take it into account when you do the dilution math. If you are trying to procure a governmental contract with your startup, you may want to take a look at Whitcomb, Selinsky, PC – government contract lawyers, and ones similar, to see how you could be legally supported during this stage.
- Stock Type – Understand what kind of stock the accelerator gets. Common stock is the type of stock founders and employees get and it is generally less valuable than preferred stock. Preferred stock is the kind financial investors favor and they often read this motley fool advisor review to learn how to get their hands on that stock. Accelerators are somewhere in between since they provide both “sweat equity” like founders do, but also money like financial investors do.
At AngelPad we mix both. We are granted 5% in common stock and make an investment of $120k for around 2% which adds up to ~7% total . Y Combinator changed their terms in 2018 to receive all equity in preferred stock . Techstars also mixes common (6%) and preferred stock .
- Pro-Rata Rights – Does the accelerator have the right to invest in your next round(s) of funding (at the same valuation than other investors) to keep their ownership at the same level? While this is ok, you should understand what it means for later fundings. If you become a “hot” company, taking on new investors may become more difficult if your existing investors have a lot of pro-rata rights. I find a simple pro-rata acceptable.
- Super Pro-Rata – Does the accelerator has the right to buy MORE than their current ownership in future fundings. This is dangerous and unacceptable IMHO. I would not sign terms with a super pro-rata for any accelerator. The right to make a larger investment should be earned, not demanded.
- Warrants – Any “hidden” benefits the accelerator might have. i.e. some accelerators have a warrant that allows them to buy a certain % of the company at a later stage for a pre-negotiated price. You need to understand why they ask this and impact on dilution. Side note: Up until 2017 Y Combinator and AngelPad used warrants to protect common shareholders from a potentially significant tax bill. In other words, it was as a benefit for the company, not for the accelerator. We stopped this practice as tax law evolved, but some accelerators may still use warrants.
- ROFR – “Right of first refusal”, meaning that the accelerator has to agree to future fundings and/or acquisitions. A ROFR may be a problem for the company later, understand why they are asking for this very unusual right. Y Combinator is rumored to have this in their funding documents for smaller exits. Understand why before signing.
- Liquidation Preference – A liquidation preference means the accelerator investment has to be paid back (at an acquisition) before any common holders. It is usually tied to preferred stock, but sometimes accelerators get common stock with a liquidation preference (I think that’s not cool).
- Credits – Some accelerators make free credits (e.g. AWS, Google Cloud) part of the invested capital. They are just an added benefit and should not be considered as an investment. At AngelPad, our startups get several hundred thousand dollars in credits from AWS, Google and others. Any top accelerator program offers significant perks/credits for their participants.
- Information Rights – Most accelerators ask for information rights, generally a quarterly update and the right to know the financial standing of the company. This is ok, but founders should benefit from a “sunset” period, generally at the A-round or within 1–3 years. An accelerator should not have insider information all the way until you go public.
- Hurdle Investments – Do you get all the money in one go, or does the accelerator require you to achieve certain goals (revenue, funding, growth, etc). I do not like this at all and would not agree to it.
- NDA – Non Disclosure Agreement; again, you need to fully understand why an accelerator would ask for it. Is it to protect themselves in case you are not happy about them or do they want to protect their intellectual property? Understanding the motivation will help you understand the accelerator.
I hope this is helpful. Joining an accelerator is a big decision, not just because you give up a significant part of your company, but because it will guide you into a specific direction. Make sure you really, really like the program and the people behind it. In the overall life of your startup, the money you will get from an accelerator is almost meaningless in regards to the guidance, the network and the knowledge it can provide and which will far outstrip the investment … if you join a top accelerator program. Do your research! Two great resources to consult are the Seed Accelerator Rankings Project (SARP) and the List of individual Seed Accelerator programs. Of course I hope you consider applying to AngelPad.