Key Takeaways:

  • Accelerator equity agreements, such as ACEs, allow startups to exchange equity for funding, mentorship, and resources.
  • The ACE (Accelerator Contract for Equity) is a unique legal agreement that can be converted into equity without incurring debt.
  • Unlike convertible notes, ACEs do not require repayment unless the business is dissolved or liquidated.
  • Startup accelerators are designed to help companies grow rapidly by providing essential resources in exchange for equity.
  • Y Combinator is one of the most successful accelerator programs, producing companies like Dropbox and Airbnb.
  • While accelerator programs can be highly beneficial, they may also have downsides, such as significant equity dilution.

In the fast-paced world of startups, securing the right kind of investment is crucial for growth and success. One of the most effective ways for early-stage companies to gain momentum is through accelerator programs, which often involve exchanging equity for essential resources like funding, mentorship, and access to networks. This process is not only a strategic move for startups but also a significant commitment, as it involves giving up a portion of ownership in the business in exchange for accelerated growth.

At the heart of many accelerator programs is the Accelerator Contract for Equity (ACE), a unique legal instrument that facilitates a direct investment into a company. Unlike traditional forms of funding, such as convertible notes, ACEs are designed to be simple, flexible, and beneficial for startups that need to move quickly without the burden of debt or interest payments. The ACE allows the investment to be converted into equity at a later stage, typically when the company raises its next round of funding. This flexibility makes ACEs an attractive option for startups that are looking to scale rapidly without getting bogged down by complex financial arrangements.

This type of legal agreement is similar to a convertible loan note (CLN), although it doesn't require interest or the company to take on debt. Therefore, the terms of an ACE generally don't include repayment requirements, unless the business is dissolved or liquidated. One similarity an ACE shares with a CLN is the requirement to convert the investment to equity in the business at some point. When certain events occur, the ACE should be converted to a class of stock.

Understanding the implications of an ACE is vital for any startup founder. It impacts not only the immediate financial health of the company but also its long-term equity structure and cap table. Transparency and education are key components of this process, ensuring that founders are fully aware of how their equity is being utilized and the potential impact on their ownership as the company grows. This guide aims to provide a comprehensive overview of accelerator equity programs, highlighting their benefits, potential drawbacks, and the strategic considerations every founder should keep in mind.

Before you start the process of an ACE, you need to make sure you understand when and how the terms of the agreement allow the investment to be converted to equity in the business:

  • Upon conversion to the same class of stock issued during the financing process, the ACE terms will convert under the same terms as the equity financing
  • Upon conversion to common stock, as long as equity financing doesn't happen within 12 months, the ACE will convert based on the investor's option

What Are Startup Accelerators?

The purpose of a startup accelerator is to allow portfolio companies to grow more rapidly. This manmade option can include office space, mentorship, an innovative community of like-minded people, and access to technology, all packed into a short period of time. An accelerator transforms the concept of starting a business into a repeatable function, churning out successful companies through an assembly line-style setup.

Although accelerators have their own nuances, all programs have some common threads:

  • A startup founder would apply to be part of the program, lasting for several months
  • The founder would receive funding, mentorship, and office space
  • The founder would give up stock in the business in exchange for these resources

An accelerator program is designed to give new business owners more opportunities while earning high returns on investments. One of the original accelerators was Y Combinator (YC), and their idea certainly seemed to have been successful. This organization sprouted Dropbox and Airbnb, two startup companies that are now worth billions since the program was incepted in 2005.

A variety of organizations are now trying to repeat the success of YC by launching their own accelerator programs, including Nike and Chile. The question is whether they are simply clones of a good idea or if the high number of startups necessitates more options for generating better businesses. Before accelerator programs came incubators, which were institutionalized environments designed to enable business ideas and startup companies to grow and succeed. The first incubator program began in 1959.

Four decades after the first incubator program, a number of similar companies popped up, including TechSpace, 100x, and HotBank. These organizations were booming along with tech companies, with a business model that exchanged equity in new companies for upscale office space. When the tech bubble burst, the business model had to change to stay afloat and these companies started renting out office space for a set monthly fee instead of exchanging the space for equity.

Paul Graham launched YC in 2005, although this program is different from the incubator model in several key ways.

  • Incubators had flexible timelines for startups, while the YC program offers a limited time period where groups of startup owners come in at the same time and graduate the program after several months
  • All partners at YC have previous experience in companies that have been highly successful
  • Startup owners must exchange pre-seed funding for equity in the business upon acceptance to the program

The Impact of ACEs on Your Cap Table

When a startup enters into an Accelerator Contract for Equity (ACE), it's not just acquiring funds or resources—it's also altering the structure of its cap table. The cap table, or capitalization table, is a critical document that outlines the equity ownership in a company, detailing who owns what percentage of the business. As a startup grows and raises additional rounds of funding, the cap table becomes increasingly complex, and each new equity transaction, including those through ACEs, has a direct impact on the ownership percentages of existing shareholders.

ACEs are unique in that they allow for the conversion of an investment into equity at a future date, usually coinciding with the next round of financing. This conversion can significantly dilute the ownership percentages of the original founders and early investors. If not properly understood and managed, the dilution effect can reduce the control and decision-making power of the founders, potentially leading to challenges in steering the company's strategic direction.

Understanding how ACEs affect the cap table early on is crucial for maintaining a balanced ownership structure that aligns with the long-term goals of the startup. Founders must be proactive in assessing how each equity event, including ACEs, will impact their stake in the company. By having a clear picture of how future equity conversions will play out, founders can make informed decisions about when and how to raise additional funds, ensuring that they retain enough control to guide their startup to success.

Key ACE Conversion Events and Their Implications

The conversion of an Accelerator Contract for Equity (ACE) into company stock is a pivotal moment for any startup, as it solidifies the investment into tangible equity on the cap table. Understanding the specific events that trigger this conversion is essential for founders to plan and manage their equity strategically. Typically, an ACE converts into equity during significant financing events, such as a Series A round, where new investors come on board and the company's valuation is formally assessed.

When an ACE is converted, the terms of conversion are usually linked to the valuation set during the financing round. This means that the earlier investment through the ACE is translated into a specific number of shares based on the agreed-upon valuation, which can lead to dilution of existing equity holders. For founders, it is crucial to anticipate these conversion events and understand their implications on ownership percentages, as they directly affect control over the company.

Moreover, some ACE agreements include provisions that allow conversion into common stock if certain financing milestones are not met within a specified period. This can be beneficial or detrimental depending on the startup's growth trajectory and funding needs. By being aware of these potential scenarios, founders can better negotiate the terms of ACEs to align with their long-term vision and avoid unexpected dilution or loss of control in their company.

Downside of Accelerators

Accelerator programs are unique, so one program might have certain downsides that another does not.

Frequently Asked Questions

  1. What is an Accelerator Contract for Equity (ACE)?
    An ACE is a legal agreement used in accelerator programs that allows startups to exchange equity for funding and resources without taking on debt. The investment is later converted into equity, typically during a future financing round.
  2. How does an ACE differ from a convertible note?
    Unlike convertible notes, ACEs do not accrue interest or require repayment unless the company is dissolved or liquidated. They convert directly into equity at a later stage without creating debt obligations for the startup.
  3. How do ACEs impact a startup’s cap table?
    When an ACE converts into equity, it changes the company’s capitalization structure, potentially diluting existing shareholders' ownership percentages. Founders should carefully manage these conversions to retain control over their company.
  4. What are the benefits of joining a startup accelerator?
    Accelerators provide startups with mentorship, funding, office space, and networking opportunities, helping them scale rapidly in exchange for equity. Programs like Y Combinator have helped launch billion-dollar companies like Airbnb and Dropbox.
  5. What are the potential downsides of accelerator programs?
    While accelerators offer valuable resources, they also require startups to give up a portion of their equity, which can lead to significant dilution. Additionally, not all programs offer the same level of mentorship and investor connections.

If you need help with accelerator equity, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.