TL;DR Nutshell: All major startup accelerators have uniquely strong anti-dilution protection in their stock purchase agreements. These provisions are serious, can have a material impact on cap tables, and founders should be aware of what they mean. Many of them are also structured in ways that really don’t make sense economically, and are unfair to founders. Some better approaches are out there and worth considering.
It used to be common knowledge in startup circles: no one, not the CEO, not your first big investor, not even your grandma got full anti-dilution protection. Maybe they got that watered-down weighted average stuff that is common in VC rounds, but the idea of guaranteeing someone X% of the cap table was a non-starter… until accelerators showed up. On top of receiving their % of the cap table (anywhere from 2-8%, depending on the accelerator), the vast majority have provisions requiring you to “top up” their shares if they experience any kind of dilution pushing their ownership below the % they originally purchased.
Granted, the protection typically expires at a seed equity or Series A round (called a ‘qualified financing’ in the docs). Full anti-dilution forever would be non-sense. But these provisions are still a big deal and can materially impact the capitalization distribution of the Company, and even impact how a company might go about structuring seed rounds. While we definitely haven’t seen every accelerator’s anti-dilution provisions, we’ve seen enough, certainly most of the top accelerators’, to say that most fall into the following categories:
A. Protection from only additional Founder issuances – The most company/founder favorable anti-dilution protection, but unfortunately not the most common; though at least one very elite accelerator uses it. In short, the accelerator is protected only if the founders issue themselves new equity, or otherwise somehow increase their ownership %s, after issuing the accelerator shares. If stock, warrants, notes, etc. are issued to outsiders, like for services or for investment, no “top up” is required.
B. Full protection until a qualified equity round – This is the least company/founder favorable, and is unfortunately the most common; including among some top brand accelerators. Basically, no matter the reason for issuing additional securities – services, investment, etc. – you must top-up the accelerator completely until the company raises $X in an equity round. That last point is extremely important, and I will discuss it further below, given the fact that convertible notes/SAFEs (and not stock) have become by far the predominant form of raising seed rounds.
C. Full protection until a qualified equity or debt/SAFE round – This is a middle-ground provision that is less common than “B” above, yet at least is more agnostic as to its impact on seed round structures. If, after issuing the accelerator shares, you raise a round of $X of equity or convertible notes/SAFEs, the anti-dilution protection stops.
The “C” anti-dilution category is a little tricky, because even if the “tolling” of the anti-dilution stops at raising, for example, $250K in convertible notes (assuming that’s the qualified financing threshold), you still have to provide a top-up when those $250K in notes eventually convert. While that’s still free shares to the accelerator, it ends up being far fewer top-up shares than there would be under the “B” (more common) type of anti-dilution protection.
- StartCo issues Accelerator 6% of stock as part of the program.
- After the program, the Company (in sequence) (i) issues stock to several employees, (ii) raises $2MM in convertible notes @ various caps, (iii) issues some more options, and then (iv) eventually closes a $4MM Series A round.
- The “qualified financing” threshold in the accelerator’s stock agreement (for purposes of ending anti-dilution protection) is $250K.
If StartCo had attended an accelerator with “A” type anti-dilution, they wouldn’t have had to top-up the accelerator at all – no free shares. As long as no equity was issued to the original founders, the accelerator continued to be diluted by future issuances just like the founders themselves were.
If StartCo had attended an accelerator with “C” type anti-dilution, they would’ve had to “top up” (or “true up,” however you want to call it) the accelerator for (i) the stock issued before the note round(s), and (ii) only for the first $250K in notes of the seed round. Once the $250K in notes was issued, anti-dilution stopped, though some top-up shares would need to be issued in the Series A round once it’s known exactly how many shares those $250K in notes convert into. While this scenario is worse for the company/founders than scenario “A,” it’s not nearly as bad as “B.”
If StartCo had attended a “B” category accelerator, which remember is the most common, including among some top accelerators, every single issuance before the Series A, including often (i) option pool shares reserved in connection with the Series A and placed in the “pre-money” and (ii) (in the worst variants of this category) all $2MM in notes, would require anti-dilution top-ups. That’s A LOT of free shares to the accelerator.
Accelerator A asked for 6% only on Day 1. Accelerator C asked for 6% on Day 1 and for maybe 3-6 months. Accelerator B asked for 6% for possibly 1-2 years. 6% is not just 6%. The details matter. A lot.
And perhaps more interestingly, “B” type anti-dilution is relevant to how founders structure their seed (pre-A) rounds. If StartCo had raised $250K in seed equity, it could’ve cut off the accelerator’s anti-dilution immediately. But by raising seed money as notes and putting off equity for a Series A round (which is extremely common), it let the accelerator’s anti-dilution drag-on. Does it really make sense for accelerator anti-dilution to favor one type of seed round structure over another?
Which accelerator’s anti-dilution makes more sense?
As someone on the company side and at a firm that (deliberately) doesn’t represent accelerators, I’m obviously partial to the “A” approach of accelerator anti-dilution. But stepping back and trying to assess things objectively, it also just makes more sense. What exactly should an accelerator’s anti-dilution protection be “protecting” for? If the concern is that a set of founders with low ethics will immediately dilute the accelerator post-program by issuing themselves more equity, then “A” anti-dilution protects for that.
Perhaps, for economic reasons and much like the qualified financing threshold in a convertible note/SAFE, the accelerator doesn’t want its ownership % to be cemented until a serious financing round has occurred that prices the company’s equity. If (and I do mean if) that is the intent, it’s not clear why it should matter whether the seed round is debt/SAFEs or equity, as long as it’s large enough to be considered a real seed round. Plenty of VCs/seed funds who are more than capable of pricing companies (via caps) are signing notes/SAFEs. The logic for “B” and “C” type anti-dilution must be, fundamentally, about grabbing a larger share of the cap table; not “protection.”
If accelerators insist on “protection” for more than just self-interested equity issuances, then they should at least modify their anti-dilution provisions to stop favoring equity seed rounds over debt/SAFE rounds, given how much more prevalent the latter have become. And founders should be aware that if a particular accelerator is asking for 6% w/ “B” anti-dilution, that could be equivalent to 10%+ on Day 1 (much more than simply 6%), after accounting for all the free shares that must be given to fulfill long-term anti-dilution obligations.
Kudos to the few accelerators who’ve moved toward the most company/founder favorable (and justifiable) type of anti-dilution; the “A” category above. As for those preferring the “B” and “C” categories, which includes some very well-known brands, it would be great to hear some thoughts on why you think they are a more reasonable structure. If I were a founder in one of those accelerators, I’d be interested in hearing those thoughts as well.
Also published on Medium.