Comparing Startup Accelerators

Background Reading:

Over the past several years, accelerators have emerged as a powerful filtering and signaling mechanism in early-stage startup ecosystems, allowing high-potential young startups to connect with investors, advisors, and other strategic partners far faster and more efficiently than before. While it definitely feels like the accelerator “bubble” has somewhat burst, and their numbers are normalizing, I’m still often asked by CEOs for advice on how to assess various programs. The below outlines how I would approach the decision:

Cash and Equity.

Very simply, what are you giving and what are you getting in return in terms of cash and equity for joining the program?

Re: cash, the more “unbundled” types of accelerators (less formalized) tend to not provide any cash upfront, but also typically “cost” less in equity, often just 1-2% of your fully diluted capitalization. More traditional and comprehensive programs often require 5-8% of common stock, but often provide between $20K and $100K up-front as well.

Anti-Dilution.

See: Startup Accelerator Anti-Dilution Provisions; The Fine Print.   Most accelerators, with a few exceptions, have much more aggressive anti-dilution provisions than a typical seed or VC investor would get, and the “fine print” can dramatically influence the total equity requirement depending on your circumstances and fundraising plans. This is something you should walk through with an experienced advisor, lawyer or otherwise, to prevent surprises.

Pro-Rata / Future Investment Rights.

See: The Many Flavors of Pro-Rata Rights. Some accelerators will require you to “make room” for them in future financings up to a certain amount. This is not necessarily a bad thing, and it’s very reasonable given that the ability to make follow-on investments in “winners” is virtually essential for very early-stage startup investors (angels, accelerators) to make good returns. However, for the most in-demand startups, over-committing on future participation rights can become a problem because it can require you to raise more money than you really need to.

Fundraising / general success of past companies.

See: Ask the users.  If fast-track access to investors is not at the top of your priority list, then this may not be as big of a deal for you. But 95% of founders I’ve worked with have viewed “cutting in line” to speak with investors as the main reason for entering an accelerator. And don’t rely solely on numbers reported by the accelerators themselves. There are lots of ways of fudging the figures, including by “annexing” already successful companies into the accelerator (in exchange for free help) and using their brand/fundraising numbers to puff up the accelerator; neglecting to mention that the accelerator had nothing to do with those numbers.

Entrepreneurs often celebrate faking it until you make it. Know that some accelerators do the same. When an accelerator says “our companies have raised an aggregate of $200 million,” they may be neglecting to mention that a huge chunk of that was raised before some of the companies (the top ones) ever “entered” the accelerator. 

Ask specific founders, off the record. Without a doubt, the overall “prestige” of the accelerator’s past cohorts will have a dramatic impact on the accelerator’s ability to deliver on its “benefits” to you. There’s a heavy snowball / power law type effect with accelerators where the best ones attract the best companies, which then attract lots of capital/great mentors, which then attracts more great companies, further improving the accelerator’s brand, and so on and so on. And the same is true in reverse: accelerators with poor reputations and bad averse selection (they are just getting the companies everyone else rejected) can actually make it harder to raise money, and are best avoided.

Time commitments and Geography.

Many accelerators involve a substantial time commitment (including travel time) in terms of going through the “program” of events, meetings, training, etc. Feedback (given privately) varies on the ROI of those obligations, depending on the accelerator, type of company, etc. Some entrepreneurs find it invaluable. Others find it a necessary cost to getting access to the accelerator’s network, which is what they’re really there for. In any case, travel and time commitments are a real cost, so take that into account.

Market Focus.

One of the most common complaints I’ve heard from entrepreneurs, after having gone through an accelerator, is that it wasn’t helpful for their “type” of business. Some accelerators are very up-front and overt about their market focus: biotech, energy tech, transportation, etc.  Others are more generalist, but if you dig deep you’ll realize that all or most of their cohort is slanted in one direction, which will mean the accelerator’s network of investors and mentors will be as well.

An example: a heavily hardware-focused startup may not find as much success in an accelerator where the vast majority of companies are SaaS based. The same goes for a health tech startup entering an accelerator full of consumer or B2B startups.

Culture.

In much the same way that entrepreneurs’ own personalities set the culture for their companies, the creators and managers of accelerators heavily influence both their “online” and “offline” culture. Personalities, ages, lifestyles, and values will vary. Some accelerators are well-known for being extremely friendly, generous, and community-oriented. Others are known for being more competitive and “eat what you kill” in their approach. I’ve seen more aggressive entrepreneurs feel that their particular accelerator was a bit too “kumbaya,” while those with opposite personalities felt right at home. 

Do your diligence before entering any accelerator, and make sure you assess its offerings in light of your company’s own priorities and needs. I’ve seen companies emerge with polar opposite opinions of the same accelerator, even within the same cohort.  In many cases, it’s less about the program being good or bad in an objective sense, and more about whether it was a good or bad “fit” for that particular startup. 

Flexibility in Choice of Counsel

TL;DR: A flaw in the “one firm for everything” law firm model is that companies are often pushed to specialist lawyers that they aren’t a good fit for, or simply don’t like. The boutique law firm ecosystem delivers far more flexibility for startups to work with specialist lawyers better suited for their specific cultures and needs.

Background Reading:

The core value proposition behind what we’ve been building at E/N over the past several years is this: new legal technology has removed the hegemony once held by large, all-purpose law firms over the high-end of the legal market; enabling an ecosystem of specialized boutiques to replicate the kind of full service that 500-1,000 lawyer firms provide, yet far more flexibly and efficiently.

Parsing that out requires a bit of backstory:

Scaling technology companies have always needed many different kinds of lawyers: corporate, commercial, tax, employment, litigation, patent, data privacy, etc. Historically, getting all of those lawyers to effectively share information and collaborate was virtually impossible without having all of them under the same firm. The cost of building and running a law firm was simply too high in terms of infrastructure, and cross-firm collaboration carried a lot of friction.

Unneeded Infrastructure

So in that old world, if you were building any kind of serious tech company, you effectively had to go to BigLaw. Running a BigLaw firm is extremely expensive: high-end real estate with top shelf furnishings, file rooms, libraries, in-house IT, lavish summer intern programs, layers of administrative staff, etc. When you have a BigLaw attorney $750+/hr, maybe 20-25% of that is paying for the attorney. The rest is funding all the infrastructure of the firm.

E/N’s position is that a very large portion of the tech ecosystem does not, and very likely never will, need that “infrastructure,” and therefore should not be paying for it. So we take the partners and other attorneys from those firms, cut their rates by hundreds of dollars an hour, and put them on a significantly leaner platform. The end-result is that, on average, early-stage/middle-market companies get better lawyers, at lower rates, and with much better responsiveness.

Flexibility in Specialist Selection

But while efficiency and responsiveness are a big part of E/N’s value prop, flexibility is another that is worth emphasizing, because it touches on a problem that companies often run into when choosing to work with a very large firm.

If you hire a “startup lawyer” (corporate) at a large firm, that firm’s business model is premised on cross-selling all of its specialties. So if while working with your corporate lawyer, a labor law issue, or a patent law issue, comes up, he/she is almost certainly going to refer it internally within the same firm. We’ve seen time and time again that this dynamic causes major headaches for many entrepreneurs.

Why? Because lawyers are people (not software), and law firms are service businesses (not product companies). Once you move past the template-ized aspects of very early-stage legal, the individual personalities, culture, and processes of the lawyers you work with have a very large impact on the end-product you get. You can have half a dozen patent lawyers, all with impeccable credentials and similar academic backgrounds, and yet the way that they each work and interact with clients is fundamentally different. And because lawyers are so different, there is every reason to expect that your particular company may simply “fit” better with one, and not “fit” at all with another.

So a fundamental flaw with the “one firm for everything” law firm model is that it very often pushes startups to work with lawyers that they simply don’t like, or aren’t a good fit for. Not only do entrepreneurs often hate this approach, but many startup lawyers hate it too, because they themselves would prefer their clients find appropriate specialists. When I was in BigLaw, I saw first-hand how startups often got pushed to patent lawyers (just as an example) who made absolutely no sense – from a pricing and technical background standpoint – for a particular company, but the startups nevertheless felt stuck with the lawyers they were sent to.

At E/N, we get exactly zero kick-backs / referrals fees when we connect one of our clients to an outside lawyer via our heavily curated specialist network. Sticking to the patent lawyer example, when a client needs patent assistance, we (i) first emphasize that we don’t do patents and don’t want to (we’re focused), and (ii) provide a list of options that, based on the company’s stage, culture, and type of technology, would be a good fit for them, and then we either make a referral or let the company conduct their own diligence, if they want to. 

Flexibility + Focus maximizes quality and “fit”

Many specialist lawyers (including in BigLaw) can be quite entrepreneurial, but by being part of firms that service 25+ different practice areas, they are institutionally constrained to a minimal level of focused optimization; in the exact same way that large conglomerate companies end up being mediocre at a lot, and excellent at very little.

How do startups take on companies 100x their size? By picking a specific segment / product offering and owning it.  That’s precisely what the boutique law firms in E/N’s specialist ecosystem are doing. By narrowing their focus, building targeted infrastructure and cutting out the irrelevant, they’re able to optimize for companies that need exactly what they deliver, and ignore everyone else. And by connecting with lawyers like those at E/N, they get merit-based referrals to ensure the companies they work with are a good “fit” for them.

I’m not bearish on BigLaw at all; at least not the truly high end portion of it. Billion-dollar companies doing complex cross-border deals needing 10 different kinds of lawyers to collaborate on a single project very quickly are almost certainly in BigLaw’s sweet spot, and that’s not going to change any time soon. At the same time, we’re seeing a growing exodus of non-unicorns toward the more flexible, efficient, and focused boutique ecosystem that is better designed for their needs. We’re enjoying being near the center of it. 

Startup Equity Compensation for LLCs

Background Reading:

As I’ve written before, with more entrepreneurs realizing that the “standard” (whatever that means) corporate trajectory for startups may not be what’s best for their specific company, we are seeing more tech companies explore the possibility of operating as LLCs (limited liability companies). By all accounts, C-Corps are still the market norm, especially for companies with no near-term plans to achieve profitability (everything is reinvested for growth) and with plans to raise conventional institutional venture capital.

But nevertheless, the “LLC Startup” market is real, and there’s far less info ‘out there’ for entrepreneurs to understand core concepts.  Here we’re going to cover the basics of how LLC startups typically issue equity, and how it differs from what C-Corp startups do.

The primary driver behind why LLC equity comp is very different from C-Corp equity comp is that W-2 employees of an LLC can’t hold equity in that LLC, under IRS rules. For C-Corps, both contractors and employees can hold equity, which simplifies equity compensation. But for LLCs, holding *true* equity requires the LLC to issue you a K-1 on an annual basis (you’re a “partner” for tax purposes), and the Company doesn’t cover employment taxes the way it does for W-2 employees.

Units/Membership Interests and Profits Interests (True Equity)

High-level executives (including founders) in an LLC startup are usually OK with this issue, and will hold direct equity in the LLC. They’ll receive K-1s annually.

That equity usually takes one of two forms: Units (sometimes called membership interests), which are the LLC equivalent of stock. Units can be voted (usually) on Day 1, and they are taxable on receipt if their “fair market value” is not paid for, which is why they’re typically issued only in the very early days of the company, like founder/early employee common stock in C-Corps. They can be expensive to receive if they are very valuable (in the IRS’ judgment) on the issue date.

As the value (for tax purposes) of units increases, companies will switch to Profits Interests, which are kind-of a LLC corollary to options, because (i) they only entitle you to the appreciation in value of your equity after the grant date, and (ii) when issued properly, they are tax-free to receive. When profits interests are granted, the Company has to obtain or decide on a valuation that pegs the “threshold value” of the company on the grant date, and the recipient of the PI is then entitled to the increase in value of the equity above that threshold value.

Returns on both units and profits interests receive capital gains treatment, like stock in a corporation. While units usually have voting rights, profits interests can have voting rights, but companies often times structure them to not vote.

Unit Appreciation Rights (Phantom Equity)

While founders and senior executives of LLCs will often be OK with K-1 status and holding true equity, it can become problematic for a number of reasons (tax oriented, benefits oriented, etc.) to have everyone be a K-1 recipient as the business scales. When LLCs want to issue equity-like compensation to lower-level employees, while continuing to treat them as true W-2s, they will usually switch to Unit Appreciation Rights, which are the LLC equivalent of phantom equity.

UARs don’t vote, and aren’t really equity at all. Instead, they entitle the recipient to a cash payment (like a bonus) upon some future milestone (typically an acquisition/exit) that is pegged to the value of equity. Much like profits interests, on the grant date a valuation is determined, and then as the LLC’s equity appreciates in value after the grant date, the UAR holder’s future bonus increases proportionately. When granted properly, UARs are also (like PIs) tax free on the grant date.

While the upside of UARs is that they significantly simplify tax filings/treatment for recipients (no annual K-1s, can stay W-2), the downside is that returns on the UARs are treated as ordinary income by the IRS; no capital gains treatment.

LLCs require Tax Specialists

The main reason startups choose to be LLCs is taxes: given the nature of their business, they want to avoid the corporate-level tax applied to C-Corps, even if that means deviating from the C-Corp norms of typical venture-backed startups.

But the cost of those tax savings is significant ongoing tax complexity in issuing and managing equity, and making annual tax filings. That requires not just good accountants, but good tax lawyers; who are very different from classic “startup lawyers.” If you’re planning to be an LLC that will use equity as compensation, make sure you’re using lawyers with access to solid tax counsel.

Tax Disclaimer: I’m not your tax lawyer or advisor. I don’t want to be your tax lawyer or advisor. The above is just a summary of what we typically see in the market for LLC startup equity. LLCs are highly flexible, and circumstances vary. Do NOT try to rely on any of the above advice without engaging your own personal tax advisors, including tax lawyers. 

Announcing E/N Alpha

I’m very excited to announce the launch of E/N Alpha, a flat-fee subscription program ($500/mo) that our firm has launched for high-potential very early-stage startups.

The details are available on the linked page, and should be fairly straightforward. In particular, I think it’s important to read the section describing what it’s not, because it reflects our firm’s thought-out response to what we see as a lot of failures / nonsense in the legal market where firms, for marketing purposes, pretend to deliver efficiency, when what they’ve really done is watered down their service so much to the point of no longer being useful.

Not software – Readers of SHL and E/N clients know I love legal tech and that we’re always integrating new tools into our practice, but as I wrote in Lies About Startup Legal Fees, there is simply too much BS floating around startup ecosystems that some magical automation tool or piece of AI will dramatically cut legal spend long-term for startups. Significant automation requires significant standardization and inflexibility, which in the world of high-stakes legal work for scaling tech companies negotiating with sophisticated parties, most smart Founders and executive teams are not willing to accept.

Yes, you can automate formations and a few very early things, but complexity increases exponentially beyond that (like a code base), and the value of software automation tapers off fast.

Not paralegals and junior attorneys – I have lost count of how many startups have switched to us from firms that talked a good efficiency game, when their main tactic was to force CEOs to get on the phone with paralegals and junior attorneys whose expertise ends the moment you go off script or deviate from a checklist. I love paralegals and juniors, and we have and train them. But if you think a founder wants to talk to your paralegal about structuring their seed financing, or making that key first or second hire, you don’t understand founders; at least not the smart ones.  See: The problem with chasing whales for what happens when founders end up having to deal with a firm’s B or C team.

Not “everything legal for one price” – Oh man, I came across a firm promising this the other day. “We’ll do everything legal you need for one flat monthly price.” Right. See: Standardization v. Flexibility in Startup Law, for an explanation of what really happens when a firm is forced to work under a ridiculous fixed fee. Fixed fees are great for low-stakes, routine work with a well-defined scope, or for high-volume projects that (again) are well-defined in scope, but the idea that you can map all of the legal needs of scaling emerging tech companies onto some bell curve and peg a number, like an insurance company, without dramatically impacting quality or flexibility, is some straight-up ghostbusters nonsense.

The only possible way it works is if you limit your client base to companies that basically all look and act the same, and have virtually all the same expectations and needs within a narrow range. That’s not how we work, nor how any serious law firm I know works. Analogies to healthcare’s move into fixed-fee pricing don’t hold water without accepting the “narrowly tailored client profile” point, because human biology is 1000x more “standardized” (bell curves) than the corporate structures, investor expectations, growth trajectories, legal obligations, and company values of tech companies.

Not the only way to work with us – This is simple. E/N Alpha is an option for startups looking to lock-in price certainty on a specific scope of work they are sure to need within their early years. But it is not the only way to work with us.

Fundamentally, what we want E/N Alpha to reflect is that E/N is a lean, flexible, high-end boutique law firm built from the ground up to address the many dysfunctions we’ve seen in the emerging tech / startup legal market. Entrepreneurs hire us because they know they need serious, specialized, trustworthy lawyers to address complex, high-stakes issues, and they need some way of affording that; particularly in the early days.

Everything else: tools, low-level professionals, and all the other ways a law firm can optimize itself should stay in the background. They aren’t, and shouldn’t be, the end-product.

 

Early Startup Employee Compensation

Background reading:

Given how deeply involved we are with early-stage startups hiring their first key employees, I figured it would be helpful to outline a few key principles to help entrepreneurs navigate the topic.

Make sure they are actually employees, and if they are, minimum wage.

States vary in how strict they enforce the line between contractors and employees. California is way harsher than elsewhere in the country.

In general, employees are under your control as to how they work and when they work. Contractors, on the other hand, are required to deliver a service/end-product, but have more control over how it gets done, and they usually are working less than full-time hours and have multiple ‘clients.’ Those are very rough guidelines, and you should work with lawyers to ensure you stay on the right side of your state’s (and federal) specific rules.

The employee v. contractor classification is very important, because contractors can be engaged for free from a cash perspective (equity only). Employees, however, need to be paid at least minimum wage, and may be entitled to benefits. The legal and tax requirements for engaging (and terminating) contractors v. employees are also very different.

Every startup lawyer knows stories of startups that treated someone as a contractor in order to keep costs low, then the relationship went south, and the person ended up filing complaints and getting the startup into hot water. On top of following the rules, your best protection is to be careful with whom you hire, and be respectful/thoughtful if you have to terminate them.

All else being equal, more equity means less cash, and visa versa.

Generally speaking, if someone is getting paid significantly less than what’s “market” for their position, they will expect to receive more equity in order to make up for the difference. Very early employees are generally working at below-market (often substantially below market) cash compensation, and therefore receive much larger portions of equity than someone hired post-Series A or Series B.

And the converse is true as well. If someone, for whatever reason, needs to make $X, even if it’s a serious stretch at the startup’s current budget, then their equity should be proportionately lower. And it should go without saying, all employee equity should have a vesting schedule. 

All of that being said, the early employees will of course expect their compensation to move closer to market as the startup raises funds and hits revenue milestones.

In the very early days, employees are often paid more than founders / senior executives.

The further you move away from the founder team, the greater the dilution of a person’s commitment to the “mission” of the startup; and that means more cash to keep them committed.  For that reason, at pre-seed and seed stage, it is not uncommon for *true* employee hires to actually be earning more, from a cash perspective, than the founder CEO; obviously with substantially lower equity ownership.

After a decent-sized seed round (and certainly Series A), it becomes a lot rarer for the CEO to not be the highest cash earner on the roster.

For more info on what founders are typically able to pay themselves at the various stages, see: Founder Compensation: Cash, Equity, Liquidity.

Don’t over-optimize for market data.

When you reach post-Series A or Series B, it can be helpful when hiring people to obtain hard data on what’s “market” for a certain position, and use that data in negotiations. There are some good services to help with that.

But at very early stages, everything is highly contextual. I’ve seen teams where everyone is making almost nothing. I’ve seen situations where the founder CEO is making nothing, and their lead developer is making six figures. I also see everything in-between. It all depends on the relationships and context. Maybe ask around if you need to, or do some AngelList Jobs perusing, but don’t put too much faith in the value of broad market data for your pre-seed or seed stage startup’s hiring needs.

Employment laws and taxes are not a place to move fast and break things.

Finally, as much as I appreciate keeping things lean, moving fast, and skirting the rules where the costs are low, realize that violating laws around employee compensation and hiring/firing can burn you, badly.

In some contexts, unpaid employee compensation is even recoverable against the Board or executives, outside of the Company. Did you catch that? Let me repeat it for you: failing to pay employees compensation you promise them, or taxes for that compensation, can in some contexts result in personal liability for you, even if the company itself files for bankruptcy.

Take. This. Sh**. Seriously. While I’ve seen more than my fair share of nuclear wars between founders – see: How Founders (Should) Break Up – the deep relationships among founders often allow for more leeway in terms of following/not following the letter of the law. Employees are usually different, and will hesitate significantly less to use every weapon against you if you cross them. Make sure you’re well-advised from the moment you bring on your first *true* hire.