Accelerator

How an accelerator works

The SBA Office of Advocacy, in research building on work by Cohen and Hochberg, defines accelerators as business entities that make seed-stage investments in promising companies in exchange for equity as part of a fixed-term, cohort-based program, including mentorship and educational components, that culminates in a public pitch event or demo day. The United States Economic Development Administration's glossary is shorter, describing an accelerator as a program that works with entrepreneurs and start-up companies for a short and defined timeframe to help them reach the next phase in their growth. Four elements do the work in the fuller definition: an investment, equity, a fixed term with a cohort, and a demo day.

The transaction is straightforward. The accelerator invests a defined amount on standard terms offered to every company in the batch, with no negotiation, and receives equity or a convertible instrument that becomes equity. The terms are the same for everyone because the model depends on volume and on not spending partner time on documentation.

Y Combinator publishes its deal, which makes it the clearest worked reference. YC invests 500,000 dollars in two separate instruments: 125,000 dollars on a post-money SAFE for 7 percent of the company, and 375,000 dollars on an uncapped SAFE carrying a most favored nation provision. YC states that it charges no fees and that the investment is not contingent on hitting milestones, and it takes pro rata rights in future rounds.

The two instruments behave very differently, and understanding why is the whole point of reading the deal.

Post-money SAFE ownership = purchase amount ÷ post-money valuation cap

The 125,000 dollar tranche is priced. A post-money SAFE fixes the holder's percentage at signing, which is what lets YC state 7 percent as a number rather than a range. Post-money here means after all other SAFEs and convertible instruments convert, so subsequent SAFE issuances dilute the founders rather than the existing SAFE holders.

MFN SAFE ownership = investment amount ÷ the valuation cap of the instrument whose terms it takes

The 375,000 dollar tranche has no cap when issued. A most favored nation provision gives the holder the benefit of the best terms the company offers later. YC states that its MFN SAFE converts in the priced round on the terms of the lowest cap SAFE, or other most favorable terms such as a discount, issued between an MFN start date around the start of the batch and the priced round, so its price is set by the most favourable convertible the company sells in that window rather than simply by the next one. YC's own illustration: with a 15 million dollar valuation cap, the 375,000 dollar MFN SAFE converts into 375,000 divided by 15,000,000, or 2.5 percent of the company.

The consequence is that the total dilution from the standard deal is not fixed at 7 percent. It is 7 percent plus whatever the MFN tranche converts into, and the better the terms of the company's next raise, the smaller that second number is.

Beyond the capital, the assets an accelerator actually provides are a deadline, a peer cohort, a mentor network, batch-standard documents, and a concentrated moment of investor attention at demo day. The SBA Office of Advocacy's research counts a competitive selection process, a cohort of companies, and a short fixed term among the seven factors that distinguish accelerators from incubators, rather than the capital, which is generally too small to change a company's trajectory on its own.

Worked example

Suppose a company completes a standard accelerator program and then raises. All figures are hypothetical and the deal structure follows the published Y Combinator terms.

At entry: 10,000,000 shares outstanding held by two founders.

Step one, the priced tranche. The accelerator invests 125,000 dollars on a post-money SAFE for 7 percent. Because it is post-money, that 7 percent is locked in as a percentage of the company measured after all convertibles convert.

Step two, the MFN tranche. The accelerator also invests 375,000 dollars on an uncapped SAFE with an MFN provision. No percentage is fixed yet.

Step three, a later SAFE. Four months after the batch, an angel invests 750,000 dollars on a post-money SAFE with a 20,000,000 dollar cap, and it is the lowest cap the company issues before the priced round, so the MFN tranche takes those terms. Its percentage becomes 375,000 divided by 20,000,000, or 1.875 percent. The angel's is 750,000 divided by 20,000,000, or 3.75 percent.

Step four, total the convertible stack before the round. 7 percent plus 1.875 percent plus 3.75 percent equals 12.625 percent of the post-conversion company, against 1,250,000 dollars raised.

Step five, the priced round. The company raises a 4,000,000 dollar seed at a 24,000,000 dollar pre-money valuation, and the investors require a 10 percent unallocated option pool in the pre-money. All the SAFEs convert at the round.

Step six, where the dilution lands. The founders absorb the SAFE conversions in full. The accelerator's 7 percent was protected against the two later SAFEs by the post-money structure; the founders were not. The option pool and the new money are different: YC states that the priced round itself and the creation or increase of the option pool dilute its ownership too, which is why it takes a pro rata right. A team that assumed the accelerator deal cost 7 percent found it cost 8.875 percent going into the round, and that the two subsequent SAFEs diluted only them.

Step seven, compare to the alternative. The same 500,000 dollars raised from angels at a 12,000,000 dollar post-money cap would have cost about 4.2 percent. The 4.7 point difference is what the program is being paid for the deadline, the cohort, the network, and the demo day.

Where it shows up

The SAFE is the instrument in most programs. Y Combinator publishes the post-money SAFE documents and a user guide, and the relevant sections are the definition of the post-money valuation cap, the conversion mechanics at an equity financing, the liquidity event provisions covering a sale or IPO, the dissolution provisions, and, in the MFN version, the provision letting the holder elect the terms of a subsequently issued convertible instrument.

The side letter carries what the SAFE does not: pro rata rights in future rounds, information rights, and most favored nation terms where they are not in the instrument itself.

The program participation agreement covers the non-financial side: the term, the obligations of the founders to attend, confidentiality, and the conditions for participating in demo day.

The cap table and any pro forma conversion analysis are where the effect becomes visible. Because post-money SAFEs stack, a company should maintain a conversion model showing the fully diluted outcome at any assumed round price before signing the next instrument, not after.

The next round's stock purchase agreement and charter are where the SAFEs actually convert. Shares are issued to the accelerator at closing, and the accelerator becomes a holder of preferred stock with whatever rights the round carries.

Common mistakes

• Reading a published headline percentage as total dilution. Where a program invests in two tranches, only the priced tranche has a fixed percentage; the second is set later.
• Missing how post-money SAFEs allocate dilution. A post-money SAFE holder's percentage is protected against later convertible issuances. The founders absorb them.
• Stacking SAFEs without modeling the total. Four small SAFEs at generous caps can add to a larger number than a single priced round would have cost.
• Treating the option pool as neutral. A pool created in the pre-money dilutes founders and SAFE holders differently depending on the drafting, and it is negotiated, not fixed.
• Joining for the money. The capital is small relative to a seed round. The deadline, the cohort, and the demo day are the product.
• Assuming demo day produces a round. It produces meetings. Companies that raise well at demo day generally had traction before it.
• Comparing programs on equity percentage alone, without asking whether the alumni network is active and whether investors who lead rounds actually attend.

Related terms

An accelerator is the cohort-based, equity-taking sibling of an incubator, and both sit ahead of a pre-seed or seed round. The standard instrument is a SAFE, the standard side letter grants pro rata rights, and the effect of the whole arrangement is measured as dilution on the cap table.

Frequently asked questions

What is a startup accelerator?

A fixed-term, cohort-based program that invests a standard amount in each company for equity, provides mentorship and structured education, and ends in a demo day. The SBA Office of Advocacy defines accelerators in exactly those terms. The EDA's glossary describes accelerators and incubators alike as often sponsored by a university or nonprofit organization, so the distinction rests on the fixed term, the cohort, the equity, and the demo day rather than on who sponsors the program.

How much equity do accelerators take?

It varies by program and is set by the terms each one publishes. Y Combinator's published deal is 125,000 dollars on a post-money SAFE for 7 percent, plus 375,000 dollars on an uncapped SAFE with a most favored nation provision, whose percentage is determined later by the most favourable convertible instrument the company issues before its priced round. Total dilution from that structure is therefore 7 percent plus a second, variable amount.

How does the Y Combinator deal work?

YC invests 500,000 dollars in two instruments. The first, 125,000 dollars on a post-money SAFE, buys a fixed 7 percent. The second, 375,000 dollars on an uncapped MFN SAFE, converts on the terms of the lowest cap SAFE the company issues between an MFN start date around the start of the batch and its priced round; YC's own example shows it converting at a 15 million dollar cap into 2.5 percent. YC states it charges no fees, does not condition the investment on milestones, and takes pro rata rights.

What is the difference between an accelerator and an incubator?

An accelerator runs a defined cohort for a defined period, invests for equity, and holds a demo day. An incubator supports companies at an earlier, often pre-product stage, on no fixed schedule, and frequently without taking equity, typically under a university, nonprofit, or economic development sponsor.

Is an accelerator worth the equity?

The capital is rarely the reason. What is being bought is a deadline, a peer group at the same stage, a mentor network, standard documents, and a moment of concentrated investor attention. The test is whether the specific program's alumni are active with each other and whether investors who actually lead rounds show up to demo day. Those conditions vary enormously across programs offering similar terms.

What happens after demo day?

The company has a set of investor meetings and, typically, a window of weeks in which the batch is being looked at together. Raising still requires the usual process of diligence, terms, and documentation, and the round is priced on the company's traction rather than on the program's brand. The SAFEs issued during the program convert when that priced round closes.