This week Ryan Roberts, of StartUp Lawyer, explains his belief that accelerator investments should be structured as convertible equity. In a blog published here, Ryan first looks back to an article he wrote about accelerator documents and the need for such documents to be uncomplicated in order to not scare away the best startups. Just like the documents used by accelerators have needed to change, there is also a need to refocus the investment documents used by accelerators, including turning such investments into convertible equity.
There are two main issues Ryan highlights that create difficulty when it comes to accelerator investments. First, tax-related issues, and second, issues due to their investment being common stock. This was working well, and then things got messy when later-stage startups starting seeking out accelerators, and there was a much bigger, and complicated, cap table. This has left accelerators essentially playing the role of the venture capitalist, and many problems can be created, such as current investors being entirely unaware that the startup was looking to join an accelerator.
Convertible equity is a potential solution to the complicated and convoluted process for later-stage startups that may already have investors and obligations to them. An investor holding stock may be less turned off by the startups’ move to join an accelerator when convertible equity is involved because the accelerator does not become a stockholder in return. Ryan writes that the startup can “tell your investors, in all honesty, that the accelerator will not get shares until and as part of the next financing.”
Lighter Capital offers an easy to understand definition of convertible equity; a security that allows startups to obtain financing but which does not need to be repaid and does not accrue interest. Convertible equity is not debt, so this puts the accelerator putting money into the startup in a more favorable position above other investors upon liquidation or dissolution. A better solution to convertible notes, convertible equity makes sense, not just because it is a lot easier, but because it solves a lot of potential problems in a better way than other structures can.