Accelerator and Fund Structure

[md]

Hi,

Anyone have good advice around recommended entity structuring for both a startup accelerator and an attached seed fund?

How have people setup these in the past and how would do it if they were doing it again (i.e. any big lessons)?

Which entities do funds flow in and out of and how (service contract of programme fee or something else), esp. if you've taken government funding, and also who employs who?

Did you give founding investors ownership in the accelerator entity itself or just into the fund - if ownership, how did you work that out regarding percentage ownership and control?

Thanks!

[Hugh Mason]

On 6 November 2014 06:59, md <dan....@gmail.com> wrote:

Anyone have good advice around recommended entity structuring for both a startup accelerator and an attached seed fund?

Like JFDI,Techstars and a lot of accelerators around the world are structured as two interlinked entities:

1. an operating business that employs accelerator staff, resources, holds a lease on any physical space required etc.

2. The operating business also owns a holding company that exists solely to own equity in the accelerated startups. Investors in the accelerator 'fund' deposit cash in the holding company, which then invests some of it in the startups and pays some as a 'management fee' to the operating business.

So the latter would be what I think you are referring to as the 'seed fund'

If you intend to do batches of startups it is arguably best to set up something like this structure as that way you can have a different holding company for each batch, meaning you have startups at a similar stage of development grouped together. Otherwise if you do batch 1 in year 1 and then in year 2 try to bring fresh investment into the same holding company you have to have a tedious discussion about valuation of last year's batch versus the new money coming in plus the investors who stuck their necks out a year ago will say ... the new guys coming in have much less risk than us because they can see what's happened to the companies over the last 12 months whereas we had to take all the risk up front, etc.

Hence many accelerators end up with one operating business and several holding companies. JFDI currently has one operating business (JFDI.Asia Pte Ltd) and three holding companies corresponding to each of the three years of accelerator operation we have done (JFDI.2012 Pte Ltd, JFDI.2013 Pte Ltd and JFDI.2014 Pte Ltd).

How have people setup these in the past and how would do it if they were doing it again (i.e. any big lessons)?

There are several positives of structuring an accelerator as I have described above, including that it feels relatively familiar to anyone who is used to looking at funds which normally have a General Partner (GP) / Limited Partner (LP) structure. The operating company is akin to a GP and the holding company akin to the Limited Liability partnership that LP's would typically stick their cash into in a fund.

However, the negatives of this structure include the fact that investors meeting an accelerator for the first time can be put off by what looks like a typical 50-60% 'management fee' (compared with the 2-4% that would be typical in a purely financial fund). In fact that's the wrong way to look at it because the value added to investees by an accelerator is the mentoring and community, not the cash, as David Cohen explains.

But that's not the only way of doing it. 500 Startups is set up differently and recovers its costs from the startups it invests into, which makes it look like more money is going into the startup. Dave McClure is totally open about this and other details of his business model.

 

Which entities do funds flow in and out of and how (service contract of programme fee or something else), esp. if you've taken government funding, and also who employs who?

In the structure I have described, if you are taking cash from anyone other than an investor, the revenue / grant / sponsorship would be billed by the operating company.

Did you give founding investors ownership in the accelerator entity itself or just into the fund - if ownership, how did you work that out regarding percentage ownership and control?

As you talk with investors you may choose to put one or two propositions or both to them:

a) invest in my accelerator business (the operating company)

b) invest in my slate of startups (the holding company)

In JFDI's case, Meng and I own the operating company equally between us at present (though we are setting up an ESOP to share ownership with the awesome team who have helped to build value alongside us). There are presently no external investors in the operating company, so Meng and I control it between us.

The equity in each holding company is divided into two classes:

• All the ordinary voting shares are owned by the operating company.
  
• A class of preference shares are owned by investors and split pro rata, ie in proportion to the relative size of each investor's stake. Those preference shares do not carry voting rights.
  

To distribute cash to the investors, the following events happen:

1 The investors get their money back, with interest, in first position.

2 The preference shares are converted to ordinary shares in such a way that they represent 75% of the equity in the holding company. Then whatever cash is left after step 1 gets divvied up amongst the shareholders (ie 25% to the operating company and 75% to the shareholders).

There is nothing to stop someone who is a shareholder in the operating company also owning preferences shares in the holding company. They just get treated the same way as every other shareholder in their class in each situation.

Hope that helps

Cheers

Hugh

[Dan Khan]

Hugh, thanks so much for the depth of this reply.

Few follow-ups:

My understanding up to this point has been much more traditional VC style fund jargon up to this point, so please bear with me :)

In your scenario for the holding co:

* Is the operating co always 25%/75% ownership regardless the amount of investment you raise per cohort? (Guess this is effectively the 2:20ish model of traditional sole fund structure?)

* At which point do you distribute cash to 'LPs' (or your version as holding co shareholders) - as it comes or is there some defined 'lifetime' at which point you dissolve the holding co and cash out?  Does the holding co have a 'hurdle rate' to cover expenses (e.g. legal, acct), or does the operating company cover/account for this as a parent or as part of the management fee?

* I assume all proceeds from holding co come back to operating co when there is a distribution (well 25% of minus original investment amounts) - how do you distribute this back to the management team of the operating co when there's a successful exit - as a dividend on their operating co shares? Or some other mechanism? Or are your mgmt team incentivised with shares in the holding co as well?

* What does governance look like for both operating and holding co - same or different, or just at operating level?

Thanks for being open.

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[Hugh Mason]

On 6 November 2014 09:04, Dan Khan <dan....@gmail.com> wrote:

* Is the operating co always 25%/75% ownership regardless the amount of investment you raise per cohort? (Guess this is effectively the 2:20ish model of traditional sole fund structure?)

Yes

 

* At which point do you distribute cash to 'LPs' (or your version as holding co shareholders) - as it comes or is there some defined 'lifetime' at which point you dissolve the holding co and cash out?

Our agreement makes provision for a couple of different scenarios but there is a lot of discretion for the Directors to act as they see being in the Shareholders best interests.

 

Does the holding co have a 'hurdle rate' to cover expenses (e.g. legal, acct), or does the operating company cover/account for this as a parent or as part of the management fee?

My understanding is that the phrase 'hurdle rate' conventionally has a different specific meaning that is probably not connected to your underlying question.

Our holding companies pay their own audit and legal fees direct.

* I assume all proceeds from holding co come back to operating co when there is a distribution (well 25% of minus original investment amounts)

Yes

 

how do you distribute this back to the management team of the operating co when there's a successful exit - as a dividend on their operating co shares? Or some other mechanism?

Value realized by the holding company simply becomes income to the operating company. The operating company can spend it, issue a dividend or whatever its board decides to do with the money.

 

Or are your mgmt team incentivised with shares in the holding co as well?

Only if they invest cash to buy shares in the holding company.

 

* What does governance look like for both operating and holding co - same or different, or just at operating level?

Can you be more specific?

[Dan Khan]

Thanks Hugh, some great answers here. 

Re: governance - I mean how is the board constructed on both entities (if on both) does each entity share the same board or do have separate board members representing diff interests on each entity?

Thanks. 

—
Dan Khan

Mobile: +64 21 203 4298
Skype: dankhan
LinkedIn: LinkedIn.com/in/dankhan
Twitter: @leancto

Sent on the run

[Hugh Mason]

On 6 November 2014 11:36, Dan Khan <dan....@gmail.com> wrote:

Re: governance - I mean how is the board constructed on both entities (if on both) does each entity share the same board or do have separate board members representing diff interests on each entity?

Meng and I are Directors of the operating company and all the holding companies.

In the case of one of the holding companies a key shareholder also has the right to appoint a Director.