UK startup accelerators take matched service charges on top of invested capital?
9 comments
I think this is really bad.
Specifically because of the way that it burns the SEIS allowance.
I would be tempted to call HMRC and explain what the accelerator are doing, that they are using the investment incentive as a service charge for themselves, and to ask them to clarify whether or not this is allowed and the degree to which it creates an issue for your company.
Specifically because of the way that it burns the SEIS allowance.
I would be tempted to call HMRC and explain what the accelerator are doing, that they are using the investment incentive as a service charge for themselves, and to ask them to clarify whether or not this is allowed and the degree to which it creates an issue for your company.
You might want to let HMRC know about this.
https://www.gov.uk/report-an-unregistered-trader-or-business
That page is aimed much more at the "cash in hand" trader, but they'll take reports on anything.
You don't have to know that it's tax evasion to make a report.
https://www.gov.uk/report-an-unregistered-trader-or-business
That page is aimed much more at the "cash in hand" trader, but they'll take reports on anything.
You don't have to know that it's tax evasion to make a report.
This is commonplace. You may also find that you have to register for VAT and claim that back on the service charge to get the full amount you're expecting. It's pretty much a standard part of the Jon Bradford mentor-led accelerator startup kit, which has spread pretty far at this point.
Only you know if it's a deal you can stomach.
Only you know if it's a deal you can stomach.
The only reason someone would take away potential runway from a startup that they are investing in is that they are running a lifestyle business rather than managing a portfolio of startups. One hit pays for all the overhead and then some. The experienced experts in startups play long not short.
Yes, I took part in a UK incubator programme. It was only seed stage investment but even still, a portion of the funding was taken by the operators for office space, mentors etc.
YC does not do this.
Congratulations. Today you figured out that startup accelerators, incubators, hubs, conferences and hackathons are just businesses trying to make money out of your enthusiasm and efforts. They don't do it out of the goodness of their hearts. They do it to turn a profit.
To answer your question, some of them take equity and others take cash. Either way, you're getting screwed. Unless, of course, you just keep finding investors to pour money into it. If that's your objective, the price is usually worth it.
To answer your question, some of them take equity and others take cash. Either way, you're getting screwed. Unless, of course, you just keep finding investors to pour money into it. If that's your objective, the price is usually worth it.
I started 2 companies through YC and Techstars and strongly disagree with this. Both were incredibly valuable and well worth the equity for us.
Edit: I didn't mean to say that all accelerators are worth it, but I disagree with the sweeping generalization that all accelerators are screwing their companies.
Edit: I didn't mean to say that all accelerators are worth it, but I disagree with the sweeping generalization that all accelerators are screwing their companies.
Looks like you're based in the US. In the UK making sure you don't fritter away SEIS money is enormously important. Effectively you have an £150k allocation up to which investors can claim 50% relief in the form of income tax deductions (plus many other great things).
Whatever reason the accelerator is doing it for (whether good or bad for them) is bad for the company if it's losing some of it's allocation without seeing the money. A lot of early stage investors won't touch a non-SEIS deal.
Edit: Also for every YC/Techstars/500 there's a 100 "incubators" that overcharge and underdeliver.
Whatever reason the accelerator is doing it for (whether good or bad for them) is bad for the company if it's losing some of it's allocation without seeing the money. A lot of early stage investors won't touch a non-SEIS deal.
Edit: Also for every YC/Techstars/500 there's a 100 "incubators" that overcharge and underdeliver.
Don't do that. It's spreading the myth that these lower-tier accelerators are trying to do things the same way as the top-tier accelerators.
That is extremely not the case, too often. Many times it's the equivalent of used car salesman / real estate broker type sales people - who are good at selling themselves to people with money and love to squeeze the most out of negotiations just for fun, with no clue or regard for the tech startups. Wish I was exaggerating.
That is extremely not the case, too often. Many times it's the equivalent of used car salesman / real estate broker type sales people - who are good at selling themselves to people with money and love to squeeze the most out of negotiations just for fun, with no clue or regard for the tech startups. Wish I was exaggerating.
could you talk about your experiences with each and how different or similar they are?
500 Startups does this too. From their website:
"We invest $100k in exchange for 7%, and charge a $25K program fee for a net $75K investment."
Not quite sure why some accelerators do this.
"We invest $100k in exchange for 7%, and charge a $25K program fee for a net $75K investment."
Not quite sure why some accelerators do this.
My understanding is that it is largely an accounting optimization.
Their explanation: http://www.quora.com/What-is-500-Startups-business-model
Important to understand: they've got one brand but two entities, the investment fund and the accelerator. The accelerator is designed to take in $X per year in revenue and pay out $X in expenses, for a net profit of zero or slightly negative. (Having more than slightly negative is tax inefficient. You get to book the implicit tax value of the loss as a carryforward asset but you would have no way to ultimately realize it since the accelerator is designed in this model to never actually make significant amounts of money.)
"But isn't it equivalent if you just give them $75k." No, not equivalent. This manages to teleport revenue through time from the eventual carry into the present, pays for present cash expenses, and gives that revenue favorable tax treatment.
How exactly it's favorable tax treatment is a great question for a tax lawyer. Here's my layman's understanding: you can deduct expenses from capital gains prior to taxing them but they have to have a certain level of connection with the gains, and it is possible that "general administrative expenses of our operation" don't have that level of connection. Shuffling those expenses into the accelerator makes them clearly deductible against the accelerator's ordinary income, since the accelerator looks like any money-comes-in-money-goes-out IT business. The program fee is clearly revenue. Their rent is clearly an expense. If revenues equal expenses than their revenues are taxed at, effectively, 0%.
"Tax optimization on $25k doesn't make sense" would be a sensible objection until you remember that 500 Startups operates at industrial scale and that this is suddenly $3 million in revenue a year.
n.b. 500 Startups would, eventually, pay whatever the normal capital gains taxes are on the carry (and/or ordinary income tax if the law is ever changed to make it less favorable), in accordance with the standard treatment of investments under US tax law. It's not an avoidance strategy, it is a temporal optimization strategy.
Edit to add: Above explanation is purely "My best understanding of the matter as someone who had no hand in putting this together." based on my inexpert understanding of standard US principles of taxation and their public statements about it.
Their explanation: http://www.quora.com/What-is-500-Startups-business-model
Important to understand: they've got one brand but two entities, the investment fund and the accelerator. The accelerator is designed to take in $X per year in revenue and pay out $X in expenses, for a net profit of zero or slightly negative. (Having more than slightly negative is tax inefficient. You get to book the implicit tax value of the loss as a carryforward asset but you would have no way to ultimately realize it since the accelerator is designed in this model to never actually make significant amounts of money.)
"But isn't it equivalent if you just give them $75k." No, not equivalent. This manages to teleport revenue through time from the eventual carry into the present, pays for present cash expenses, and gives that revenue favorable tax treatment.
How exactly it's favorable tax treatment is a great question for a tax lawyer. Here's my layman's understanding: you can deduct expenses from capital gains prior to taxing them but they have to have a certain level of connection with the gains, and it is possible that "general administrative expenses of our operation" don't have that level of connection. Shuffling those expenses into the accelerator makes them clearly deductible against the accelerator's ordinary income, since the accelerator looks like any money-comes-in-money-goes-out IT business. The program fee is clearly revenue. Their rent is clearly an expense. If revenues equal expenses than their revenues are taxed at, effectively, 0%.
"Tax optimization on $25k doesn't make sense" would be a sensible objection until you remember that 500 Startups operates at industrial scale and that this is suddenly $3 million in revenue a year.
n.b. 500 Startups would, eventually, pay whatever the normal capital gains taxes are on the carry (and/or ordinary income tax if the law is ever changed to make it less favorable), in accordance with the standard treatment of investments under US tax law. It's not an avoidance strategy, it is a temporal optimization strategy.
Edit to add: Above explanation is purely "My best understanding of the matter as someone who had no hand in putting this together." based on my inexpert understanding of standard US principles of taxation and their public statements about it.
There is an added item at play here: the equity stake and future pro-rate amounts are based on invested capital, so for $75k you can get 100k (or more) in pro-rata.
(The more comes from the fact that a lot of times this is convertible note with a discount, and the discount also provides a bump in pro-rata rights. See http://www.bothsidesofthetable.com/2014/10/12/the-authoritat...)
So this isnt just tax optimization, but investment/equity optimization as well. That said, smart founders should probably value their involvement in the accelerator as an valuation multiplier: if it isnt, they shouldnt join one.
(The more comes from the fact that a lot of times this is convertible note with a discount, and the discount also provides a bump in pro-rata rights. See http://www.bothsidesofthetable.com/2014/10/12/the-authoritat...)
So this isnt just tax optimization, but investment/equity optimization as well. That said, smart founders should probably value their involvement in the accelerator as an valuation multiplier: if it isnt, they shouldnt join one.
The incubator could avoid profitability equally well by not charging startups at all. So capital structure and tax incentives are irrelevant in that sense, leaving the question of why startups are being charged more than 8000 USD EACH MONTH in fees and whether they are getting a good deal.
I personally consider it deceptive for any incubator to ask a participant to pay for things the incubator positions as free support (i.e. use of "our" office space). And it is perfectly valid to call out any business as predatory when its behavior seems purposefully structured to confuse customers about how much they are paying and what they get for it.
I personally consider it deceptive for any incubator to ask a participant to pay for things the incubator positions as free support (i.e. use of "our" office space). And it is perfectly valid to call out any business as predatory when its behavior seems purposefully structured to confuse customers about how much they are paying and what they get for it.
If you invest $100k in exchange for $25k services purchased, you now have $25k revenue. If your business is valued at a price/sales ratio of 20, your business is now worth $500k.
> If your business is valued at a price/sales ratio of 20
How is that multiple even close to right? Everyone I've ever talked to says 5-10 is more realistic, and the push-back you get grows exponentially as you approach 10.
How is that multiple even close to right? Everyone I've ever talked to says 5-10 is more realistic, and the push-back you get grows exponentially as you approach 10.
It depends on what kind of bubble you're in, and how negligent your investors are regarding due diligence. Obviously, if you invest $100k in a business in exchange for $25k services rendered, that isn't $25k of "real" revenue.
During the 1999 .com bubble, Yahoo (iirc) and some other companies invested in startups, in exchange for an agreement to purchase their services. That let the corporation pad its revenue, inflate its earnings, and with an already-high P/E ratio, gullible investors bought.
During the 1999 .com bubble, Yahoo (iirc) and some other companies invested in startups, in exchange for an agreement to purchase their services. That let the corporation pad its revenue, inflate its earnings, and with an already-high P/E ratio, gullible investors bought.
Commonplace, but what's the amount? Often they ask you to set aside 5% to 25% for them.
The one we went through got most of their fees via "highly recommended" legal and accounting service kickbacks, which charged far higher than market rate monthly retainers, for doing absolutely nothing in some cases. Lawyers and accountants who stood to benefit were literally partners at the fund... We decided to stick with our own accountant, and the accelerator got extremely upset at us for doing so. Some shockingly unprofessional, threatening, vague emails and lots of criticism for not choosing their accountants.
You are correct that the people running these funds will get paid no matter what, and will have absolutely no financial incentive to make you succeed. Quite the opposite. Ours in particular has done a lot to minimize their work, drag out anything they're required to do over months, and get rid of companies as quick as possible after their investment.
These can still work out, just know that these aren't the tier #1 funds that we're used to hearing about. Founder beware.
The one we went through got most of their fees via "highly recommended" legal and accounting service kickbacks, which charged far higher than market rate monthly retainers, for doing absolutely nothing in some cases. Lawyers and accountants who stood to benefit were literally partners at the fund... We decided to stick with our own accountant, and the accelerator got extremely upset at us for doing so. Some shockingly unprofessional, threatening, vague emails and lots of criticism for not choosing their accountants.
You are correct that the people running these funds will get paid no matter what, and will have absolutely no financial incentive to make you succeed. Quite the opposite. Ours in particular has done a lot to minimize their work, drag out anything they're required to do over months, and get rid of companies as quick as possible after their investment.
These can still work out, just know that these aren't the tier #1 funds that we're used to hearing about. Founder beware.
This particular one was £50k investment for 9% equity, plus they send an additional £50k to the company, which is transferred immediately as a "service charge".
Writes off £50k of your SEIS allowance as a business, which as I'm sure you know is like gold dust for the first £150k, as 50% of the investment can be written off against investors income tax, then a further 30% if the company fails.
If the company succeeds, the investors pay no capital gains on sale of shares.
Writes off £50k of your SEIS allowance as a business, which as I'm sure you know is like gold dust for the first £150k, as 50% of the investment can be written off against investors income tax, then a further 30% if the company fails.
If the company succeeds, the investors pay no capital gains on sale of shares.
To further add to this, it's not necessarily the fact that they take a service charge that I take issue with. It's the complete lack of transparency up-front and only once you're close to getting on the program that it's ever disclosed.
Founder of http://Accelerat.io here. This is exactly why we started our project, we hear a lot of these stories of second and third tier accelerators doing these kinds of shenanigans.
Would love to put up the accelerator you're talking about with clear information so future entrepreneurs applying can know about this upfront.
If you contact me at hello at accelerat.io I'll set it up for you. Rest assured, it will all be 100% anonymous.
Would love to put up the accelerator you're talking about with clear information so future entrepreneurs applying can know about this upfront.
If you contact me at hello at accelerat.io I'll set it up for you. Rest assured, it will all be 100% anonymous.
The transparency for accelerators is terrible now. Every founder presumes that the new accelerators are at least trying to follow the template of the best accelerators. Surprisingly often that's not the case whatsoever, down to the smallest meaningless details.
A good start might be submitting those details to (http://accelerat.io/). They seem to be tracking this.
A good start might be submitting those details to (http://accelerat.io/). They seem to be tracking this.
In the process of negotiating terms, it was slipped into conversation that the accelerator actually invests double the amount requested into the business (artificially inflating the business valuation and potentially creating some pretty big burnrate questions for future investors), which is paid directly to the accelerator on receipt of funds as a service charge.
This service charge is apparently there to facilitate the other "free" mentorship, office space and introductions that the accelerator offers.
It seems like this is a bit of a tax fiddle from an SEIS (Seed Enterprise Investment Fund) perspective, as all they are doing is draining the fund to essentially pay themselves, exposing very little risk, but obtaining a decent equity share in a new start up business. This also eats into the £150k of available SEIS funding, as a chunk of it is not invested at all, just leaving through the backdoor to pay the accelerator.
Is this commonplace and is anyone aware of other accelerators doing the same thing?