Startup Valuations Created By Government Investments Aren’t Real and Can Hurt Startups

A version of this post appeared in the Chilean newspaper El Mercurio on August 18th with the headline Inversión sin riesgo no es inversión.

The Chilean government, via CORFO, has tried to seed the Chilean startup ecosystem to get it to grow more quickly. There’s always room for improvement, but overall, they’ve done good work and the ecosystem has grown. The three main programs CORFO has to support startups are:

  • Startup Chile – $20m ($40-25k depending on exchange rates) equity free grants
  • SCALE – $60m (89k-120k) equity free follow on grants
  • SSAF – $20m, then $40m (89k-120 total) follow on either direct or via incubators for 7% option for up to three years

CORFO awards many SSAFs each year, most via incubators that use CORFO’s money to “invest” in startups. These startups pass a selection process, then get $10-20m upfront, and then if they make it through each incubator’s unique process, they can get the $40m follow on. The incubators put the startups through an acceleration process, which can either be helpful, neutral, or in some cases harmful to the startup, depending on the incubator’s skillset.

Each incubator has slightly different terms, but most are a total of $60m in exchange for a 7% option for up to three years. Some take a percentage of the startups sales in addition or to replace this equity. Others have buyback terms where the startup can buy the option back for a bit more than the original “investment.” Many of these options last for 2-3 years.

The incubators’ options bring up two questions I won’t address in this post:

  • Should incubators with little (or no) skin in the game get equity in startups they “invest in” or select?
  • Should these incubators get equity? And CORFO, and by extension the Chilean taxpayers whose money is being “invested”, get nothing?

And two issues that I will address:

  • Incubators give startups CLP$60m (between US$89k-120k, depending on exchange rate) for 7%, creating an implied post money valuation of CLP$857m (Between US$1.2-US$1.7m, depending on exchange rate).
  • Incubators’ options have 2-3 year terms and most don’t have private money triggers that force the incubator to convert to equity.


The valuation issue is simple: many entrepreneurs ask for private capital and say they have an US$3 valuation, justified by their “previous round at US$1.2-$1.7m” and the progress they’ve made since then. Some deserve it, as they have great teams, traction, growth and a large market. Others don’t, yet they insist that their new valuation is justified by the “valuation” they got from an incubator “investing” public money. Government funded valuations aren’t real. They’re one size fits all deals to help support the local ecosystem. We review each startup on its merits and don’t take into account government funded valuations. Founders shouldn’t either.


So what’s the issue if incubators have a 2-3 year option? We’ve seen many deals where incubators hold these options and it adversely affects startups’ ability to access private follow on capital. I’ll give an example of a startup that went through a CORFO incubator where the incubator both converts at the same time as private capital enters, and where it doesn’t.

Here’s what the cap table looks like when the founders start the company, leave 10% of the business for employee stock options and then get into an incubator:

founders corfo incubator

Now, the company receives private investment. In the first table, the incubator converts to equity when private capital enters. This is the way it should be. One could argue that the incubator’s slot should have been diluted, as they invested previously, but I’ll leave that for another post.

private investment 1

In the next two charts, here’s what happens if the incubator doesn’t convert when private capital comes in, but then coverts at the end of their option:

private capital 2

There are two main differences if the incubator converts at the end of their option:

As you can see, if the incubator exercises their option after the private investor invests, they dilute the private investor who invested a few months earlier. Exercising the option later isn’t fair to the private investor.

At Magma, we mitigate this issue by first asking the incubators to exercise their option at the same time as we invest. Some incubators haven’t had a problem with this, but others have forced us to fix this issue by either asking entrepreneurs to take the extra dilution when the incubator exercises its option, or by investing at a lower valuation so that when we’re diluted by the incubator, we end up with the same equity percentage that we would have had otherwise.

test 2

We believe this change isn’t fair to founders and initial employees. Founders and incubators can solve this issue by converting when we invest. Note: Chilean incubators aren’t the worst, there are others in Latin America that are worse…We evaluated a deal where another Latin American accelerator had a perpetual option for 10% equity!

Photo credit: punchup


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