How much equity should you give to compensate an advisor? Should the shares carry any special provisions like anti-dilution or change-of-control acceleration? What about giving the advisor cash compensation? Tough questions for a startup founding team that’s doing it for the first time and faced with an advisor they desperately want to bring on board.
Note: This article is the second in a three-part series. The first in the series is “Selecting an Advisor” and the third is “Maximizing Value from an Advisor“.
(Note: If you’re an aspiring advisor or board director wanting more information on compensation for the role, read this article instead: “Startup Advisor and Board Director Compensation“)
The short answer is there is no universally-agreed market rate for advisors. And if you want a superstar, you’ll need to pay whatever they demand or be forced to go with one of your other options. But I realize that doesn’t give any guidance so for purposes of this article let’s take superstar advisors out of the equation and just deal with “normal” scenarios.
The compensation you give an advisor should be tied to three factors: expertise, timeframe and activity level. Obviously, the greater the expertise, the longer the timeframe and/or the greater the activity level, the higher the compensation needs to be. Let’s break these down a bit more:
A serial founding entrepreneur with some huge exits under their belt and a Rolodex of contacts and investors to die for is going to command more than someone less experienced. Part of this is the law of supply and demand, as the most experienced and successful advisors are in high demand and not only can be more selective in the engagements they take but also can demand more in the way of compensation. The other factor is that someone that’s done it many times before (both running and advising companies) and has highly relevant contacts and expertise should demonstrably increase your odds of success. That’s worth something.
Side Note: The value you get from an advisor can generally be characterized as a combination of what they know (knowledge, experience, wisdom) and who they know (network). Both can be equally valuable but make sure to think about this and determine what you’re getting with a particular advisor.
A general-purpose advisory engagement is commonly 1-2 years. I say “general purpose” in contrast with a purpose-specific advisory engagement that might only be 3-6 months in length. An example of a purpose-specific advisory engagement would be helping the startup get through a near-term fundraising round or the initial product introduction (launch) into the marketplace.
Side Note: There’s often little downside from agreeing to a longer term than you think might be needed. That’s because the equity you grant will have a vesting schedule. If you sign them for a 2 year term and only end up needing them for 18 months, they’ll only end up with 75% of the total equity you granted (18/24 = 75%). But look yourself in the mirror first to determine if you’re capable of terminating a bad-ass advisor’s service with the company. I recommend having this honest discussion up-front (ie – “We’re thinking we will only need your services for 12-15 months but are happy to put a 2-year term in place in case we both want to continue our working relationship longer. I just need you to know that it’s very possible this engagement won’t run the full term.”)
On one extreme you might want an advisor to meet with you for 1-2 hours every week plus be available phone calls and emails in between. That would be a very active engagement. On the other extreme you might only need someone “on the bench” for periodic questions and more of a sounding board. It’s what I often refer to as “as needed, as available”.
Also know that most advisor engagements involve inconsistent waves of activity, even if there are scheduled, recurring interactions. Your business has ups and downs and you’ll find periods where you need your advisors to be more active and others where you don’t need them hardly at all. What you’re trying to anticipate is the average level of activity over longer periods of time. You might want to make sure your prospective advisor also knows this and doesn’t stick out their hand for more compensation during the periods of higher activity.
Side Note: Having an advisor that also serves in a fractional executive or part-time contractor mode is a different role than is described in this article. Such an operational role, even if part time, would be accompanied with even more equity or perhaps some cash compensation for that part of their contribution. The possible scenarios are infinite, and so are the compensation options.
What About Company Risk Profile?
The final adjustment relates to the company’s risk profile and that is often best evidenced by the company’s current phase of evolution. In other words, a startup that’s still in the early idea development phase is far more risky than one that has just launched their product and with some first paying customers. And that recently-launched startup is far more risky than one with $1M in ARR and $1M of cash in the bank.
Side Note: One way to think about the overall risk profile is to use commonly-used descriptions of funding phase because they usually map pretty closely. In other words, Bootstrap phase (no funding raised, no product, no revenue) versus Pre-Seed (F&F or small angel round raised, clunky MVP, pre-launch) versus Seed (product launched, early revenue) versus Series A.
Bringing It All Together
First, think about the first three factors described above (expertise, timeframe, activity) before even engaging in discussions with advisor prospects so that you can make it clear what you’re looking for. You might find that if you need an advisor for 2 years at a fairly active level (weekly meetings), some of your candidates will need to politely decline because they aren’t able to devote that much time and energy to the engagement. No problem, it is better to know that at the outset rather than after you’ve already signed them on with equity compensation.
Next, notice that the first three factors are about the Advisor whereas the fourth factor (risk profile) is about the Company. I know it’s basically a four-dimensional puzzle that you’re trying to solve but I’ll give some guidance shortly to serve as a starting point.
As for the type of compensation to give the advisor, clearly equity-only is the predominant method for early stage companies. For companies that have raised $1M or more, it’s possible that a combination of equity and cash is given. But even then it’s most common for advisors to only take equity for their compensation. Otherwise, they start to call themselves “consultants” that charge by the hour or day.
I know what you’re thinking: just give me the ranges of what is most commonly used for compensating advisors. Although I’ve said there’s no standard for advisor compensation, below are a couple of example scenarios that would not seem unusual to me for an experienced startup advisor that is advising a seed-stage startup (less than $1M funding to-date but with a product launched and very early revenue). Hopefully with this you can adjust up or down based on various the other key factors such as advisor experience level, engagement timeframe and activity level, and your own company’s maturity or desperation.
Short, Active, Purpose-Specific Engagement
- Compensation: 0.25% equity
- Timeframe: 4-6 months
- Activity Level: Half-day strategy/planning kickoff meeting. 1 in-person meeting per week (~1 hr). Multi-hour workshop once or twice during the engagement period plus intermittent questions via email or short phone call/videoconference.
Moderate, General-Purpose Engagement
- Compensation: 0.5% equity per year
- Activity Level: In-person meeting or lunch once per month (~1 hr) plus intermittent questions via email or short phone call/videoconference. Possibly one multi-hour workshop or planning session each year.
Relatively Intense, General-Purpose Engagement
- Compensation: 0.8% equity per year
- Activity Level: In-person meeting once per week (~1 hr) for the first 3 months, then usually less frequent after that (monthly or bi-monthly). Multi-hour planning/strategy sessions twice per year. Intermittent questions via email or short phone call/videoconference.
Adjustments over Time
As mentioned, the above scenarios are for a seed-stage startup. There are generally two factors that cause the equity amounts to reduce over time:
- Company Maturity – As a company’s financial results improve and its business model and management system matures, the odds of a successful outcome (ie – exit event) increase. With less risk comes less upside reward (ie – equity).
- Dilution Events – As a company raises equity-rounds of financing, previous shareholders get diluted. For example, someone that has 1.0% equity prior to a Series A will might end up with something like 0.75% after the Series A. As a result, after each equity round of funding you should be able to reduce the amount of equity you give to advisors by about that same ratio. It is also true that just raising funding makes the company less risky, which further justifies reduced equity.
What about the type of equity to grant and any special terms that should be offered? Most companies will simply grant stock options from the Common stock pool and with a monthly vesting schedule that corresponds to the term of the advisory agreement. Notice that I mentioned monthly vesting rather than the typical cliff vesting schedule that you probably have for your employees. Advisor equity is a essentially a form of compensation. If an advisor only worked 4 months of a 1 year advisory contract for cash compensation, you would have paid them each month. It should be the same with equity using monthly vesting.
Here are a few other special terms to consider granting to your advisor:
- Early Exercise – It is a nice benefit to give the advisor early exercise/purchase rights if the stock is still “cheap”. In the US, this allows the advisor to lock in the cost basis by filing an 83(b) election with the IRS. You don’t have to take any responsibility for filing the 83(b) election but make sure your advisor does it within 30 days (IRS requirement) and ask them to provide proof afterwards for your files. For more on that, see the 83(b) Filing Guidelines that I’ve published on my Resources page (scroll down to Legal Resources section).
- What if the advisory agreement is terminated half-way through the engagement and they have already purchased the shares? Typically, the company has the right to re-purchase the shares on a prorated basis throughout the term (in this example, half of the shares could be re-purchased).
- Exercise Window – Most US stock option plans force non-employees to exercise their stock options within a short window of service termination (30-90 days). Because of this, you should consider giving your advisor 5-10 years to make an exercise decision by writing this into the advisory agreement, board resolution and/or stock option grant document. Of course, if your advisor purchases the shares via an early exercise option, this is not an issue because they became an owner of the shares at the start of their service.
- Change of Control – The founders almost certainly have special vesting acceleration terms in the event of a change of control (ie – acquisition). In most cases, this provision should also be extended to your advisor.
- Anti-Dilution – Usually, advisors are not granted anti-dilution rights, which is a special provision you want to be very careful granting to anyone because of its downstream implications.
- Potential exception – If the primary purpose of bringing on your advisor is to help with fundraising, you could have a misalignment of motivations if you don’t grant some level of anti-dilution. For example, the right amount of money to raise might be $2M but if your advisor will be diluted via the fundraising activity, they might push you to raise less money to reduce their dilution. To better align interests between you and your advisor in this case, consider granting them anti-dilution rights for a certain period of time (enough to successfully complete the fundraising).
Disclaimer: I am not a licensed attorney and none of the legal mentions in this article should be considered professional legal advice. Instead, make sure to consult with your attorney to properly understand the concepts and suggestions described.
This is the second article of a three-part series. See the associated articles titled “Selecting an Advisor” and “Maximizing Value from Your Advisor“.