Startup Advisor & Board Compensation Guidelines

startup advisor compensation

You’ve been working with a startup founder or perhaps a co-founding team and they pop the question: “Would you be interested in joining our advisory board?”  You were secretly hoping they would do just that but now you’re realizing you haven’t done this before and don’t know what sort of compensation is fair for both parties.  You also don’t know if there are any gotchas to look out for or special considerations to request.  You came to the right place because this article will step you through most of what you need to know for advisory board or board director compensation.

Disclaimer:  I am neither a licensed attorney nor a certified tax accountant.  The information and recommendations contained within this article are from a layman’s perspective, but one that has served on more than a dozen startup advisory boards and five board of director assignments – at least as of the time of this writing.

Assessing the Fit

Before we get into the compensation aspects of your advisory gig, I strongly recommend you make sure the engagement is a good fit along multiple dimensions:

  • Do you truly feel like you can deliver value, based on the needs expressed by the company?
  • Are you genuinely excited about what they’re working on and the potential they have?
  • Do you have enough available time in relation to what is expected for the engagement?
  • Do you get a sense that you’ll be able to work with the founders from a personality match and style perspective?
  • Do the founders have ethics that match your standards and are they running a generally clean business?

Before I agree to take on a board director or advisory role, I always spend enough time with the founders to make sure I can answer all of the above in the affirmative.  Unwinding a formal relationship after it’s papered up and compensation starts flowing is stressful for both parties.  I recommend that you measure twice and cut once.

Side Note 1:  I wrote an article titled “Selecting an Advisor“.  I wrote it for startup founders, but it might give you some helpful insights into what’s going on in the minds sitting across the table from you.

Side Note 2: Regarding my mention of running a “clean” business, cutting some corners is a normal practice for a fast-moving startup.  But drifting too far from “clean” causes the accumulation of what I refer to as “by-the-book debt”.  I recommend assessing this up front to understand how many issues exist and how much work will be needed to correct.  I wrote an article on that titled “Accumulated By-the-Book Debt Will Eventually Come Due” and it includes an online assessment for the startup to take.

Forms of Advisor Compensation

Equity is so dominant as the form of compensation that I don’t see a reason to cover cash-based compensation.  Cash isn’t a currency that early-stage startups want to use for advisor compensation.  That means equity will be the focus of the conversation.  As an advisor or board member, you are aligned with the founders and employees rather than the investors.  That means you will get Common-class equity for your efforts.  Investors get Preferred-class equity and if you also decide to invest money into the company, you’ll get some of that type of equity as well – but I want to focus on your role as an advisor.

One thing to remember about Common-class equity is that it sits subservient to Preferred-class equity in a variety of situations – especially distressed ones.  Most notably, if the company doesn’t execute well or if the vision and potential don’t play out as expected, for whatever reason, the liquidation preference rights that are held by Preferred shareholders could cause you to make nothing for your advisory efforts.  Preferred shareholders get their money back first and there might not be anything left (or very little) after that to spread among the Common shareholders.  Basically, you sit with the same jeopardy as the founders and employees in this regard.

Stock options that vest over the length of your agreed advisory term are most typical.  The vesting schedule is usually monthly and starts from the beginning of your advisory term rather than include a cliff period that is typical for employee stock option grants.  This means that a 2 year advisory gig for 1% equity will vest 0.042% per month (1% divided by 24).

I recommend negotiating an equity amount on a fully-diluted basis (rather than an issued & outstanding basis).  With this approach, the equity available for grant in the stock option pool is taken into consideration.  As options are granted to others over time, you still have the same equity percentage on a fully-diluted basis.  This also lets you know your worst case equity percentage until the company takes some action that requires more shares of stock to be issued into the company (ie – equity investment or true-up of the stock option pool).  Those actions will dilute your equity, but that’s natural over time.

Amount of Compensation

Negotiating the amount of equity for your advisory services is part art and part science.  At the end of the day, the amount needs to seem fair to both parties.  As I explained in an article I wrote for startup founders, titled “Compensating an Advisor“, the three key factors that come into play are as follows:

  1. Expertise of the advisor – as it relates to the needs of the company
  2. Duration of the engagement
  3. Activity level

advisor compensationThe duration of the engagement is very straight forward but the other two factors are a little more subjective.  The one I make sure to discuss up front is the expected activity level.  If the startup wants to book 1-hour weekly meetings on a recurring basis, that’s fairly active.  Contrast that with a startup that just wants the advisor to be available from time to time as issues and opportunities arise.  Mentally plot each of the three variables for a particular advisory engagement on a low-to-high continuum to guide you towards the right amount of equity compensation.  For example, if you have ninja-level expertise as it relates to a seed-stage startup’s needs and agree to a 2 year engagement with a high level of activity, you might ask for 2-3% equity.  If, instead the startup wants a 1 year term and only needs your help casually and infrequently, you might ask for 0.4%.

Side Note: Regarding the activity level for the engagement, it’s typically elevated for the first few weeks or so as the two parties are digging in together to get the relationship started.  After that, it often moderates for the remainder of the engagement but with ebbs and flows as needs arise.  Because of this, try to assess and agree on the activity level that will take place after the honeymoon period while knowing it will be more active than that at the very beginning.

Notice that, for the example, one of the qualifiers I included was the stage of the company (the example mentioned a “seed-stage startup”).  There is a risk-reward dynamic that also comes into play when negotiating the right amount of equity.  You should expect to get more equity from a startup that is still in the idea development phase (no finished product or paying customers) than one that is generating $2M in annual revenue and recently raised a $6M Series A.  In fact, all factors of expertise, duration and activity level being equal, you might expect 2-3X the equity amount from the idea-stage startup versus the Series A funded one.  That’s because the idea-stage startup is at a far more risky stage of evolution, with many more death risks than the Series A funded startup.

The other factor that comes into play is dilution from equity rounds of funding.  My general rule of thumb is that each real round of funding will dilute the prior stakeholders in the range of 30% (with plenty of exceptions both higher and lower).  When I say “real rounds”, I am excluding small bridge rounds of funding because they might only dilute 10-15%.  This means that 1% equity for an advisory gig with a company right before they close a Series A is equivalent to 0.7% equity right after they close the Series A.  And that adjustment is purely an economic adjustment.  The Series A funded startup has a load of cash in the bank and is definitely less risky than before they raised the round of funding.  Because of this, something less than 0.7% could easily be fair compensation.

Side Note:  Realize that rounds of funding that use convertible securities like convertible notes or SAFE’s won’t convey the dilution to prior stakeholders until the next equity round of funding that causes them to convert to equity.  If you get 1% equity before a startup raises a real seed round using convertible notes and then late they raise a real Series A, you might end up with about 0.5% equity after the Series A closes.  This assumes 30% dilution from the seed round (but not felt until the Series A) and another 30% from the Series A itself.  Let’s do the math: 1% * 0.7 * 0.7 = 0.49%.  If you aren’t familiar with how convertible securities work, read my article titledConvertible Note Basics“.

After you have a few advisory engagements under your belt, you will develop your own personal “price list” that covers different situations that span the variables described here.  I often engage with seed-funded startups that have a product in the market and light revenue ($10-25K monthly).  This has allowed me to establish a rule of thumb amount of equity for a 1 year term and three different activity levels (casual, moderate, heavy).  From there, I can adjust for a longer duration, such as 18 months or 2 years.  I can also increase the equity for a pre-revenue startup or descrease it for a Series A funded one.  If you become an active advisor, you’ll naturally do the same.

Board Director Compensation

Serving on the board of directors carries some different attributes than just being an advisor.  Board directors have oversight and governance responsibilities.  This means they can be subjected to lawsuits from disgruntled investors or others.  They aren’t necessarily expected to serve as an active advisor in between quarterly board meetings, but for seed-stage and Series A funded startups, it is typical for board directors to engage in some advisory fashion in between board meetings.  What you want to know is if the company expects more than just casual interactions.

All other things being equal to a standard advisory gig (expertise, duration, activity level), a board director role should call for more equity compensation due to the governance responsibilities and associated liability risks.  How much extra is subjective and usually minor, but still should be taken into consideration by both parties.

Related Article: For more insights into how board meetings are conducted and related best practices, read an article I wrote for founders titled “Your First Board Meeting“.

Other Nuances to Consider

Benefits of a Longer Term

You might be faced with some flexibility on the length of your advisory term.  After all, if either party wants to terminate the relationship, for whatever reason, the advisor agreement usually allows either party to do so with 30-days notice.  If so, the vesting schedule ensures the advisor only gets whatever equity they deserve.  The benefit to the advisor of taking on a longer term has to do with locking in the exercise price.  The fair market value (FMV) of a company’s Common shares usually escalates over time as the company’s valuation increases.  I would rather lock in 2 years of equity with a $0.05 exercise price versus 1 year of equity with a $0.05 exercise price followed by a 1 year extension and a $0.25 exercise price.  The difference in total exercise cost could be dramatic.

Early Exercise

If the total exercise cost for all of your equity is really cheap, in your perspective, you should consider asking to do what’s referred to as an “early exercise”.  For pre-seed and seed-stage startups, such a request is often honored.  For a Series A funded startup or later, it is unusual – but so is the likelihood that the exercise cost is still really cheap.

Doing an early exercise means you purchase (exercise) the stock before it is vested.  The biggest benefits to this are tax-related.  You get to lock in your cost basis and also get to start the long-term capital gain clock ticking.  You also avoid the risk of having to pay taxes on any unrealized gains, which could be the case if you instead exercise the stock later.  This has to do with the different tax treatment for the Non-Qualified stock options you can be issued as a non-employee (versus the Incentive Stock Options, or ISO’s, that are granted to employees).

The paperwork used for an early exercise is different than a normal stock option grant.  Usually, a form of Restricted Stock Purchase Agreement is used.  It calls for you to purchase the stock up-front, before it is vested.  It also gives the company a right to repurchase any unvested shares if your service is terminated before the end of your vesting term.  This means that there is still vesting, even though you purchased the stock up-front.  If your 1 year advisory gig for 1% equity only lasts 6 months before it’s terminated, you’ll end up with 0.5% after the company executes their repurchase of your unvested shares.

If you do an early exercise, the IRS needs to know about it and they require that you submit some paperwork.  This is really important!  You must file an IRS Form 83(b) within 30 days of your stock purchase.  If you don’t, it creates a really big mess for you, the company, and their attorney to try and fix things.  You are responsible for this IRS filing, not the company, and the company will want a copy of your filing.

Side Note: I take a belt-and-suspenders approach to my 83(b) filings.  Not only do I send the paperwork to the IRS, but I mail it return-receipt-requested so that I get confirmation of delivery.  I also include an extra copy of the filing for the IRS to stamp and return to me in a self-addressed, stamped envelope.  I have a cover letter and cheat sheet of instructions that you can download from the Resources page of this website (scroll down to the Legal Resources section).

Extended Exercise Rights

If you elect to get regular vesting stock options (instead of doing an early exercise), there is a nuance to consider.  The company’s stock option plan will require that you make an exercise (purchase) decision within 60-90 days of your service termination.  If you don’t complete the exercise process, your vested equity will evaporate forever.  The exact period of allowed time will be defined in the company’s official stock option plan.  If the total exercise cost is high, you might have a concern about spending so much money on a still-super-risky investment.  Additionally, due to the different tax treatment for non-qualified stock options, you’ll be hit with a tax obligation if the fair market value of the stock when you exercise is higher than your exercise price – even though you don’t have a way to sell the stock.  In other words, you get taxed on the unrealized gains that only sit on paper.

Because of this, you should consider asking for extended exercise rights.  It means that regardless of your service termination, you have longer than the typical 60-90 days to make your exercise decision.  You might ask for 5 years or 10 years from the date of the original equity grant to make your exercise decision.  The important part about this is the exercise period is not tied to your status as a service provider but rather the start date of the option grant.

It is important that this special exercise period is spelled out in your stock option grant document.  If the company simply uses their standard option grant form, this won’t be included.  I have done this enough times that I keep handy some suggested language for the company’s attorney to consider.  Most option grants refer to a termination period, and expiration date, or both.  Below are some example paragraphs with the key language shown in blue text:

  • Option Expiration Date:  The date ten (10) years after the Date of Grant, regardless of Participant’s continued Service (as such term is defined in the Plan).  Notwithstanding the foregoing, in no event may this Option be exercised after the Option Expiration Date and this Option may be subject to earlier termination as provided in Section 8 of the Stock Option Agreement.
  • Termination Period:  This Option shall be exercisable for ten (10) years from the date of the grant, regardless of Participant’s continued service.  Notwithstanding the foregoing sentence, in no event may this Option be exercised after the Term/Expiration Date as provided above and this Option may be subject to earlier termination as provided in Section 13 of the Plan.
  • Termination Period:  The portion of this Option that is vested as of the date on which Participant ceases to be a Service Provider shall be exercisable until the Expiration Date set forth in the Notice of Stock Option Grant in Part I of this Agreement; provided that this Option may be subject to earlier termination as provided in Section 13 of the Plan.

Authorizations

All matters related to equity compensation should be properly authorized by the company’s board of directors.  This usually means some form of board consent that follows the company’s bylaws.  I usually inquire to make sure this was done and that the board consent includes mention of any rights that are different than what’s typically called for in the company’s official stock option plan.  Examples, include early exercise (via a restricted stock purchase agreement), monthly vesting with no cliff period (rather than 4 year vesting with a 1 year cliff), and an extended exercise period after the advisory services are terminated.

Indemnification

Since board director roles carry liability risk, it is customary for the company to provide some level of protection.  Before getting Series A funding, most startups offer a basic Indemnification Agreement that calls for the company to make a reasonable effort to use both their financial and legal resources to defend any board members that get named in a lawsuit.  After Series A funding, it’s more customary for the company to put a Directors & Officers (D&O) liability insurance policy in place.  Again, this is not for regular advisory gigs but rather for board directors with governance responsibility.

LLC’s

Much of what I’ve written in this article only pertains to working with companies that are incorporated as a C-corporation.  If you find yourself exploring an advisor relationship with a company formed as an LLC, the methods for deriving the amount of equity compensation is still valid, but much of the rest isn’t.  That’s because whereas C-corps are rigid and standardized in structure, LLC’s are very flexible.  You’ll want to get your hands on the company’s Operating Agreement and use that to get some professional advice before taking on an advisory gig with an LLC.

Summary

When it comes to negotiating advisor or board director compensation, every situation is different.  But it’s good to have a standard approach to assessing and negotiating the right amount.  The flowchart below summarizes some of the key decisions and related actions that are often involved.  Use it as a reference.

startup advisor compensationAfter you enter into an advisory relationship, you’ll be on the hook for delivering value.  That’s a whole other topic and one that I wrote about from the founder’s perspective in an article titled “Maximizing Value from Your Advisor“.

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