Advisors bring immense value to startups through their expertise, experience and networks. They provide guidance on strategic planning, fundraising and industry insights. They can also help navigate building challenges, make informed decisions and accelerate growth, ultimately increasing the likelihood of success in a competitive business landscape.
A critical question to answer is: How do you compensate these advisors for their strategic role? In this article, we’ll delve into the nuanced dynamics of advisor compensation, discussing the merits of cash and equity compensation, and providing guidance on how to tailor an approach that suits your startup’s unique needs and circumstances.
As each situation is distinct, it’s important to work with legal counsel to structure the optimal deal with your advisors. If you’re looking for counsel, feel free to reach out to us here.
Determine the Scope of Work and Time Commitment
Before deciding on compensation, determine the scope of work and time commitment required from an advisor. This will help you understand how much value they can bring to your startup and what type of compensation is appropriate.
One way to do this is by creating a detailed list of tasks or projects you’d like the advisor to work on and how you hope they will “advise.” This list should include specific goals and timelines for completion and the types of support they will provide (i.e., strategic recommendations, written deliverables, attendance to board meetings, review of and comment on select materials, etc.) Consider how involved you want the advisor to be in your company’s day-to-day operations.
Once you have a clear understanding of the scope of work and time commitment required, explore different compensation options that align with those expectations. Keep in mind that some advisors may require more compensation if their workload is particularly heavy or if they are expected to be involved in key decision-making processes.
Cash v. Equity
When compensating advisors in a startup setting, the two options are cash or equity compensation. Each carries unique advantages and considerations.
- Cash compensation is direct payment for the advisor’s services, which can be a fixed amount, hourly fee, project-based or performance-based. It provides an immediate, tangible value to the advisor.
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- Cash compensation offers immediate value and is a straightforward reward for the advisor’s contribution. For advisors, this form of payment is predictable and doesn’t involve any risk related to the company’s future performance.
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- Cash compensation can strain a startup’s limited resources. It also doesn’t offer the advisor a stake in the company’s future success, potentially reducing their long-term commitment.
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- When appropriate: Cash compensation is typically suitable when a startup is well-funded and wants short-term, specific advice without sharing ownership. It may also be more suitable for advisors who prefer immediate compensation over a stake in the company.
- Equity compensation means offering a stake in the company in exchange for the advisor’s services. This could come in various forms such as stock options or restricted stock.
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- Equity compensation aligns the advisor’s interests with the startup’s long-term success. It can be an effective way to attract high-quality advisors when cash is limited. If the startup thrives, the equity may provide significant financial rewards.
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- Equity compensation is more complex to manage, with varying tax implications and vesting schedules. The advisor takes on risk; if the startup doesn’t perform well, the equity could end up being worth little or nothing.
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- When appropriate: Equity compensation is often used in early-stage startups with limited cash but high-growth potential. It’s suitable for advisors who provide ongoing strategic advice and are willing to invest time in the startup’s future success.
Ultimately, whether to use cash or equity to compensate an advisor will depend on the startup’s specific circumstances, the nature of the advisory role and the advisor’s preferences.
Rule of Thumb: Early-stage startup advisors are generally paid exclusively in equity.
Of course, there may be exceptions to the rule. From time to time, advisors will take a performance-based fee. For example, an advisor who has strong retail connections may make introductions to retailers. If retailers agree to distribute your product, they would get a cash success fee.
Advisor Equity
By giving equity, startups incentivize advisors to become more involved. Advisors with a stake in the company provide additional support when needed, and equity aligns their interests with other stakeholders. This benefits both parties. Advisors have a financial incentive to contribute their skills and knowledge, while startups get valuable guidance and mentorship from experienced professionals.
When it comes to equity compensation for advisors, there are generally two types of equity: stock options and restricted stock.
- Stock Options. Stock options give the advisor the right to purchase a certain number of shares at a fixed price, known as the exercise price. The exercise price is usually set at the fair market value of the company’s shares at the time the option is granted. Stock options typically have a vesting schedule, which means that they become exercisable over time. To learn more about stock options click
- Restricted Stock. Restricted stock (sometimes called restricted stock awards, or RSAs) is an issuance of a certain number of shares of the startup’s common stock. These shares are typically subject to vesting. To learn more about restricted stock click here.
Size of Advisor Equity Grant
When deciding on how much equity to give an advisor, there are several factors that need to be taken into consideration. These factors can include:
- Level of Involvement. The level of involvement an advisor has with the startup is a critical factor in determining their equity stake. If an advisor is only providing occasional guidance or advice, then a smaller equity stake may be appropriate. On the other hand, if an advisor is deeply involved in the day-to-day operations of the company and contributing significantly to its growth and success, then a larger equity stake may be warranted.
- Expertise and Experience. Another factor to consider when determining equity for advisors is their level of expertise and experience. Advisors who bring unique skills or knowledge to the table that are particularly valuable for the startup may warrant a larger equity stake than those who do not have such specialized expertise.
- Time Commitment. The amount of time an advisor commits to the startup is another important consideration. Advisors who are willing to devote significant amounts of time and energy toward helping the startup grow should be rewarded accordingly with a higher equity stake.
- Market Rates. Finally, it’s important to consider market rates when determining equity for advisors. Startups should research what other companies in their industry typically offer in terms of equity compensation for advisors with similar levels of involvement, expertise and time commitment. This can help ensure that the offer is competitive and fair.
Rule of Thumb: Advisors usually get between 0.25%–1% of fully diluted equity.
Advisor Equity Vesting Schedule
A vesting schedule determines when an advisor’s equity stake in the company becomes fully earned, and the company’s right to repurchase has lapsed. Typically, vesting schedules are structured over a period of time and/or based on the achievement of certain milestones.
Unlike the standard vesting schedule for founders and employees, the most common vesting schedule for advisors is two years with no cliff. This means that the advisor’s equity stake would gradually increase each month until it reaches 100% at the end of the two-year period. Occasionally, a six-month cliff will be added to the vesting schedule. This cliff provides the founders with six months to assess the value added by the advisor. If the advisor is not adding value, the founders can terminate the relationship, and the advisor does not receive equity in the company.
It is important to structure a vesting schedule that incentivizes the advisor to stay committed to the company while also rewarding them for their contributions over time.
Advisor Equity Agreements
There are two agreements between the startup and its advisor:
- Advisor Agreement. This agreement is similar to an independent contractor agreement. It sets out terms such as scope of work, confidentiality and equity compensation. If the startup is seeking a specific service from the advisor, such as hiring support, coaching or fundraising assistance, then that should be clearly stated in the advisor agreement.
Many startups use the FAST Agreement. However, we don’t particularly like this agreement because our experience is that it creates confusion and unnecessary debates about equity compensation. Nonetheless, it’s better than not having an advisor agreement in place. Ideally, you should work with an attorney who can draft an agreement that meets your needs. If you’re looking for legal counsel, feel free to reach out to us here.
- Equity Award. This agreement issues equity to the advisor. If you’re issuing restricted stock, it will be a Restricted Stock Purchase Agreement or a Restricted Stock Award. If you’re issuing stock options, it will be a Stock Option Grant.
Additional Value for Advisors
In addition to providing compensation, offering networking opportunities can be a valuable way to compensate your advisor. This involves connecting them with other professionals and companies in your industry who may be able to provide additional insights or resources.
One way to offer networking opportunities is to introduce your advisor to other professionals in your network. This could include investors, mentors or other advisors who can provide valuable advice and guidance.
Another option is to invite your advisor to attend industry events or conferences with you. This can give them the opportunity to meet other professionals in your industry and learn about new trends or developments.
By providing networking opportunities, you’re not only compensating your advisor but also investing in their professional development. It shows that you value their expertise and are committed to helping them succeed. In some instances, this non-financial benefit may be more important to some advisors than the financial benefits.
Conclusion
In conclusion, compensating advisors is an important aspect of building a successful startup. By determining the scope of work and time commitment required from an advisor, researching industry standards, and being transparent about your financial situation, you can create a compensation package that attracts top talent and aligns their interests with the success of your startup.
Whether you choose to offer cash, equity or a combination of both, it’s important to have a clear agreement in place that outlines the terms of the compensation package. Additionally, offering perks, networking opportunities, and the chance to attend important meetings and events can further incentivize advisors to contribute their expertise and help your startup reach new heights.
As each situation is distinct, it’s important to work with legal counsel to structure the optimal deal with your advisors. If you’re looking for counsel, feel free to reach out to us here.
