Equity represents an ownership interest in a company. When an advisor receives equity in a startup, they become a part-owner of the company. This means that they have a stake in the success of the company and will benefit financially if it performs well. The prospect of equity motivates advisors to work hard and provide valuable advice to the startup. It also aligns their interests with those of the company’s other stakeholders, such as investors and employees.
Rationale for Issuing Advisors Equity
Advisors are key to startup success. They bring valuable expertise, experience and knowledge that can guide a startup through its early stages. Advisors provide insights into industry trends, market opportunities and potential pitfalls. They also mentor the founding team, offering guidance on challenges such as fundraising, product development and scaling.Â
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.
Types of Equity Compensation for Advisors
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.
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, meaning that they cannot be sold or transferred until certain conditions are met, such as the advisor remaining with the company for a specific period of time.
In general, when the fair market value (FMV) of the startup’s stock is low, restricted stock is generally the best form of equity compensation. However, as the FMV increases, stock options become the better option. For more information on the differences between stock options and 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. Generally speaking, 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.
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 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 like 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.
Tips for Negotiating Equity Compensation with Advisors
Negotiating equity compensation with advisors can be a delicate process. Here are some tips to help ensure that the negotiation process goes smoothly and both parties are satisfied with the outcome:
- Set clear expectations. Be transparent about the advisor’s role, responsibilities and expected involvement. Clearly communicate the equity offer and vesting schedule to avoid future misunderstandings.
- Be transparent about your financial situation. Startups should be transparent about their financial situation when negotiating equity compensation with advisors. This includes existing funding or revenue streams, potential risks, or challenges that may impact the company’s growth prospects. By being transparent, startups can build trust with advisors and demonstrate their value for open communication.
- Research market rates. Before entering into negotiations with an advisor, startups should research market rates for equity compensation in their industry. This can help ensure that their offer is competitive and fair.
- Consider non-financial benefits. Finally, startups could offer non-financial benefits to advisors when negotiating equity compensation, such as professional development or network-enhancing events that expand advisors’ skills and knowledge while also contributing to the startup’s success.
These tips should prepare you to have a productive conversation with your advisor.
