Startup Advisors & Equity Compensation - Explained
Compensating Advisors with Equity Ownership
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How Much Equity Do Startup Advisors Get?
You may have heard the expression, “it takes a village”. This is certainly the case for startup ventures. The founders will or should seek ideas and advice from those who have the ability and willingness to help. Founders often formalize an advisor or mentor relationship with individuals who have a level of knowledge or expertise in their field. Later stage startups often form an advisory board made up of these individuals.
In this article we address how to compensate startup and advisors and how much to compensate them.
Back to: Entrepreneurship
Startup Advisors Want Equity
In a perfect world, we would have lots of connections with talented, experienced individuals who would be willing to help us for free. Unfortunately, that is not the reality. Startup advisors and mentors generally expect to be compensated for their efforts. They generally do not ask for monetary compensation. This is good, as the startup generally does not have available cash to divert from marketing or operations. Instead, the advisors desire an ownership interest (equity) in the startup. The benefit to the advisor is that the equity interest will rise significantly in value if the startup is successful.
Generally, startups awarding equity to advisors (as well as employees) will award restricted stock. Restricted stock cannot be sold or transferred for a specific period of time. Often, the startup will also include right of first refusal provisions that entitle the startup to repurchase the stock from the advisor if the advisor seeks to transfer it or if the company goes through a predefined event or transaction (such as an equity funding round or company acquisition). The shares may also be subject to a vesting schedule. If the advisor fails to continue serving the startup, she could forfeit the shares.
When to Grant Equity
If the startup does decide to compensate its advisors with equity, it must decide how much equity to offer. This decision is generally based upon the following factors.
Value Added - Naturally, the amount of equity awarded should reflect the value of the advisor’s services to the company. Not all advisors will contribute the same amount of value. Remember, the startup generally selects an advisor based upon their knowledge or skill in a specific area or matter relevant to the company. Some of these company hurdles are temporary or less important than others. Also, it is common for advisors to go beyond simply providing advice to the company during regular (monthly) meetings. They often attempt to aid in company recruiting (employees and contractors), customer acquisition, and professional connections (such as introduction to equity investors).
Company Value - The award of equity should also take into consideration the value of the company. The company’s value generally corresponds with the nature of the company’s operations and the stage of development. A technology startup will likely have a far greater early valuation than a traditional product or services firm. This is generally due to the scalable nature of technology and the potential value of intellectual property for the tech company. Also, later the stage companies tend to be far more valuable than early-stage companies. This is because the company has reached later stages of development regarding its value proposition, operations, and finances.
How Much Equity to Offer
There is no hard and fast rule for how much equity to award an advisor. The above considerations will be used to arrive at a number. In general, an advisor who adds lots of company value will receive between .5 - 2% of the company’s equity in the form of restricted shares. Of course, the actual percentage will vary in this range depending on the characteristics of the company. Adding a lot of value in an early-stage company would entitle the individual to a higher percentage in the range. That percentage might be 1% of less in a later-stage company. Adding lower value in an early stage company might have the same result.
The Founder Institute (https://fi.co/) has developed a model document for awarding advisor equity, known as a “FAST” (Founder Advisor Standard Template). This document provides the legal verbiage for an advisor compensation agreement. It also provides a model for calculating the percentage award based upon the above-identified factors.