I have been sharing the below with folks via email and privately, but realized I should do so publicly**.
Regarding some of the plans I have seen work well — I am going to give you two answers; one wearing my advisor hat for the company, and one wearing my non advisor hat.
As an advisor looking out for the company;
You should look to get 2–4 competent advisors that can shore up on areas that complement you well. Think about the things you DON’T know. This is the classic “hire people smarter than you” which is harder said than done. Typically these folks get between .01-.25% for regular advisors, .25-.50% for mid range to expert advisors who are willing to spend the time, .50–1.0% for very special circumstances where you have someone that is deeply involved with the company and you might want to recruit later.
Advisor 1 = 0.25% Advisor 2 = 0.25% Advisor 3 = 0.25% Total = 0.75% for 3 advisors that vest as you see fit to help you over the next 1–4 years (more on vesting below)
This leaves plenty of room for a final 4th advisor for .25%
Bigger/better advisors who get more equity have things like; excellent domain expertise to help you avoid pitfalls, deep connections within the industry to help with the intros, partnerships, and more. I try to recommend people bring on advisors that can 10X a business.
Big strategic advisors are the folks that add credibility to your co. and provide everything above, but have expertise and knowledge that you can’t find anywhere else. Think former CEO of the biggest player in your space, former lead exec. from a 10 year old co. in your space that is a public company — that sort of thing.
Advisors refer to these percentages as “basis points” such as “25 basis points” which equals 0.25%. You might already know this but just in case you hear it, wanted you to know.
As a potential advisor looking to get involved with the company;
MORE EQUITY! Lots of people here build up their portfolios by asking for 1%-5% to advise and I think that’s crazy. People claim to be incredible, but you don’t know until you work with them. Tread cautiously here. I have seen what I call “predatory advisors” come in and really mess up a cap table by promising big intros and sales contracts only to disappear after the first 6–12 months.
The funny thing about these moves is that it ends up being bad all around, even though the advisor thinks they are getting a great deal. I have seen cap tables with these folks and investors question who they are, why/how it happened, and how someone who doesn’t work as an FTE own so much.
Here are the questions I like to see founders ask potential advisors;
1. How much time do you have for this company on a weekly, monthly, quarterly basis? 2. Do you currently work with companies that are competitive or could conflict with my business? 3. How many companies do you advise today? 4. What would your current companies you advise say about you? 5. Could I speak with one of them? 6. What do you hope to gain out of this time and energy you spend? 7. What/when/how is the best time to reach you if we need something? (this one is great as its telling about how your time will go)
Much of these questions are based around time and engagement. A standing call or meeting with an advisor is great, but when you really need them will they be there for you?
Good lawyers will tell you the best contractual relationships are those in which you never have to look back at the contract once it’s signed. The relationship is strong, both sides know their roles and goals, and neither side has to resort to external mechanisms (e.g., contracts, courts) to force desired behavior. The world isn’t a perfect place, though, and sometimes it makes sense to add a little more contractual protection.
It is always recommended to spend time with someone before bringing them on as an advisor. I refer to the close confidants of a company as a “kitchen cabinet“, and always feel like you should be able to break bread with an advisor in your own home/kitchen.
Advisors typically ask to vest in equal installments over 48 months. However, I have seen many derivatives of schedules and you have to find a timeline that works best for you.
Another schedule is to use a traditional FTE grant; 4 year vesting with a 1 year cliff. This is the standard 25% of the grant vesting on the one year anniversary of the grant date, with the remaining 75% vesting in equal installments monthly over the next three years. Another innovative approach is to change the cliff to something shorter such as six months.
This gives the advisor an incentive to add enough value that you want to keep them on the team for at least a year; anything less, and they’ve earned nothing. This requires a lot of trust: the advisor in your good faith and the advisor in his/her ability to add value.
Note that an advisor may reasonably push back on a request like this, however: they don’t want to potentially work for free.
Remember when I talked about getting an advisor that can 10X a business? This is putting them on the line to actually deliver for you.
A little bit of background first on options: In order to issue options, your company must have a valid 409A valuation setting the fair market value (“FMV”) of a share of common stock. You cannot issue options at a strike price below FMV without incurring serious tax repercussions. So what most companies do is get FMV from a 409A valuation and use that for their strike price. Companies are not prohibited, however, from issuing options with a strike price greater than FMV.
So why would you do this? Say your current 409A puts your FMV at $0.25/share of common stock, and you’re negotiating with an advisor who’s promising to 4x your company value (beware of promises like this in any event…). You can offer the advisor options with a $1.00 strike price. Unless your company actually 4x’s in value, those $1.00 options will be of no value. Why would an advisor pay $1.00 to exercise an option for a share worth less than $1.00?
This is flexible: you could issue a number of options with the current FMV, and some with a heightened FMV to provide an additional incentive to hit certain targets.
Hopefully you are setup for success, but in the event it doesn’t work out it is best to be prepared. This is why vesting makes so much sense. If things go south after two years, you have 50% of the unvested shares to revert back to the Company.
For example, if you give an advisor 0.4% grant, and they work for you for one year before you decide to part ways, your company won’t be out the full 0.4%. Rather, an advisor in this circumstance would likely have only vested in 1/4 of that amount, with the unvested 3/4 returning to the company. Playing out the math they will walk away with 0.1% of your company, and the remaining 0.3% will revert back.
All of this is one way of saying that the initial grant you provide isn’t set in stone. If a relationship isn’t working out, you can terminate it or renegotiate to mitigate costs.
If an advisor is confident they can add value (and you have a reputation as a fair dealer), these aren’t unreasonable asks. That said, while these tools may get you to a better place directionally, you can see they’re far from perfect. For example, if you set an advisor’s strike price greater than FMV, what happens if FMV rises for reasons completely aside from an advisor’s efforts? At the end of the day, there’s simply no replacement for a good relationship, and that’s what you want to spend your time–not in more nuanced contract negotiations.
**LAWYERLY DISCLAIMER: This is not legal advice. Before embarking down this path, please check with your outside counsel, Board of Directors, and equity plan and financing documents etc… before making moves. Every company’s plan is different, and just like a contract isn’t a substitute for a good relationship, a blog post isn’t a substitute for legal counsel.
Originally published at www.ericgfriedman.com on June 27, 2016.