Advisors; When to appoint them to the Board of Advisors and how much, if any, equity to grant them.
A start-up wants to formalize a relationship between the company and certain advisors who have been providing invaluable advice for the last couple of months. The start-up is also considering granting these advisors some equity in the start-up and want to know what market is. The answer, infuriating for some, is the classic lawyer answer of “it depends”.
Advice is not hard to come by, especially in the very early conception phases. Sorting the good advice from the bad is a much harder matter. Bringing on someone to a board of advisors signals a long-term relationship between the start-up and this person. For an effective relationship to exist, the flow of information between the start-up and the advisor must be a two-way street. The company must share information (sometimes sensitive) to get concrete, relevant advice – a certain level of trust must exist. A grant of equity to an advisor serves the additional functions of letting your advisors have some skin in the game (not much) and allows the company to formalize certain conditions between the company and the advisor that would normally not exist in a free advice scenario. This, in turn helps reinforce trust.
How much equity a company should grant depends on several factors, some of which include: what the particular advisor brings to the table in terms of contacts and experience; the level and volume of advice that they are going to be dispensing to the board of directors and the officers of the company; how long they will be actively involved with the company and ; whether the advice that they are providing is something that is conceptually important in the long run or is more relevant to a certain phase of the company. Generally speaking, a company should add somebody to their board of advisors only when the person will have a long-term relationship with the company and when their advice and contacts will actually help the company move from one stage to the next.
Most advisors do not work for equity, rather, they do it because they are drawn either to one or more likely a mix of the following: the problem that the company is addressing, the founders, or the technology the company is producing. At the same time granting them equity is a nice gesture on the part of the founder to show them that they are part of the company. Granting advisors equity also allows founders to draw-up non-disclosures, confidentiality, and other ancillary documents for advisors to execute to formalize the relationship between them and the company. In the terms of ranges, take everything I say with a grain (or pound!) of salt. We’ve seen ranges anywhere from 0.25% of the outstanding equity to 0.5% and sometimes even 1% or higher in exceptional circumstances.
One thing to note about the board of advisors is that unlike the board of directors, the advisors are not really bound to the company by fiduciary duties. These duties include the duty of care, the duty of loyalty, the duty of confidentiality, the duty of disclosure and other duties that are inherent in a director’s role and bind them in their day-to-day activities. To counter this deficiency, any advisor you bring on into a formal advisory role with the company should execute, at the very least, a confidentiality and non-disclosure agreement. In some cases I have seen situations where advisors are asked to sign a non-compete agreement (rather extreme!) that restricts them from giving advice to similar companies during the relationship or for a certain term after their relationship with the company ends. I have also seen assignment-of-invention clauses which require the advisor to assign any technology that he or she develop during his or her relationship with the company. Of course, this is limited to the particular sphere of business of the company.
In sum, advisors can greatly help the founder or the founding team get some direction on where they want to take their business, building their core product and gaining some traction in the marketplace in terms of contacts and strategies to reach out to customers. Bringing on the right advisors can be critical to the success of the company. To be effective, advisors must be privy to confidential information and to certain facets of the start-up. A company should make sure its advisors are bound to the company by certain agreements. Once a company thinks it has that special advisor and wants to take that next step – it should call a start-up lawyer and run through the necessary risk analysis first. This is a smart move.