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Think giving away equity is no big deal? Think again. A small equity grant today can turn into millions as your startup grows. Protecting equity while securing expert advice is critical for early-stage founders. Here’s how to do it:
- Define advisor roles clearly: Core, strategic, or casual - each has different responsibilities and compensation.
- Use written agreements: Outline duties, deliverables, and expectations to avoid disputes.
- Secure sensitive information: Use NDAs and ensure IP rights stay with the company.
- Structure compensation wisely: Consider vesting schedules, non-equity options like cash retainers, or performance bonuses.
- Follow legal rules: Comply with securities laws and include share buyback rights for added protection.
Startup Advisory Board: Should You Compensate & How Much?
What Advisors Do for Early Startups
Clearly defining advisor roles is key to preventing unnecessary equity dilution and staying within legal boundaries for advisory agreements. Since advisors contribute in different ways, startups need to evaluate these partnerships carefully to determine fair compensation.
Measuring Advisor Impact
Advisors typically fall into three categories based on the level of their contributions:
- Core advisors: These individuals dedicate 5–10% of their time to tackling major challenges alongside the CEO. Because of their deeper involvement, they often receive higher compensation. Their roles should be clearly outlined to safeguard equity.
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Strategic advisors: These advisors engage regularly - often monthly or bi-weekly - to offer value through activities like:
- Making introductions within their network
- Assisting with hiring needs
- Providing expertise in specific areas
- Casual advisors: These advisors offer occasional guidance without taking on significant responsibilities.
Casual vs. Formal Advisory Roles
It’s important to distinguish between informal mentorship and formal advisory roles to protect equity. As ff Venture Capital highlights:
"It is important to define the specific role an advisor will play in the development of your company."
Formal advisory roles should include written agreements that clearly outline deliverables and the expertise required. These agreements help determine fair compensation and ensure equity is allocated appropriately.
Setting Advisor Expectations
Once roles are defined, it’s essential to set clear expectations for measurable contributions. Eric Friedman underscores the importance of regular evaluations:
"With the right kind of experience and help, advisors can be a welcomed addition to the extended team, be a great group to lean on, and help the business."
Here’s a quick breakdown of expectations by advisor type:
| Advisor Type | Expected Deliverables | Communication Frequency |
|---|---|---|
| Core | Strategic guidance, crisis management, CEO mentorship | Weekly or bi-weekly |
| Strategic | Network introductions, specific expertise, recruitment help | Monthly or bi-weekly |
| Light Touch | General feedback, occasional consultations | Quarterly or as needed |
It’s a good idea to hold quarterly check-ins to review contributions, assess areas for improvement, and ensure progress aligns with defined goals.
Must-Have Elements in Advisory Agreements
Advisory agreements should clearly outline advisor responsibilities and deliverables to protect your startup's equity and set clear expectations for everyone involved.
Duties and Exit Terms
Make sure to define key aspects like meeting schedules, time commitments, specific deliverables, and preferred communication methods. For exit terms, include details such as required notice periods (typically 14–30 days), reasons for immediate termination, post-termination responsibilities, and instructions for returning company property.
Once these are in place, the next step is securing your startup's sensitive information.
NDAs and IP Rights
A well-crafted NDA safeguards your company's assets and ensures a trustworthy relationship with advisors. Be sure to include:
| Protection Area | What to Include |
|---|---|
| Confidential Information | Trade secrets, business plans, customer data, and technical specifications |
| IP Ownership | A clear statement that all intellectual property created during the engagement belongs to the company |
| Usage Rights | Restrictions on how advisors can use or share company information |
| Post-Term Obligations | Requirements to maintain confidentiality even after the agreement ends |
After securing duties and IP protections, move on to compensation and record-keeping.
Payment Terms and Records
Clearly define how advisors will be compensated - whether through equity, cash, or a combination of both. Include the payment schedule and any conditions that must be met. Also, outline documentation requirements for:
- Time spent on advisory tasks
- Completed deliverables
- Expenses eligible for reimbursement
- Equity vesting milestones
These detailed terms help align advisor contributions with compensation while protecting your company’s equity.
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Non-Equity Payment Options
Startups don’t always have to give up equity to compensate advisors. Cash-based payment structures can reward advisors fairly while keeping ownership intact. The right approach depends on your startup's stage and how involved the advisor will be.
Flat Fees and Performance Pay
One option is to set a fixed fee, like a monthly retainer, and add performance bonuses for hitting specific milestones. These could include goals like securing funding, forming partnerships, or reaching revenue targets. This approach aligns compensation with both the advisor’s contributions and your company’s progress.
Mixed Payment Methods
Another approach combines immediate cash payments with performance-based incentives. For instance, an advisor might receive a base cash retainer along with bonuses tied to specific, measurable achievements. This setup allows for predictable budgeting while ensuring bonuses are earned through tangible results.
To ensure clarity and structure, tools like the FAST (Founder/Advisor Standard Template) Agreement can be helpful. The FAST Agreement lays out advisor roles and compensation terms, making expectations clear for both sides.
When deciding on a model, consider factors like upfront costs, the variability of performance-based payouts, and the effort required to manage these arrangements. Non-equity compensation not only protects ownership but also aligns advisor rewards with measurable outcomes, giving startups the flexibility to retain control while gaining expert guidance.
Legal Requirements and Equity Protection
Equity-based advisory agreements must follow strict legal guidelines to protect ownership. Understanding these rules is crucial for drafting agreements that safeguard the company while ensuring fair compensation for advisors.
Securities Rules and Regulations
Advisory shares fall under securities laws and demand careful compliance. Unlike standard stock options, advisory shares generally do not come with voting rights or a share in the company's profits. This setup ensures clear governance while still offering compensation. Startups must document equity grants thoroughly and meet all relevant reporting requirements to stay compliant.
Equity Vesting Rules
Vesting schedules are a key tool for protecting a startup's interests while ensuring advisors receive equity for their contributions over time. These schedules link equity compensation to the advisor's continued involvement.
"Advisory shares should be subject to a vesting schedule, just like employee shares. This ensures that equity is tied to the advisor's ongoing contribution." - Lineke Kruisinga
Advisory equity often follows a monthly vesting schedule over two years. For instance, if an advisor is granted 0.1% equity (10,000 shares) over a 24-month period, about 416 shares would vest each month. These vesting arrangements work alongside other measures to protect the company's equity.
Share Buyback Rights
Advisory agreements should include provisions for share buybacks to further protect the startup's equity. These provisions might cover:
- Early Termination: Rules for reclaiming unvested shares if the advisory relationship ends early.
- Performance Issues: Steps for recovering equity if the advisor doesn't meet agreed-upon expectations.
- Acquisition Scenarios: Guidelines for handling advisor shares in the event of a sale or merger.
Conclusion
When drafting advisory agreements, it's crucial to outline compensation and protection terms clearly. Equity holds immense importance, even in the early stages of a company's growth. Proper planning for advisors helps avoid costly errors and ensures you make the most of your resources.
Here are three steps to help secure your startup's equity effectively:
- Set clear expectations: Put roles, responsibilities, and deliverables in writing. This helps avoid misunderstandings and ensures both parties are fully aligned.
- Structure compensation wisely: For advisors contributing fewer than 5–10 hours a month, opt for a single payment method. A starting point of 0.5% equity is common, with higher equity reserved for those who bring exceptional contributions.
- Establish safeguards: Use 24-month vesting schedules and include provisions for early termination and performance to protect your interests.
FAQs
What are the risks of giving equity to advisors in an early-stage startup, and how can you avoid them?
Granting equity to advisors in an early-stage startup can carry risks, including ownership dilution that reduces the stake of existing shareholders and may complicate future fundraising. Additionally, if an advisor underdelivers, the company might end up overcompensating them for minimal contributions.
To minimize these risks, startups should clearly define the advisor's role, responsibilities, and expectations in a written agreement. Using vesting schedules ensures equity is earned over time, aligning the advisor's incentives with the company’s growth. You can also link equity to specific milestones or performance goals to maintain accountability. Finally, consider starting with a trial period to evaluate the advisor’s fit before committing to long-term equity arrangements.
How can startups fairly compensate advisors based on their contributions and impact?
To fairly compensate advisors, startups should evaluate factors like the advisor’s expertise, the company’s stage, and the level of involvement. Compensation often reflects the value the advisor brings, such as strategic guidance, industry connections, or specific skills.
Equity is a common form of compensation, typically ranging between 0.25% and 1% for most advisors, depending on their contributions and the startup’s growth stage. Early-stage startups may offer more equity due to higher risk and limited cash flow. Alternatively, startups can explore non-equity options like fixed fees or milestone-based rewards to align compensation with measurable outcomes.
By clearly defining expectations and aligning rewards with contributions, startups can ensure fair and mutually beneficial advisory agreements.
What key legal steps should startups take to protect equity and intellectual property when working with advisors?
When setting up advisory agreements, it's important to safeguard both your startup's equity and intellectual property. Start by using non-disclosure agreements (NDAs) to protect sensitive information and ensure confidentiality. Clearly outline the advisor's responsibilities, the duration of the agreement, and the compensation structure, whether it's fixed fees, milestone-based rewards, or equity.
If equity is involved, consider using a vesting schedule (e.g., over two years) to ensure long-term commitment. Additionally, include provisions to protect your intellectual property (IP) by ensuring that any ideas or contributions made by the advisor are assigned to the company. Taking these steps helps you build a fair and legally sound relationship while avoiding unnecessary risks.
