Jay Parkhill September 24th, 2009
Clients frequently ask me how much equity they should give out to advisors. It’s a multi-layered question and worth pulling apart a little bit. Here is how I think about it, following by my basic rule on how to allocate equity in an early-stage startup.
Low Value Proposition – to the Company and to the Advisor
Most startups are cash-constrained; many get enormous benefit from informal advisors on business models, finance, sales strategy, etc. The companies want to reward these people for giving their time; they also want to reward the behavior so that the advisors will be more likely to continue helping.
At the same time, most advisors have only limited capacity to donate their time so most advisory stints are short term. On top of that,brand-new startups are about as risky as any investment gets and the return on equity for most advisory-level stock grants is incredibly low. If I start out with 1% of a startup and I hold on to as much as 0.1% by the time of a sale, the sale price needs to be $100M in order for me to get $10,000 out.
So- potentially big short-term help for the company; low return to the advisor in most situations. Everyone needs advisors and fortunately there are plenty of people will to help others along, but be aware that the principal reward is not economic. Every once in a while someone does a good deed and gets a big windfall for it, but that is not and should not be the norm.
Where Does the Advisor Equity Grant Fit In?
I am a rules-oriented guy, especially when it comes to equity. My rule here is that an advisor’s equity should be proportional to his/her contribution to the company and should fit in the cap table scheme. The typical early stage cap table should look something like:
* Founders at 60 – 80% ownership (depending on investment)
* Seed investors at 15 – 33% ownership (depending on investment amount)
* Equity pool for employees and advisors at 15%
Put the advisors in the equity pool, then compare their contributions to those of the employees. Equity grants less than about 0.5% become meaningless really quickly and I don’t see companies going below that in most cases, but the amount of equity given to an advisor should be compared to employee grants. If the lead engineer gets 2% and the person who made several introductions and advised on sales channel development also gets 2%, those introductions should be giving the company serious traction.
Advisor Equity is the Tip, Not the Full Payment
There is a balancing act here for sure: an advisor’s short-term help needs to be weighed against the long-term contributions of the full time team members. In the end, it becomes unfair to the team to give out large advisor grants in most cases. My favorite way to think about it is that advisor equity is like the tip paid at a restaurant- it is not the full meal ticket. Sometimes the advisor gets her/his full bill paid in cash too, and sometimes the payment is in goodwill and the satisfaction of having helped out. Equity grants that reflect this do the best job of treating everyone appropriately across the board.