May 11, 2019 by Fred Haney
How Startup Companies Should Compensate Their Advisors
How should a startup company compensate its advisors? This is a tricky question because there are no guidelines and most founders do not have experience in this area. But there are some general principles that can help you arrive at compensation that should be fair to the company and attractive to your advisors.
One obvious approach is to try to give your advisors an interest in your start up that is comparable to the dollar value of the time you expect them to contribute. This assumes of course that you can anticipate how much of their time you will need and how to value that time. For example, if you want to buy $25,000 worth of an advisor’s time and your company is worth $2 million, then you could give that advisor an option to purchase 1.25% of the company. Some advisors might reasonably want a premium in exchange for the risk and delay in payment they are taking, so you might settle on something like 2.5%, for example.
Another important principle, I believe, is that an advisor’s compensation should be comparable to the value he or she is likely to add to the company. The concept of “value-added” is subjective, but it is possible to make reasonable estimates as to the value of some contributions.
“How much we owe to good teachers, good education, and good advice!”— Robert Mundell
Valuing Early Contributions
In the very early stages of a startup—before any capital has been raised—the value of the company might be something like $1-2 Million. At this stage, it may be possible for an experienced advisor to add a few percentage points in value or possibly as much as 5-10% in value. Here are some examples of ways this could be done. Helping to:
- Create the initial business strategy
- Create a strong business plan presentation
- Shape the Board of Directors
- Get the right professional service providers (lawyers and accountants)
- Avoid getting unqualified vendors
- Select qualified vendors
- Obtain early financing
- Establish good accounting and forecasting practices
- Negotiate partnerships
- Make important strategic decisions
- Make introductions to resources for marketing, public relations, website development
- Negotiate other important agreements
For example, I have seen a number of startups that spent at much as $50,000 with a website developer that had few qualifications and very little previous experience. So, the $50,000 was wasted. How much value has an advisor added if he or she can steer the startup away from this vendor and in the direction of one that has a history of success? The same logic can apply to lawyers, accountants, software developers, public relations agents and other service providers.
“If we could sell our experiences for what they cost us, we’d all be millionaires.” — Pauline Phillips
A Few Benchmarks
It is fairly common for a venture capitalist who sits on the board of directors of a startup company to get an incentive comparable to approximately 2-4% of a company’s equity in exchange for sitting on the board, helping to build value, and—of course—helping to bring the capital. This gives some idea of the magnitude of compensation for an advisor who has extensive experience in building companies and who will be actively involved until the company achieves an exit.
Investment bankers and finders frequently take a commission in the neighborhood of 3-5% of the investment amount for relatively small investments. If an advisor is instrumental in arranging a $2 million investment that acquires 33% of the company’s equity, he or she might be entitled to something like 1 to 1 1/2% of the company’s equity just for that accomplishment.
“Money is usually attracted, not pursued.” – Jim Rohn, entrepreneur and motivational speaker
Once a company receives its first round of financing, its valuation might increase to something like $5-10 million. At this stage it becomes more difficult to add 1% to the company’s value, as this requires adding $50-100,000 in value. This would require saving the company a substantial amount of money, negotiating a very favorable partnership agreement, or some other action representing relatively high value.
As you can see, at this stage, compensation of 1-2% is fairly aggressive and requires advisors to make a substantial contribution.
Advisors who joined a company after it has received one or two rounds of financing would have a difficult time increasing the value by as much is 1%, so their expectations might be some fraction of a percent of the company’s equity.
Arriving at fair compensation for advisors is a very subjective matter, but if you make some effort to relate their compensation to the value that they can be expected to add to your company, everyone should be satisfied.
“Never give advice unless you have walked the walk, because anybody can talk the talk.” ― Valencia Mackie
About the Author
Dr. Fred Haney is the founder and President of the Venture Management Co., a firm that provides assistance to high tech companies. He is the author of “The Fundable Startup: How Disruptive Companies Attract Capital,” published on February 6, 2018, by Select Books of New York. Download the first chapter for free below: