Pando

Why greedy advisor deals hurt companies and the advisors

Just say no to anything more than 1%

By Blake Commagere, Guest Contributor , written on August 19, 2015

From The Lessons from the Trenches Desk

Editor's note: This is a guest post by Blake Commagere.

Over the years, I’ve taken several advisory roles and I’ve brought advisors on to my company. In that time, I’ve seen scenarios where an advisor negotiates a fairly ridiculous advisory agreement out of an inexperienced founder.

Sure, getting a founder to carve out 3% of their company to listen to you opine once in a while sounds like a great deal, but doing so creates a huge red flag on their cap table. It effectively guarantees that the company will look like amateurs when they raise — and investors will push back on this. So the 3% either has to be renegotiated, or they company won’t ever be able to raise money and the advisor will get 3% of nothing dollars.

The most common structure of an advisory agreement includes the following:

Four years of NSO shares, monthly vesting, no cliff

0.5% to 1% of the company

The typical obligations from the advisor to the company tend to be vague: “consult with and provide advice to the company” and the company typically has the option to terminate the agreement at any time and cease further vesting.

There’s a few problems with this structure.

Very few advisors can provide value the entirety of the four year term. If a company is successfully growing, then the odds that an advisor can provide critically helpful advice when the team is three people as well as at 300 people are very slim. Thus it’s not unusual for an advisor to vest shares for three years during which they do not, and can not add any meaningful value to the company.

Advisory is nowhere near as hard as building a company. Essentially, you lean on your armchair and pontificate about a ton of hard work that the startup should do — or make introductions to folks that might be helpful to the company. Conceptualizing what a company should focus on is much easier than actually doing it. Yes, advisors have years of experience that they are able to draw from and can add significant value to a company, but, by its nature, advisory does not require an enormous time commitment.

A company’s equity should be treated as very valuable, and sharing such a large amount of equity with someone that is not in the trenches of the company 24/7 is a problem. Essentially, the more equity you give to advisors, the fewer shares you have available to give your team.

And while the vast majority of advisory agreements allow you to terminate the advisory agreement at any time and stop the advisor from continuing to vest, doing so is akin to firing them — and thus the termination right is rarely exercised when it should be.

Here’s what I have found to be a much, much better structure:

One year of NSO shares, monthly vesting, no cliff

0.1% of the company

If the advisor is phenomenal and can continue to add value for another year, then another advisory agreement can be established each year. This properly aligns incentives in that if the company outgrows the advisor after a year, there is no need to renew them and compensate the advisor for an additional three years during which the advisor can no longer add significant value.

This means you have more equity available to distribute to your team — and you can bring on advisors at different stages of the company without worrying that you’ve given up too much equity

This also solves the termination problem. If an advisor isn’t adding as much value as you would expect, it’s far easier to simply ‘not renew’ than to ‘terminate for non-performance’. This has the added benefit of placing the advisor and the company on much more amicable terms than if you’d terminated the agreement.

Admittedly, this structure does compensate advisors significantly less, but it better reflects the contribution that an advisor makes — and I’ve never had an advisor turn down an advisory agreement with me because they felt it was not enough shares. Some potential advisors have asked me about the structure, and when I walk them through it, they agree it makes much more sense — after all, if they can add value 5+ years in a row and we keep renewing the agreement, then their ownership in the company is similar to the older model. In the event a company becomes successful an advisor is still generously compensated for their contribution.

On a side note, if an advisor did ever push back on this structure, it’s a red flag and I would avoid them like the plague.

Lastly, before formalizing a relationship with documents, it never hurts to have a coffee or a call once a month for a few months to test whether an advisor is a good fit. If there is a mismatch in time expectations or if the advisor doesn’t provide sufficient value during that time, then they won’t be able to add value over the course of an advisory agreement anyway. It’s best to save both sides a little bit of time and trouble.