How Much Equity Do Startup Advisors Get?
If you are creating a startup, you need to bring in a group of advisors in addition to your founders. These advisers should be able to introduce you to potential customers, partners, and investors. The question is, how do you compensate them? How much equity should you give to them? That depends on which stage your project has reached and how much value they are bringing to the table.
Many of the considerations discussed here may need to be adjusted to match your situation based on things like the level of funding, the nature of the project, and the number and level of your advisors. Still, all of these are essential things for you to consider.
Your advisors are the ones that are going to help point you to investors. But if you don’t have investors yet, how do you pay your advisors?
Before you go looking for investors, you should have some funding already lined up. This is called “pre-external funding.” It usually comes from investments that you and your partners have pooled together.
One of the best ways to grow your funding is to give some of your pre-external funding to advisors in exchange for their services. This should be around 1% to 2% per investor. This can go up if you have low funding and few investors, but you shouldn’t pay your advisors more than 10% of your pre-external funding. After all, you have other expenses, and if you give all of your funding to advisors, you won’t have any to develop prototypes and early models that you might need to convince the investors that your advisors bring in.
Some funds should also be going into legal fees involving the drafting of contracts between your organization and your advisors, especially if your advisors are being paid in shares rather than cash. This opens up the opportunity for potentially complicated legal content like vesting periods, which will be discussed toward the end of the article.
After Seed, Before Angel Raise
Ideally, your advisors will help you to identify “angel investors.” Angel investors are wealthy or powerful individuals who are dedicated to helping new businesses to develop. They give seed money to up and coming businesses in exchange for equity in the company. Angel investors are usually, but not always, licensed or certified by some reputable body.
As with all of your funding, the lion’s share of the seed money should go into your general funds to pay for expenses and development. However, some of the seed, .5% to 1% should go to each of your advisors.
Depending on the structure of your company, you might also have partners that are being paid with these funds who are likely making more than your advisors. Expenses like these can take quite a bit out of your early-stage funding, even when you’re just talking about seemingly small percentages.
After Angel Raise
When Angel investors are impressed or enthusiastic about your progress, they may increase your funding beyond the initial seed investment. While angel investors understand the nuanced expenses of starting a business, they aren’t giving it to you so that you can pile it on your advisors. Further, unless your advisors are maintaining communications with your angel investors, it’s more your work than your advisors that is impressing your original angel investors. Still, your advisors initially located the angel investors, so make sure that your advisors see some of the raise – around .25% to 1%.
After VC Raise
It’s not often that angel investors are the sole source of early funding. They usually help to get you off of the ground so that you can have enough of a portfolio to begin attracting venture capitalists.
Venture capitalist often comes from firms rather than individuals, though there are individual and independent venture capitalists. Whether an individual or a firm, they fill a similar role to that of angel investors but are usually more interested in funds than in seeing you grow. They usually invest more money but also demand more equity in exchange. Between .1% and .5% of this funding should go to your advisors. This may sound like a small share, but keep in mind that it is likely a larger sum of money than you have previously seen from one source.
The source of the funding may also provide some stipulations as to how the funding is supposed to be spent. This may seem restrictive, but it is often a way of guiding small businesses towards wise spending habits that they may not have learned yet. After all, while venture capitalists may seem more cold and calculating than angel investors, your advisors and your partners, they still want your company to succeed and have a history of working with small businesses. They are often seen as simply a source of funding but they can often be a source of guidance as well.
Other Sources of Funding
Depending on the size and nature of your company, it may be eligible for grants. This is often the case with companies pursuing health solutions or advanced technology. It is also often the case with companies that promise to provide job growth.
Some grants can be used to pay figures like partners and investors, but others cannot – the grant will usually specify how funding may be used. Keep in mind that if you do intend on using grant money to pay people, you will be expected to include that in the grant itself, usually in the budget section.
Whether you pay advisors with grant funding should also depend on their involvement in the process. If they located the grant or wrote it, they should see a cut. However, if you, one of your partners, or another group identified the grant and wrote the draft, it makes sense not to include advisors on the funding, though this can depend on the nature of the grant.
If you would be receiving the funding to promote science, health, &c. It can be wise to not include pay for anyone in the requested budget. If you would be receiving the funding because of your company’s ability to create economic growth, it may be wise to include money for advisors, even if they aren’t involved.
Other Kinds of Advisor Compensation
Generally speaking, this article has recommended giving each of your advisors a percentage of funding that your business comes into, through your advisors, through the early fundraising process. Recommended payments have been given as percentages of each funding source that your advisors bring in. You can look at this as a commission that you pay your advisors for their work and to keep them involved in your process. When we give these recommended percentages, however, we are assuming that you are not paying the advisors any other sort of cash payment. If you are, subtract these payments from the percentages that we recommend at each step.
Further, it is also normal to require advisors to have a “vesting period.” This is a period during which your advisors are receiving shares in your company but do not unconditionally own them. If things don’t work out between you and the advisor by the end of this period, the company can buy back the shares at their original price. This prevents predatory advisors from making money off of your work and the work of other advisors without contributing. Suppose that you have three advisors being paid in shares but operating on a vesting period, which usually lasts between one and three months. If two of the advisors are bringing in quality options and investors and one of them is not, the advisor that is not may see their shares and their value going up despite not having done anything. If you terminate your relationship with that advisor before the end of the vesting period, your company can buy back the shares at their original price. This prevents predatory advisors from trying to gain from the hard work of other advisors, and it recoups your company for the money that it would have lost paying an advisor that didn’t carry their weight.
Another way to further incentivize your advisors is through option grants. Option grants allow an individual to purchase a set number of shares in your company at a set price. An advisor that diligently works for the betterment of your company while sitting in their option grants will see the value of shares in your company go up while the price at which they can buy shares stays stable. An advisor that doesn’t work diligently for your company will see the value of shares stay the same or go down and so will not be rewarded by their option grants.
No two companies are alike, and this is especially true for startups. As a result, the figures in this article should be seen as suggestions rather than words to live by. The way that your funding should be divided depending on the size of funding, the kind of funding, and where it’s coming from. It should also depend on your expenses, the number of investors, their level of activity, and their level of expertise.