Advisors help startups by offering expertise or perspectives that the core founder team may not have. Since most startups don’t have the cash to compensate these advisors, a common way to pay for their guidance is to offer equity.
We are often asked how companies should best go about this. In this guide we cover the types of advisor equity (shares versus options), how vesting can be incorporated, what else to cover, and other common questions.
types of advisor equity
When offering equity to advisors, there are two common roads to take: either giving shares, or granting options. The fundamental difference between shares and options is that if someone owns shares, they are immediately a shareholder in the company. If someone owns options, they have the right to purchase shares in the future.
Shares are a straightforward way to compensate an advisor. In most cases, advisors prefer shares rather than receiving options under the company’s option scheme. Like any share issue, the company will need to pass board and shareholder resolutions, as well as receiving necessary waivers and consents under the constitution and shareholders’ agreement in place. For that reason, a company intending to issue shares to advisors in the future usually carves this out under the constitution and shareholders’ agreement in the same way as they would an ESOP.
Options are an alternative way to compensate an advisor, and can be granted easily if a pool of options (such as an ESOP) has already been established. However, often advisors can come on board before the ESOP is formally set up.
If options are issued to an advisor, in the event that the advisor wants to exercise their options and convert them into shares, they will need to pay the ‘exercise price’, which may be around the price that the investors paid in the last funding round. This means that they will need to come up with cash to exercise their options.
how much to give?
There are different models to decide how much equity to offer. The Founders Institute gives a useful framework based on the stage of the company (idea, startup, or growth) and based on the various levels of engagement. This is really just a guide however.
|Idea Stage||Startup Stage||Growth Stage|
|Standard: Monthly Meetings||0.25%||0.20%||0.15%|
|Strategic: Add Recruiting||0.50%||0.40%||0.30%|
|Expert: Add Contacts & Projects||1.00%||0.80%||0.60%|
Advisor agreements typically have a vesting schedule of around 12-24 months, i.e. they are shorter than vesting schedules for founders and employees under an ESOP. This is because advisors generally bring greater value over a short term. As your startups grow, it cycles through different advisors that fit their applicable stage of growth.
Some advisor agreements also contain some measure of ‘claw back’ if the advisor does not perform make the expected contributions over the agreed period. An alternative to a provision like this would be using a cliff of 3-6 months to provide for a ‘test run’ to see if the relationship is beneficial.
The advisor should agree that all intellectual property and other business, technical and financial information that the advisor obtains from the company or learns in connection with his or her services is appropriately assigned to the company.
As a minimum, the advisor should be subject to confidentiality provisions. You may want to add a no-conflict provision, and also a provision that the advisor complies with certain company policies.
Finally, there is usually a termination right for both parties and sometimes automatic termination if the company has not requested that the advisor render any services for a lengthy period.
Options and shares are treated differently with regards to how they are treated in a tax sense. Generally speaking if you are issued shares for services, you would expect to have an income tax liability whereas options do not trigger a liability until exercised. We recommend obtaining tax and accounting advice before putting in place any advisor agreement.
advisor agreement template
We have produced a simple template agreement that a startup can use when bringing an investor on board. The template is drafted on the basis that the advisor receives shares, and that no cash compensation will be paid. It also provides that some of the shares may be clawed back by the company if the advisor fails to make the expected contributions over the agreed period, which is usually one or two years.
You can download our advisor share agreement template here. If you have any questions regarding the template or want to work with us to draft your advisor agreement, get in touch.