The Case of the Ace Advisor

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HEIDI: Welcome to the Startup Solution and “The Case of the Ace Advisor.” I’m Heidi Roizen from Threshold Ventures.

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I’m a big fan of advisors for startups. Advisors can help you with their knowledge and their networks. And their reputations can bring further credibility to you and your startup. Many advisors are willing to work in exchange for equity, which essentially means that they’ll only get paid if you end up winning, too – and I like that kind of alignment. 

But like most things, there’s a right way and a wrong way to work with advisors. And based on this voicemail, I think a student of mine, who we’ll call Miles, may be heading down the wrong way. 

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MILES:  Hey Heidi, it’s Miles. I’m raising my seed round right now, and one of our investors I really like introduced me to this professor at Cal. He’s an expert in biomedical engineering. We talked and really hit it off, and I’m thinking about asking him to help us out, maybe by starting an advisory board and having him join. He’s got a reputation that’s interesting, so having him in our pitch deck could be really attractive to investors. And I figured he’ll be helpful to me in other ways, too. So, I was going to reach out to him today and ask him to join, but before I do, I thought maybe you could help me with how to approach this and what to offer in terms of comp and anything else I should be aware of. Thanks.

HEIDI: Generally, I like how Miles is thinking. Advisor roles can be perfect for industry experts like the type of person he’s describing – people who don’t necessarily want or need a full-time job – but who can still add great value even with only a few hours or days per month. But there are some warning signs in his message that he’s setting this up in the wrong way.

This wrong way usually starts out with an innocent first step: the entrepreneur mostly wants to burnish their pitch deck with an advisory board of important people. They hope those smiling faces and big titles will add sparkle to their little company. So, the entrepreneur works with their network to reach those big shots and then offers them shares for little or no work – maybe just being available to the entrepreneur for occasional advice and maybe an advisory board dinner now and then.

Many advisors who agree to these arrangements are themselves well-meaning people who just want to be helpful. Plus, maybe they like the idea of being associated with a startup. And they certainly don’t mind receiving some startup shares – which probably seem kind of like free lottery tickets to them. So far, no real harm.

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Now, armed with a pitch deck sparkling with shiny advisors, the entrepreneur goes out to raise money. And investors like me do tend to be impressed when we see those big names in the deck. That is until we call those advisors and find out that they really don’t know much at all about the company. That is not impressive – and it may even worry us a bit, like, what else might be overblown in that pitch deck? 

If the fundraising process drags on, the entrepreneur may ask the advisor for some real help, but what they need now is not so much industry advice as to help with fundraising. So, they ask the advisor to make intros to investors or to put on the hard sell if called by investors. 

The advisor, at this point, still doesn’t know that much about the company or the entrepreneur since neither side has put any time into the relationship yet. And, since they were originally asked only to ‘help with some advice here or there’ – they now feel like this wasn’t at all the deal they signed up for. So, they might just say, ‘Sorry, I can’t be helpful with the fundraise’. Or worse, they might decide that this isn’t a good fit for them after all and resign. And that’s a bad look for everyone involved.

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I don’t want Miles to head down that path, but I still think advisors can be great. So, I need to give him a quick education about how to work with them.

First, Miles needs to understand why he's recruiting an advisor – and then make it clear to that advisor, too. So many approaches are so loose, like, ‘Oh, just generally be helpful when I ask.’ But I think that’s a recipe for mismatched expectations and ultimate failure. 

Instead, Miles should explicitly define the elements of an advisor relationship in terms of what specific help would be expected right up front.  

Entrepreneurs often make the mistake of thinking that an advisor should, in essence, do anything they ask of them. But that’s not how most advisors think. An advisor may be perfectly willing to help with strategic brainstorming or provide product feedback – but they may not, for example, be willing to vouch for the entrepreneur or open their network to that entrepreneur. At least that is until they know a lot more about the company and the person. Or the advisor may want to wait even longer to open doors if they feel that the company is not ready yet. And that may be really frustrating to the entrepreneur – even though I think it’s fair.

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But these problems are pretty easy to avoid. You just need to talk about them upfront. 

When I talked to Miles about his potential advisor, who I’ll call the Professor, Miles had a very clear picture of what he wanted from him. Miles wanted the Professor to understand the product sufficiently to be able to talk about it in a reasonable amount of detail if investors called. He also wanted the Professor to open doors for him inside his biomedical network so that Miles could seek potential development and sales partnerships. And, of course, Miles wanted to put the Professor in his pitch deck. I thought these were reasonable asks and suggested he write them down in detail so that what’s being asked is not only clear but could ultimately be codified in a written agreement.

Even the more mundane, logistical stuff should also be discussed in advance and captured in writing. Is the Professor expected to spend, say, three days a month working on the company? Is he required to spend some time on-site? Is he expected to travel for the company? Is he expected to answer phone calls and emails? And roughly how much time per week or month will he be committing to do all this?  

And remember, in order for the Professor to start being truly helpful, he’s going to have to spend some time, probably with Miles, getting up to speed on the specifics of the company and the product. So be sure to bake that into the time commitment, too.

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Most advisor agreements I’ve seen start out with something simple, like a set of expected activities and an approximate time commitment from the advisor. I’ve seen some people set up detailed time tracking for advisory work, but in my experience, an honor system works perfectly well.

Let me cover a few more things that should be captured in the agreement upfront. You’ll want to cover the intellectual property rights if your advisor is going to be involved in any technical advising. If exclusivity is important to you, that is, if you don’t want your advisor showing up on the pitch decks of your competition, you’ll want to pin that down as well. If you’ll be sharing confidential information with your advisor, you’ll want to be specific as to how that will be treated. Many advisor agreements also include a clause on conflict resolution because sad as it is, some agreements do end up going sour. And finally, you’ll want to specify how long the agreement is for and how the advisor gets paid.

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Let’s do the easy one first: how long the agreement is for. Until you learn how well you work together and how much value they’ll bring, I’d go for something short, like six months. Then you have a built-in “out” if you’re not seeing the value you expected. Some entrepreneurs really don’t like the idea of having advisors who don’t pan out getting shares, so they put in a condition that no stock is earned if things don’t work out in, say, the first three months.

I think that structure is a bit unfair to the advisor, who’d end up working for free for many months. But one way to thread the needle on this is to have the option to pay them in cash at the end of the time period if you don’t want to settle in equity and want to close out the relationship. For the right exchange rate, I’ve found most experienced advisors understand why this is desirable and will agree to it. 

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And as for that exchange rate, that’s part of the harder topic we’ve arrived at now: how to calculate pay. 

Of course, this is going to be a negotiation between you and your advisor. You’ll need to figure out what their market rate is and then create some way to translate that value into equity. Whatever number you come up with, you’ll want to be sure you gut-check it against your overall company compensation philosophy to make sure it measures fairly against what you pay everyone else.

Now we just have to figure out what that number is!

When I try googling ‘what to pay a startup advisor,’ I get lots of different answers, most in the percentage of the startup since most advisory positions are stock-only compensation. I don’t really know how you can say something like ‘an advisor should be paid one-fifth of a percent up to two percent’ when there’s no discussion of what value the advisor provides or what a percent of the company is worth. That’s just not very helpful.

So, instead, I have a way to arrive at a number that may sound completely unscientific to you, but I’ve used it over and over again, and it seems to result in a number that’s at least in the ballpark for both the advisor and the company.

First, find out the advisor’s typical billable time rate for consulting, which they’ll already know or be able to guesstimate based on their current comp and industry peers. Now, multiply that by the time you expect them to spend per month to get the dollar amount that you’d pay them per month if you were doing this in cash.

Now, multiply that number by four. 

Why four? Well, here’s the super unscientific part. I multiply by four because the actual compensation is in something the advisor can’t make liquid for probably many years. Plus, startups are risky. So, being paid four times your cash rate for something you can’t access for years and may be worth nothing seems like a decent risk adjustment to me. 

If you don’t like four, you’re welcome to try out other multipliers, but this one has served me pretty well over the years. And it seems to make sense to the advisors I’ve worked with as well. Honestly, most people wouldn’t take a deal at four times their billing rate, paid many years later, with a more than 50% chance it will actually result in no pay at all. But then again, there’s also the upside to consider – after all, this is private company stock, so there’s always the chance that it may be a big winner, and then it’ll be worth way more than four times. And that extra potential may be enough to motivate the advisor to take the leap.

Of course, how you translate the 4x cash rate into a number of shares is a bit squishy, too. Some companies use options, while some use Restricted Stock Units – or RSUs – which are inherently different in how they’re valued. Some companies use the 409a valuation to calculate value, while some, especially those who are at a very early stage and haven’t raised much money, may argue that the preferred share price is a better reflection of the current value. I wish I had a concrete answer for you, but there’s no perfect solution. I’d suggest you try it a few different ways, model the outcomes, and see if the numbers you get make sense to you. If not, keep trying other approaches until something feels right.

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Another heuristic you can use to test the number you get is that independent director grants are often similar in value to VP grants, while advisor grants are often similar in value to director-level employee grants. But even as I say this, I’m cringing a little because none of these are perfect proxies. And, of course, if you’re asking your advisor for a lot of time, you’re going to have to pay them even more. If all this still befuddles you, feel free to run it all by an experienced startup compensation consultant. Your attorney probably has a decent idea of the going rates for advisors, too.

And speaking of attorneys, it’s a good idea to use one to finalize the paperwork. Luckily, a number of great law firms have posted advisor agreement templates that cover all the basics, including an advisor agreement generator by the law firm Cooley. It’s a great place to start and should save you some legal fees. I’ve posted a link to it in the show notes.

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I would hope that this goes without saying, but bringing on an advisor is not that different from bringing on an employee. You should first be doing your due diligence on them, including reference checks, especially if you’re going to post them on your website and include them in your pitch deck.

Let me also say a few things that advisors are not. In my book, if you hire someone to raise funds for you and you compensate them with a percentage of the funds raised, whether in cash or equity, that’s not an advisor; that’s a broker. And as The Entrepreneur’s Handbook puts it so succinctly, anyone offering to introduce you to investors in return for a commission or a finder’s fee is breaking the law unless they’re a registered broker/dealer. Also, many VCs, myself included, don’t really like to be pitched by a third party for a startup fundraise. At the early stages of a company’s life, our relationship needs to be with the entrepreneur, and that’s who we want to hear from.   

I’ve also seen some entrepreneurs try to create complicated performance-based advisor agreements, with lots of deliverables and measurements and variable pay based on those. I’ve never seen that work well, and when I ask my partners about this, none of them have either. So, if you want to create some form of incentive payment for sales or other measurable returns, I’d recommend something more industry-standard, like a plain old commission agreement settled with cash.

Oh, and one final point. In the very beginning, Miles talked about asking the Professor to join an advisory “board.” From my experience, especially for early-stage companies, you get far more from an advisor if you craft the expectations individually for each advisor and then manage those expectations one-on-one as time progresses. If you want to call it an advisory board on your slide deck, sure, be my guest. But unlike a board of directors, a board of advisors has no real legal or fiduciary responsibility, so it doesn’t really mean anything. 

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Let’s get back to Miles and the Professor. Let’s say he hammers out a contract, and they agree on compensation; what happens next?

Well, like anything else, advisor relationships need to be managed. Most advisors are more responsive than proactive, at least in the beginning, because you know more about what you want than they do. So be sure you set aside time in the beginning, and then at least monthly, to check in, review what’s been accomplished, and ask for what you’d like to see next. And if they’re not fulfilling your expectations, let them know what you need. I’ve been an advisor a number of times, and I’ve always appreciated clear communication from the entrepreneur about what they need. So don’t be shy.    

At the end of the six months, Miles can negotiate a re-up, or if it doesn't deliver the value that he wanted, he can thank the Professor and sunset the relationship with no hard feelings. As I mentioned earlier, some entrepreneurs specify that at the end of the period, they can simply pay out the contract in cash instead of stock. In that case, it’s not necessary to pay at the ‘4x’ rate since that was a multiplier for time and risk, which no longer applies in a cash deal.    

On the other hand, if both Miles and the professor are excited about continuing the relationship, he could put together a longer-term contract. But even then, I’d suggest two years at the max. In my experience, as a company grows, you’ll end up wanting different advisors with different types of experience, and the ones you had at the beginning may no longer have much to add.

If Miles really likes the Professor and wants to give him a bigger role, there may be the option to promote him to an independent director. The independent director role is different from the advisor role, but there is some overlap, and once you’ve worked with an advisor for a while, you’ll develop a good sense of their potential for a more fiduciary director role. I’ll be covering independent directors in season three of The Startup Solution, so stay tuned.

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And what can you learn from “The Case of the Ace Advisor?”

First, advisors can be a great addition to your team, but it’s important to explicitly define the body of work to be done to avoid mismatched expectations.

Second, it’s also important to be specific about time commitment, exclusivity, confidentiality, and, of course, compensation.

Third, consider opting for shorter advisor contracts, like six months, so you can get a feel for the value that will be delivered before paying for more.

Fourth, treat this like any other key hire, including due diligence and reference checks, to ensure the person is the right fit for your startup.

And finally, manage the relationship with frequent communication and course correcting to make sure you’re getting the maximum value out of your advisor.

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HEIDI: And that concludes “The Case of the Ace Advisor.” Thanks for listening to The Startup Solution.  We hope you’ve enjoyed this episode, and if you have, please pass it along to someone who could use it. I’m Heidi Roizen from Threshold Ventures.

Further Reading

Here’s a rundown from MentorCruise on all things advisor, from what they are to how to contract for and pay for them.  

Here’s a great summary of how not to choose and work with an advisor, from the entrepreneur’s perspective. Author Tony Clemendor mentions some bad practices I often see, and I agree should be avoided.

I highly recommend using your attorney to craft an advisor agreement, but looking at a few templates can help inform you. Here and here are a few examples, while the law firm Cooley has an advisor agreement document generator that you can use as well as more advice here. 

And for those of you who want to know more about my stance against ‘fundraising advisors, ’ see this excellent post by DC Palter: Why Using an Agent for Startups is a Deal Killer for Startups

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