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Advisor Equity: A Powerful Incentive or Potential Pitfall?

Published On
May 24, 2023
Read Time
Shanti Mohan

Bringing on advisors or people who can help you is critical for an early-stage startup, particularly a first-time founder. A startup advisor brings impressive connections and valuable insights that help navigate those early days. 

But more importantly, a founder can draw upon an advisor’s experience to make smarter decisions.

However, with advisors, you have to make sure they have skin in the game, which means offering some form of compensation. The most common setup is advisor equity. But because issuing equity comes with risks like overcompensation and dilution, the decision is not cut and dried.

Let’s elaborate on the topic in detail. 

What is Advisor Equity?

Advisor equity offers advisors a small percentage of equity, including stock options, restricted stock units, or warrants, in your company in exchange for their time, expertise, and support. 

The idea is that giving the advisor a stake in the company ties them to your success.

Advisor Equity: Should You Offer?

Advisors often have multiple engagements and are quite busy. In this context, equity becomes a powerful incentive, as it makes it worth their while to commit time and resources to your startup. 

It also aligns interests, as the advisor is more invested in your company’s growth.

On the other hand, giving away equity dilutes ownership and limits the ability to raise future funding rounds. 

Additionally, if the advisor’s contributions are minimal, you give away valuable equity for little or no return. So, you genuinely want to ensure the advisor will lend value.

Ultimately, whether you offer equity depends on specific circumstances and the startup's needs. For example:

  • Equity becomes a commanding tool if you’re struggling to attract high-quality advisors.
  • You may not need to offer equity as a motivator if you already have a strong advisory board.

Navigating Advisor Equity: How Much to Offer?

There are methods to calculate advisor equity, like the "Travis Kalanick" method or the guideline method (FAST agreement). 

Alternatively, you can use Paul Graham’s formula: "give up n% of your company if what you trade it for improves your average outcome enough that the (100 - n) % you have left is worth more than the whole company was before."

However, there is no one-size-fits-all answer to how much advisor equity to offer, as there is a great deal at play, including:

  • The startup stage
  • The type of advisor and their experience and expertise
  • The time commitment required
  • The advisor’s network and connections

Essentially, it should be based on the value that they bring. A general rule of thumb is a range of 0.1% to 2.5%. This may be granted at once or vest over time, with either no cliff or a 6-month cliff.

  • An advisor who brings only name value may get 0.25%
  • An advisor who brings value no one else can create would get more.

Be thoughtful and strategic when determining equity grants. Consult a legal or financial advisor to determine the appropriate percentage if necessary.

How to Go Back on Advisor Equity?

It is possible to undo or reclaim an advisor equity arrangement. Nevertheless, it can be a complex and potentially expensive process, notably if the advisor has already exercised their equity.

1. Terminate the agreement

 Review the terms for any provisions for undoing the equity grant. Or check if the advisor has breached a term, and you can reclaim the stake.

2. Negotiate a buyout

 If the advisor has not yet exercised their equity, offer a cash buyout or a reduced equity stake.

Advisors are valuable allies in the startup ecosystem, and burning bridges unnecessarily can damage reputations. 

So approach the situation carefully and respectfully. The best option is to simply wait for the equity to expire.

Final Thoughts

Building a startup is a tough road, and you want to talk to people who have done it before. But if you’re trading equity for it, the value they offer should make you richer.

Make that the crux of your decision. If offering equity increases your startup's worth and puts you net ahead, you should do it.

Visit Scalix if you're a founder looking for expert guidance on navigating the world of advisor equity. 

We help startups get the initial thrust they need by connecting them with the right community of founders, investors, and more.

Contact us today!