Advisory Boards - Fair Compensation

Angel to Exit is all about providing advice to startups and SMBs wishing to grow. We do this by providing free online information and for-fee services. The for-fee services include our live (online and in person) "Go To Angel" pitch sessions and advisory board services.

One of the most frequent questions we get is about advisory board compensation.

Of course as companies move on to VC funding levels ($5M in revenues for example), these numbers may make sense.

What does good executive advice cost?

Here's a simple way to calculate the value of a good advisor's time. What do you pay your lawyer?

But few startups can afford to actually pay that much.

Be warned:

History shows that, even for companies that are already funded by angel groups who have done in-depth due diligence, 70% return less than the investment over 10 years. Another 22% return from 1x to 10x over that same period. So investment is about break-even for 92% of the startups, and only better (actually beneficial) for the remaining 8%. I will simplify this to a 10% chance of success, or a 90% chance of failure.

Taking the odds into account

If you spend ~2h/mo advising a company, which is the minimum for most advisory board members, and way less than what a lead of an advisory board spends, you need to get an actual $1000 for that company for that month.

That is the reasonable and fair compensation for the advisor who starts with you and stays till the average exit, and who gets equity only.

Now let's look at exits

Successful exits are on the order of 20x for angels. Average angel investments are about $500K for 25% equity, and earlier stage investments are better leveraged than that. That means that a $40M exit would be 20x at the angel invested stage, and that at an earlier stage, where the risk is even higher, 20x would be at $20M.

The experience part

In the late 1990s, I was asked to join an advisory board for a startup in the business of detecting and helping respond to cyber-security (the cyber-name was not used at that time, but I have modernized for your reading pleasure) incidents in near-real-time.

Most startups realistically could use an advisory board member in each of (1) General business issues, (2) Financial issues, (3) Go to market issues, (4) a subject matter expert, and (5) Legal issues. This comes to 5 people, or about 20% equity if fairly compensated.

Most people I have asked (and I have asked and read from quite a few) who advise startups tell them that they should reserve about 5-10% of the equity (non-dilutive preferred) for the advisory board. That is far less than the 20% that would be fair compensation at a very early stage.

Some startups and others I have heard, make the claim that advisors are always given equity and never cash. Here are some facts from a quick survey I did of an executive search firm that specializes in executive and advisory board placements. I looked at for-profit advisory board positions only, for the 50 most recent companies (all startups or close to it by the search criteria). The options (and counts) in the database were "Equity" (16), "Cash" (4), "Equity and Cash" (13), and "Negotiable"(17). Negotiable means a possible combination of equity and cash. Note that the equity-only category has only 16 of 50, or 32% of the cases. I conclude, and my personal experience confirms, that:

Startup advisory board compensation is usually a combination of equity and cash.

So how can the advisor be fairly compensated?

It seems that the fair way to compensate an advisor is a combination of equity and cash adding up to an expected value equal to their alternative income stream. The problem is that startups don't generally have the necessary cash flow to support cash payments for 5 advisors at their reasonable rates. They can, of course, seek out less able advisors and presumably get less able advice. But let's ignore that for now. It is an obvious tradeoff.

Suppose we reserve 5% of equity for an advisory board and decide to pay the rest of the fair 20% in cash. That reduces the pay to just under 3/4 of the previous amount, which doesn't normally adequately solve the problem for the startup, but let's see what we can do.

If the actual pay for the advisor was 3/4 of the fair amount, the pay would be something like 375/h. At 2 hours/mo this comes to $750/mo for each advisor, or $3750/mo for 5 advisors. It's starting to look feasible. But suppose as an early stage company, that will blow out your cash flow. That's when we go to a deferred compensation model for the advisors. Instead of paying them the entire $3750/mo right away, the compensation is deferred, say until there is enough cash flow to be able to afford to pay it.

The idea is to pay $5,000/mo (total value) for the advisory board, but defer the compensation until (and only if) the startup reaches a defined level of cash flow (including all inbound cash flows - funding, sales, loans, etc.). The extra money compensates for the deferred (and conditional) payment, under the theory that a good advisory board will help get 2/3 of early stage companies to the threshold of compensation. If they do worse, they suffer the consequences, and if they do better, it's better for everyone.

This way, for ~$60K/y (for the first year), a really good advisory board may be attained, fairly compensated, and only paid as and if the company can afford it. After the first year, compensation can operate at an hourly rate reasonable for the advisors. They get their combined 5% equity, which is at risk but worth a lot if they succeed. If they are good at what they do and management performs reasonably well, they will start to get paid regularly (and in arrears) 6-12 months into their efforts more than 50% of the time. The rest of the time, the failed (or failing) companies will likely never pay the advisor anything, and the equity will be worthless, but that is compensated for by the successfully funded companies. It's fair to all and fixes the cash flow problem for all.

An improvement on the model

We can do even better of course. There are various mixes of compensation that can meet the needs of advisors and companies, and doing similar calculations for different cases is fine if you are on 3 or 4 advisory boards or have 3-5 advisors for your company. But as a company that does this systematically, A2E had to devise an approach that allows for mismatches in advisors and companies after they start working together, changes in situation, companies that fail, companies that want to continue year after year, and so forth. Here's our current (and ever-evolving) model.

Thus the AB as a whole operates cleanly for the company and the advisors at a known cost and commitment, advisors have a very low cost of customer acquisition, and companies have better and more consistent service.

HOWEVER: Advice is just that. It is humans advising humans who then make decisions based on the advice given. Attempts to automate advice have and will continue to fail to replace the need for experienced people to help startups and SMBs succeed.

The final excuse

Startups have come to me asserting that they aren't going to get funded if (1) they compensate advisors with funding to the company or (2) they don't get investment from advisors who are also angel investors. Here are the facts and understanding based on my experience:

The final excuse is a negotiation tactic. "My company is worth more than the average angel investment" (yes, and we know that all your children are above average as well). A rational advisor just doesn't believe it. We won't get involved in companies we don't think are reasonable on some basis. And we don't buy into the trap of believing what you are trying to sell us. There are lots of opportunities to be on advisory boards, and we know that we are not always good judges of which company will win or lose. We know we are not because we have more failures than successes, as do all angel investors I have ever met. So rational advisors will take the statistical approach and startups can recognize them by the fact that they value themselves and their time.

You can tell they know what they are doing by the fact that they take the Angel to Exit approach!

Note: For every lame excuse you come up with to pay me less, I can come up with a pitch that, if not examined too closely, will seem to justify paying me even more. And that, in itself, is a sound justification for paying me more.

In summary

In the first 90 days of effort by one of our advisory boards, the advisors provided specific advice and contacts that generated ~$6,000/mo in additional income for less than $500/mo in additional expense. This advice alone paid for the entire out of pocket cost of the advisory board for the indefinite future. The board paid for itself many times over in other advice. And this is not an exceptional case. Good advisors help companies make more money at a pace that far outruns the cost of the advisors.

The Angel to Exit model for advisory board compensation is consistent with the fair interests of all parties and within the normal operation of advisory boards and compensation models for the majority of advisory boards studied.

Startups: Don't believe the folks who tell you that advisors rarely get paid in cash, or that good advisors are almost impossible to gain and fairly retain, or that investors will refuse to pay for good advisors. You just have to use a fair compensation model and learn how to present the benefits of your advisory board to the investors.

Good advisors: Don't believe that it's a waste of your time to work on advisory boards for startups. It's not just a time suck, if you use the fair compensation model. Pick your companies well, but get paid fairly for your work in a combination of equity and partially deferred cash.

Copyright(c) Fred Cohen, 2017 - All Rights Reserved