Equity and Compensation for Advisors and Boards in Startup Exits

When a startup achieves a successful exit, the question of whether the founders should pay advisors and board members naturally arises. This is a complex issue involving legal, financial, and moral considerations. In this article, we will delve into the nuances of equity and compensation for advisors and boards, ensuring that both stakeholders are treated fairly and in accordance with best practices.

Are Advisors and Board Members Entitled to Payments?

Some argue that founders should keep all gains for themselves, viewing advisors and board members as mere "hangers-on." However, it’s important to recognize the significant contributions that these individuals make during the startup’s journey. Advisors provide strategic advice, board members offer governance and oversight, and both groups contribute to the success of the company, even if indirectly.

LEGAL AND FINANCIAL RAMIFICATIONS

From a legal and financial standpoint, advising agreements and board member contracts typically stipulate the manner of compensation. Advisors and board members are generally given equity in the form of options or grants, which vest upon certain conditions, such as the company reaching certain milestones or being acquired. Advisors typically receive a modest amount of equity, often between 0.1% to 0.25% of the company's capitalization, with extraordinary cases allowing for up to 1% of the capitalization. This equity often accelerates upon an acquisition or an initial public offering (IPO), providing significant financial incentives to these stakeholders.

For early-stage boards and advisors, the equity granted typically equates to a substantial payday in case of a large exit. For instance, in a $1 billion exit, a modest 0.1% of $1 billion could amount to a $1 million payday. This compensation is designed to be a fair and motivating reward for their contributions.

In later private company stages, particularly when outside board members are involved, there may be cash compensation for their continuous service. Inside board members, which include founders and investors, often have substantial equity positions from the outset, mitigating the need for additional cash compensation. Advisors become less common in later stages, further emphasizing the equity-based compensation model.

Avoiding Last-Minute Frustrations

One of the most critical aspects of handling equity and compensation is ensuring that these matters are settled well before the exit. Delaying these discussions until the final moments of an exit can lead to unnecessary tensions and legal disputes. If equity and compensation have not been clearly defined and agreed upon in advance, it’s high time to address these with transparency and fairness.

It’s also important to note that any back compensation, unpaid expenses, or other debts are usually settled during the exit process. This ensures a smooth transition and maintains the trust and cooperation between all parties involved.

Best Practices for Equity and Compensation

To ensure that advisors and board members are properly recognized and compensated for their contributions, here are some best practices:

Clear Agreements: Draft and sign clear, legally binding agreements that outline the terms of equity or cash compensation. These agreements should be comprehensive and cover all aspects, including vesting schedules, conditions for acceleration, and the specifics of equity or cash payments. Transparency: Be transparent in all discussions related to equity and compensation. This fosters trust and ensures that all parties have a clear understanding of the terms. Fairness: Be equitable in the distribution of compensation. Advisors and board members have varying levels of commitment and contributions, so tailor the compensation packages to reflect these differences. Legal Advice: Consult with legal counsel to ensure that the agreements are legally sound and aligned with industry practices.

Managing equity and compensation in a startup is a delicate process that requires careful planning and transparent communication. By following these best practices, founders can ensure that all stakeholders are treated fairly and justly, leading to a successful and peaceful exit.

Conclusion

A startup’s journey is challenging and complex, with a multitude of stakeholders contributing to its success. Properly compensating advisors and board members through a well-defined equity and compensation model is not only the fair thing to do, but it also aligns the interests of all parties, fostering a positive and productive relationship. After all, the true success of a startup lies in the collective efforts of all those involved.

By ensuring that stakeholders are fairly compensated, startups can create a culture of trust and cooperation, leading to a smooth and successful exit. It's essential to keep these considerations in mind as the company navigates its journey, from the early stages to the final exit.