So, You Want to be a Start-up Advisor: How to Secure Maximize

As you embark on your journey as a new advisor to founders and startups, here are some over-arching first order principles. Then I will share some content for further consideration later in the article.

1. Align Interests with Founders: - Shared Vision: Ensure your goals align with the founders'. When everyone is working toward the same vision, it creates a more cohesive and effective partnership. Your compensation should reflect the value (expertise, network, etc.) you bring and should be structured in a way that benefits both you and the startup as it grows. I always start from a position of, be founder friendly while considering the other considerations in this article

2. Build Trust Early: - Open Communication: Establish trust through transparent and consistent communication. Be upfront about your expectations and encourage the same from the founders. Trust is the cornerstone of any successful advisory relationship.

3. Stay Flexible and Adaptable: - Startup Dynamics: Startups are often agile and dynamic organisms. They can even be unpredictable, and the needs of the business can change rapidly. Be prepared to adapt your role and contributions as the company evolves, and remain open to renegotiating terms if necessary.

4. Value Your Time and Expertise: - Set Boundaries: Your time and expertise are valuable, so set clear boundaries and manage expectations from the outset. Make sure the founders understand the level of commitment you’re providing and the value it brings to the table. Time, frequency of contact, and responsiveness to the founder are some of the top considerations.

5. Know When to Step Back: - Assessing Impact: Regularly evaluate the impact of your contributions. If you find that your expertise is no longer as valuable to the startup, or if your involvement is lessening, it might be time to step back or renegotiate your role.

6. Network Strategically: - Leverage Connections: Your network is one of your biggest assets as an advisor. Use it strategically to open doors for the startup, but also to stay informed about trends, opportunities, and potential challenges that could affect your advisory role.

7. Focus on Learning: - Continuous Improvement: Every startup you advise will provide unique learning opportunities. Be curious and open to new experiences, and use these insights to refine your approach as an advisor. Have your own network of mentors and advisors. For me many of these people are friends who are a a few years down this path. I refer to them as near-peers. Ross Guieb and Joseph Kopser are two that come to mind for me (thanks men!). Then pay it forward when the opportunity presents itself.

8. Document Everything: - Clear Agreements: Ensure that all agreements, especially those related to compensation, roles, and responsibilities, are clearly documented. This protects both you and the startup and prevents misunderstandings. Have a financial, legal and tax specialist review a final draft contract

9. Protect Your Reputation: - Long-Term Thinking: Your reputation as an advisor is built on trust, reliability, and the value you provide. Be mindful of the startups you choose to work with and always act in a way that upholds your professional integrity.

10. Enjoy the Journey: - Embrace the Experience: Advising startups can be incredibly rewarding. It’s a chance to make a significant impact, mentor emerging leaders, learn, and be part of innovative ventures. Enjoy the process and the unique experiences that come with it. Starting as an advisor is an exciting and impactful role. By approaching it with clarity, strategic thinking, and a commitment to continuous learning, you’ll be well-equipped to succeed and help the startups you work with thrive. Now here's some additional and more nuts and bolts wisdom.

Compensation, Taxes and More:

1. Equity Compensation: - Type of Equity: - Stock Options: These give the advisor the right to purchase company shares at a fixed price (exercise price) after a certain period. The potential benefit comes if the company's valuation increases, making the shares more valuable than the exercise price. - Restricted Stock Units (RSUs): RSUs are grants of company shares that are vested over time. Once vested, they become actual shares that the advisor owns. Unlike options, there’s no need to purchase them. - Direct Equity Grants: This involves giving the advisor a percentage of ownership outright. It’s more common in early-stage companies and may come with voting rights and dividends. - Vesting Schedule: - Standard Vesting: A typical vesting schedule is over four years with a one-year cliff. This means that after one year, the advisor would earn 25% of the equity, and the rest would vest monthly or quarterly over the remaining three years. The cliff protects the company from giving away equity to someone who may not stay engaged long-term. - Accelerated Vesting: In some cases, advisors may negotiate accelerated vesting, especially if the company is acquired or reaches certain milestones. - Equity Percentage: - Market Standards: The percentage of equity can vary widely depending on the stage of the startup and the advisor's value. Early-stage companies might offer anywhere from 0.25% to 2%, while more mature startups may offer less. - Dilution Protection: - Anti-Dilution Clauses: These are less common but can be negotiated to protect the advisor's equity from being significantly diluted in future funding rounds. Anti-Dilution Provisions Anti-dilution provisions are contractual mechanisms designed to protect the value of an advisor’s equity in a company, particularly in situations where the company issues new shares that could dilute the advisor's ownership percentage.

a. Understanding Dilution: - Dilution Basics: When a company issues new shares, the percentage ownership of existing shareholders (including advisors) decreases unless they purchase additional shares to maintain their percentage. This can reduce the value of the advisor’s stake, especially if the new shares are issued at a lower price than the previous ones (a "down round"). - Example: Suppose you hold 1% of a company with 1,000 shares, so you own 10 shares. If the company issues 500 new shares to raise funds, and you don't buy any of the new shares, your ownership drops to 0.67% (10 shares out of 1,500 total shares).

b. Types of Anti-Dilution Provisions: - Full-Ratchet Anti-Dilution: - Mechanism: This is the most aggressive form of anti-dilution protection. It adjusts the advisor's equity as if they had purchased the new shares at the lower price of the down round. - Impact: It can significantly increase the number of shares the advisor receives to compensate for the dilution. However, it's rarely granted because it can heavily impact other shareholders, especially the founders. - Weighted-Average Anti-Dilution: - Broad-Based Weighted Average: - Mechanism: This provision adjusts the price at which the advisor's equity was granted based on a weighted average of the previous and new share prices and the number of shares issued. - Impact: It provides more protection than no anti-dilution but less than full-ratchet, balancing the interests of all shareholders. - Narrow-Based Weighted Average: - Mechanism: Similar to the broad-based method but only considers the shares issued in the new round and the price difference. - Impact: Slightly more favorable to existing shareholders than the broad-based method, but still less protective than full-ratchet.

c. Negotiating Anti-Dilution Clauses: - When to Ask: Advisors might negotiate anti-dilution protection if they are making a significant contribution to the company and the equity stake represents a substantial part of their compensation. - Limitations: Companies may resist strong anti-dilution provisions because they can complicate future fundraising and dilute the interests of other shareholders. As such, broad-based weighted-average adjustments are more common.

2. Cash Compensation: - Retainer Fees: - Regular Payments: Retainer fees provide a steady income for the advisor, ensuring they're compensated for ongoing involvement regardless of specific outcomes. This could be a fixed amount paid monthly or quarterly. - Scope of Work: The retainer amount should reflect the expected level of involvement and can be adjusted if the advisor’s role expands. - Performance-Based Bonuses: - Milestone Achievements: Bonuses can be tied to specific achievements, such as securing a certain amount of investment or landing key clients. This aligns the advisor's incentives with the company's success. - Bonus Structure: Define clear metrics and timelines for achieving these bonuses to avoid misunderstandings.

3. Success Fees: - Introduction Fees: - Deal Closure: If the advisor introduces a business opportunity or investor that leads to a closed deal, they can earn a success fee. This fee could be a fixed dollar amount or a percentage of the deal size (e.g., 1-5% of the investment raised). - Timing and Payment: Clearly define when the fee is due—often upon the closing of the deal or receipt of funds. - Revenue Share: - Ongoing Revenue: For advisors bringing in significant business, a revenue-sharing model might be appropriate, where the advisor earns a percentage of revenue generated by the deals they’ve facilitated. - Duration: Determine how long the advisor is entitled to this revenue share—this could be for a few years or until the customer or deal is no longer active. - Exit Bonus: - M&A or IPO: If the advisor’s efforts contribute to a successful exit (e.g., an acquisition or public offering), they might be entitled to an additional bonus. This could be a lump sum payment or additional equity.

4. Advisory Time Commitment: - Time Expectations: - Defined Scope: Clearly outline how many hours per week or month the advisor is expected to contribute. This helps manage expectations and prevents over-commitment. - Deliverables: Specify any regular deliverables or meetings the advisor is expected to attend. - Additional Consulting Fees: - Extra Work: If the advisor’s workload increases beyond what was initially agreed upon, they should be compensated for the extra time. Set a clear hourly or daily rate for this additional work.

5. Expense Reimbursement: - Travel and Accommodation: - Business Travel: If the advisor needs to travel for meetings, conferences, or other business purposes, the company should cover reasonable travel and accommodation expenses. Define what is considered reasonable, such as economy vs. business class flights or hotel standards. - Miscellaneous Costs: - Other Expenses: This might include software tools, professional memberships, or communication costs. Ensure there’s a clear process for submitting and reimbursing these expenses.

6. Intellectual Property and Confidentiality: - IP Rights: - Ownership: Clarify who owns any intellectual property (IP) developed by the advisor during the engagement. Typically, the company would own the IP, but the advisor should ensure they can retain rights to their pre-existing IP. - Non-Disclosure Agreement (NDA): - Confidentiality: An NDA should be in place to protect both parties. The advisor will likely receive sensitive company information, and the company may also need to protect the advisor’s proprietary information.

7. Termination and Exit Clauses: - Termination for Cause: - Defined Causes: The contract should clearly outline the conditions under which either party can terminate the agreement, such as breach of contract, failure to meet expectations, or misconduct. - Consequences: Include the consequences of termination, particularly regarding the vesting of equity. For instance, if terminated for cause, the advisor may lose any unvested equity. - Post-Termination Involvement: - Equity and Fees: Define what happens to the advisor’s equity or any success fees if the engagement ends. The advisor may negotiate to retain vested equity or receive a portion of success fees for deals they were instrumental in setting up.

8. Tax Considerations: - Tax Treatment of Equity: - Tax Implications: Different types of equity compensation have different tax implications. For example, stock options might be taxed at the time of exercise and later upon sale, while RSUs are usually taxed as ordinary income when they vest. - Section 83(b) Election: For advisors receiving stock options, making an 83(b) election could allow them to pay taxes on the fair market value of the shares at the time of grant, potentially reducing their tax liability if the shares appreciate significantly. - Withholding Taxes: - Obligations: The company may have obligations to withhold taxes on certain cash or equity payments to the advisor, particularly if they’re classified as an employee rather than an independent contractor.

Filing an 83(b) Election Section 83(b) of the Internal Revenue Code allows advisors who receive restricted equity (like stock options or restricted stock) to elect to be taxed on the value of the stock at the time of grant rather than at the time of vesting. This can be beneficial if the stock's value is expected to increase significantly.

a. Why File an 83(b) Election? - Avoid Higher Taxes Later: If you believe the value of the company's stock will rise over time, filing an 83(b) election allows you to lock in the current (often lower) value of the stock for tax purposes. You pay tax on this lower value now, potentially reducing your overall tax burden. - Capital Gains Treatment: If you file an 83(b) election and hold the stock for at least one year after vesting, any gain on the sale of the stock is taxed at the more favorable long-term capital gains rate rather than as ordinary income. - Risk of Loss: The risk with an 83(b) election is that if the stock decreases in value or the advisor leaves before the stock vests, they may have paid taxes on equity that is worth less or even worthless.

b. How to File an 83(b) Election: - Timing: You must file the 83(b) election with the IRS within 30 days of receiving the restricted stock or options. There are no exceptions to this deadline. - Content: The 83(b) election filing must include: - Your name, address, and Social Security Number. - A description of the property received. - The date on which the property was received. - The fair market value of the property at the time of receipt. - The amount paid for the property (if anything). - A statement that you are making an election under Section 83(b). - Copies: Send a copy of the election to the IRS, and provide one to the company and keep one for your records. You should also attach a copy to your income tax return for the year the election was made. #### c. Example of an 83(b) Election: - Scenario: You receive 10,000 shares of restricted stock at a startup, and the current value is $0.10 per share. Without an 83(b) election, you would be taxed on the value when the shares vest, which might be $5.00 per share in a few years. With an 83(b) election, you pay taxes now on the $1,000 value ($0.10 10,000), and any future appreciation is taxed as capital gains. - Outcome:* If the shares increase to $5.00 when they vest, you avoid paying taxes on $50,000 of ordinary income, instead paying capital gains tax when you eventually sell the shares. ### Conclusion: Both anti-dilution provisions and an 83(b) election are powerful tools that can help protect and optimize the value of an advisor’s equity compensation. Understanding these mechanisms can significantly affect the financial outcomes of your advisory role, making it essential to consider them when negotiating your compensation package.

9. Legal and Regulatory Compliance: - Regulatory Considerations: - SEC Compliance: When introducing investors, the advisor needs to ensure compliance with SEC regulations to avoid any legal issues. This could involve understanding rules around broker-dealer registration, accredited investor criteria, and anti-fraud provisions. - Employment vs. Independent Contractor: - Proper Classification: It’s crucial to properly classify the advisor’s role to avoid issues with employment law. If the advisor is an independent contractor, the contract should specify this, and both parties should adhere to guidelines that distinguish independent contractors from employees. By carefully considering and addressing each of these areas in the contract, a first-time advisor can protect their interests while ensuring a fair and productive relationship with the founders and startups they are advising.

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