Startups

Equity Grants to Startup Advisors

By Mark Tyson

October 13, 2021

Early stage startup founders often work with advisors. These advisors tend to be experienced entrepreneurs who enjoy giving back to the startup community. While their motives in helping out may not be primarily commercial, advisors do usually expect to receive a small equity grant. For some startups, this equity grant may be the first non-founder equity issuance, which can (or at least should) prompt questions about how to do it properly and within prevailing industry norms.

Types of Equity

Let’s start with the types of equity advisors are usually issued. The two most common types are common stock and stock options.

If the company is at a very early stage and the fair market value of its common stock is very low, then it may be feasible to issue common stock to an advisor. If, on the other hand, the company has raised a round of financing or has otherwise seen a meaningful increase in the fair market value of its common stock, then the typical approach is to issue stock options to advisors. This allows the advisor to defer the decision on whether to purchase shares until a later date when the startup (and thus the investment) has been further de-risked.

Tip: Advisors may only receive non-qualified stock options given that they are not employees and are thus not eligible to receive incentive stock options.

Size of Awards

Don’t issue big equity awards to your advisors. This is rarely appropriate. With some exceptions, the ceiling for an advisor equity award should be 1% of the company. Realistically, the possible range will likely be 0.1%-1%.

One popular template, the FAST Agreement, sets out a matrix ranging between 0.30% and 1%. The variables considered are advisor performance level and company stage.

Carta looked at data from advisor equity issued in 2019 for companies that have raised under $2M and found the following data:

Common stock grants ranged from 0.2%-1% of the company
Stock option grants raged from 0.1%-0.5% of the company

Seeing a higher range for common stock grants makes sense. Granting common stock is usually only viable if the fair market value of the company’s common stock is still quite low, meaning that the advisor would have to join early, and joining early—as we see in the FAST Agreement and in general with equity and early stage startups—tends to be rewarded.

Advisor Agreement

A startup should present an advisor agreement to the advisor for signature detailing the nature of the advisor’s relationship with the company. The FAST Agreement mentioned above is a commonly used template but there are other template versions from Carta, Clerky, and others. It’s worth linking up with your lawyer on this to ensure everything is in order, but the need for legal involvement should be minimal here.

One thing to make sure of is that the agreement specifies that the equity award will be granted subject to the approval of the board of directors. It’s also important to specify the number of shares to be purchased or the number of shares the grantee will have the option to purchase. Startups often specify a percentage rather than a specific number, which can create unnecessary ambiguity which can lead to disputes.

To be clear, it is helpful to reach an understanding with the advisor about the percentage ownership the equity grant will represent in the company at the time of the grant. But when it comes time to document the offer, it’s important to express the actual number of shares. If you instead write in a percentage and then there’s a delay between the offer and the actual grant—a common occurrence, as discussed more below—the company’s ownership structure may look very different by the time the grant is actually made.

Timing

It’s not uncommon to have an advisor informally helping a startup for a period of time before any equity is granted. After all early stage startups are notoriously chaotic and disorganized and unless something is mission critical, it doesn’t get done. Ideally, though, startups won’t wait too long to issue equity to advisors, otherwise the advisor’s strike price—the price at which it has an option to purchase shares—may end up being significantly higher.

For instance, if a startup waits until it has a term sheet from an investor, it is too late at that point to grant equity to an advisor. The startup will need to wait until after it closes the investment round and gets a fresh 409A valuation, which will then be used to set the strike price for the option grant to the advisor. Unfortunately for the advisor, this means the strike price will be higher than if the grant had been made several months earlier when there was no term sheet on the table. This does happen with some frequency and it’s not the end of the world, but your advisor will be happier if you take care of the equity grant when the strike price is still quite low.

Vesting

Vesting for advisor grants is common, but the vesting periods are almost always shorter than for founders, employees, and other service providers. Typically vesting is 1-2 years on a monthly basis. There may or may not be a cliff.

Note that the FAST Agreement' default contains a 3-month cliff; however, a cliff may not always be appropriate. For instance, if you have an advisor who you know well and who has been helping out for months prior to getting equity, then a cliff probably isn’t necessary (and may not be well received if proposed). On the other hand, if you’re not sure an advisor is going to add real value, then having a cliff can function like a probation period where you can assess whether the advisor is a good fit before they vest.

Your advisor may ask for single-trigger acceleration. What this means is that the advisor wants all of his or her unvested shares to accelerate and become vested if there is a sale of the company, the “trigger” being the sale of the company. While single-trigger acceleration is not the norm with founders, employees, or other service providers, it can be appropriate to grant to advisors. Usually an advisor’s value to the company is heavily front-loaded, meaning that by the time an acquisition opportunity comes along, the advisor is probably no longer very valuable to the company moving forward. That may result in the acquiring company terminating the relationship with the advisor and cutting off vesting. Having single-trigger acceleration protects an advisor from this scenario.

Exercise

Stock plans typically require vested options to be exercised within 3 months of the holder’s termination, otherwise the option to buy expires. This is a requirement for “incentive stock options” which is the reason most plans default to this, but it is not a requirement for “non-qualified stock options” which is what advisors will get.

Note: Only employees are eligible to receive incentive stock options; everyone else, including advisors, will get non-qualified stock options (assuming options are used).

Advisors can, and some will, negotiate to have the 3-month exercise period extended. Startups should consider agreeing to this request if it is made. If the advisor agreement terminates after, say, 2 years, and the startup is still a ways off from a liquidity event, the advisor may not want (or be able) to pay the exercise price within that 3-month period. However, failing to do so will cause the advisor to lose out on its option to purchase shares. Giving your advisors more time to wait for the startup to de-risk is a good way to establish good will with your advisor.

Takeaways

Doling out equity to advisors isn’t rocket science but, as with many tasks for early stage startups, it’s often done haphazardly and without awareness of the common legal mistakes that are made. Approaching this task with a concrete plan and support from legal will help avoid pitfalls and keep your advisors feeling taken care of.