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Founders Beware: True “Advisors” Don’t Ask for Free Equity

Posted on January 25, 2010. Filed under: startups, venture capital | Tags: angel investment, Founders, startups, venture capital |

Fred Wilson wrote a post over the weekend about the importance of role models to early stage founders. The discussion around this post led to the subject of Advisors and Advisory Boards, and I thought I’d take a minute to shed some light on the bright and dark sides of startup advisors.  This post came on the heels of a meeting I had on Friday with a young entrepreneur here in New York with whom I was sharing some fundraising ideas.  At the end of the meeting, we agreed that I’d spend a little more time reviewing his pitch with him and maybe making some introductions to angels, to which he responded “okay, so let me know how you want to structure that and we’ll go from there?”  I asked what he was talking about, and it became clear that he expected to pay me for my advice/help.  I further learned that another now-well-known entrepreneur/investor here in New York (for whom I sort of had respect) had taken a piece of his equity in exchange for “formal advisory services,” and although I didn’t say anything at the time, I was thoroughly disgusted by this “advisor’s” behavior.

Here is my advice to startups trying to secure advice and mentorship from experienced entrepreneurs and executives: advice and guidance in our community is abundant and free…equity in your company is not. This is not to say that you shouldn’t use early equity as a form of compensation to get your company off the ground, but be watchful of the scenarios in which you do so:

Scenario 1 (Complete Bullshit): You meet with a guy/girl who you think could add a lot of value and/or credibility to your project.  At the end of the meeting, they say “I’d love to get involved.  Typically I’d look for 1-2% of a company at your stage, and that 1-2% gets you an hour of my time every week and some great introductions and relationships.”

Savvy founder’s response: Run for the hills.  This “advisor” is a complete predator.  The value they add will not be worth the equity they are asking for, but more importantly, they are trying to take advantage of your lack of experience in this world.  General rule of thumb: anyone who directly asks you for equity in your company without investment is a scumbag.  Stay away.

Scenario 2 (Better, but still not good): You meet a guy/girl who you think could add a lot of value and/or credibility to your project.  At the end of the meeting, they say, “Good luck, let me know if I can be helpful.”

Savvy founder’s response: Build a relationship with this person, continue to seek whatever amount of guidance they are willing to provide out of interest and belief in your project.  If you find you are asking more of them than they are able to give, perhaps offer them the opportunity to invest on favorable terms in your company.  If they believe in what you’re doing, and they have made enough money to part with $25-50K, they will be honored that you are asking…don’t be afraid to.  But, if they say no, don’t say “okay, can I give you some equity to be formally involved?”  If they aren’t going to pony up as an angel investor, a couple fractions of a point (point=1% of equity) is not going to incentivize them to go beyond what they are already willing to give in terms of time/advice/introductions.  Granted, if you make this offer and they accept, they are not a scum bag (as is the case in scenario 1, but the truly righteous and high quality mentors in our community will not accept your freebee. So there is an adverse selection process that occurs when you try to build an advisory board through free equity allocations.

Scenario 3 (Makes Sense): You are missing a key piece of DNA in your company necessary to execute on your plan (i.e. non-technical founder engages outsourced development shop and does not have the domain expertise to effectively manage the project).

Savvy founder’s response: This is actually a scenario where I would advocate parting with some equity to get a “technical advisor” to help manage the project.  But this is not really an advisor at all.  The person you bring on will be performing a day to day role within your company.  In reality, they look more like an independent contractor who is willing to accept equity (as opposed to cash) as payment.

My argument is not that an early stage founder should be stingy with his/her early equity…in fact quite the opposite.  At the onset of a venture, the financial outcome of your company is pretty much binary: either you build something and successfully exit (make a lot of money), or you fail…a couple of points allocated toward increasing the likelihood of a positive outcome are well spent…just make sure they are being spent on actual work and output, as opposed to advice and guidance.

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