Four Best Practices Every Entrepreneur Should Heed When Structuring Advisor Agreements

By ffVC Associate Andrew Kangpan

The best entrepreneurs surround themselves with a skilled group of individuals who will increase the probability of their company succeeding. Advisors are a key component of this trusted circle. They bring a highly specific skill set and network to the table, and can help a team shortcut many of the early challenges they will face.

I often review advisor agreements that lay the foundational principles for an entrepreneur and their advisor. One consistent question I receive is how to best structure these relationships. These agreements vary wildly, and can either set a company up for success, or serve as a hindrance. In dealing with many such agreements, we’ve aggregated some best practices to which we feel entrepreneurs should refer when considering bringing on an advisor.

1. Clearly outline an advisor’s role and responsibilities

It is important to define the specific role an advisor will play in the development of your company. Advisors can help with strategic decisions, introductions to potential customers or business partners, and even evangelize and bolster the credibility of the company within their network. Never assume that everyone is on the same page when it comes to roles.

It should be clear, in writing, as to how the company expects the advisor to provide value. Vaguely defining the “services” that an advisor provides often leaves room for interpretation, and another variable you’ll have to think through. Being clear as to what your company needs—and how the advisor can support—is the critical foundation for a successful relationship.

2. Align your advisor’s incentives with the company’s success

Companies should try to avoid paying advisors in both cash and equity, especially if they are contributing less than 5–10 hours of their time per month. Paying an advisor in both cash and equity provides a near-term incentive, leaving less of an incentive to work on ensuring a successful long-term outcome.

Are you bringing on an advisor to help with a short-term goal? Great. Pay them a standard advisory fee that is within budget. However, if the advisor is someone you believe is value-additive to the long-term success of the company, provide them with a stake in the company and align their incentive to the company’s success.

3. Appropriately compensate your advisors

Advisors can be extremely valuable. However, companies should not be awarding significant amounts of equity to the advisor for their services. We’ve seen advisors attempt to receive 10% or more from companies early in their lifespan. This creates an odd capitalization structure from inception, and excessively dilutes the founding team before a single dollar has been raised. Raising your first institutional round is already challenging enough — don’t add unnecessary complications if you can help it.

Additionally, make sure that an advisor’s equity vests over a period of time. The traditional period is one to two years, with extremely valuable advisors receiving 1–2% of the company issued as common stock options.

4. Prepare for a relationship that does not work

Sometimes relationships don’t work. That’s a common occurrence, and something that is bound to happen every once in a while. However, we often see advisor agreements that make it difficult to get out of these relationships. Typically, this comes in the form of a termination clause that makes it difficult for a company to exit (only for “cause”), while the advisor has the ability to exit an agreement at any time.

It’s important that this dynamic is fair to both parties. The last thing you want as an entrepreneur is to be stuck in an argument with an early advisor when your time and money is already stretched thin.

Ultimately, every advisor relationship is different. Each company should consider what their immediate business needs are, and whether they would benefit from bringing an advisor to the table.

Before entrepreneurs even get to structuring an agreement, it is important to conduct the same type of basic diligence they would conduct prior to hiring an employee. Background checks, references, and interviews are all acceptable gut checks that any valuable advisor will be glad to help with if they are truly excited about working with the company.

Once a company and an advisor agree on the relationship, following these principles — in addition to closely reviewing the legal documentation — will help set the relationship up for success.

If you have any questions about advisor contracts please feel free to email me at andrew@ffvc.com.