02 September 2009

The Care and Feeding of Startup Advisory Boards

A recent post on Vator.TV got me thinking about startup advisory boards. This is an often-overlooked, under-utilized, or completely neglected strategy for early stage companies.

But it needn’t be so; setting up a startup advisory board can bring benefits well beyond the cost (in terms of time and equity) required. A brief primer:

Why, When and Who

To begin with, let's start with a basic question: why bother? In short, because a good advisory board can help open doors, keep you on track, and avoid common company-killing mistakes. An advisor's role can take any form, but the most common duties are to provide guidance, introductions, and feedback. They help you think through difficult decisions, and act as a sounding board for company strategy and positioning. Ideally, they tap their network and provide leads for funding sources, early customers or partners, and key hires.

Advisory boards have the most relevance and bring the most 'bang for the buck' for startups that are very early stage—generally, when the company is just 2-3 founders, pre-launch or recently-launched, and trying to gain initial market share and/or raise money. They are particularly useful for first-time entrepreneurs or for founding teams lacking a substantial amount of domain experience in the market.

After the first round or two of funding, an advisory board can still be quite helpful, but by that point there are usually enough people around the table—new senior-level hires, investors, etc.—that talent gaps are mostly filled. Indeed, many startups find that the usefulness of their original advisory board is diminished once they have a complete team and a formal Board of Directors, and contract terms are structured to reflect this (more on this topic later).

In a typical situation, a startup will put together a group of 3-5 people to turn to for counsel. Ideally, this group has diverse yet relevant experience; they will be local (within driving distance for meetings); and, they will have all run or grown young companies before-- but each will bring a different, non-overlapping skill set.

Sample Scenario

As a hypothetical example, let's say your startup is developing a SaaS-based system for managing inventory at independently-owned pet shops. Your founding team is made up of two developers and one person acting as manager/marketer/visionary. The product is nearing beta release and has half a dozen potential customers in the pipeline.

To complement this founder group, an advisory "dream team" might include a former product manager from Netsuite or Salesforce or even SAP, maybe a marketing VP or CFO from Petco, and one or two folks who have started and exited software businesses. To throw an extra bit of flavor to the mix, it might also include a co-founder from Web 1.0 flameout Pets.com.

In this scenario, the product manager advises on development and feature sets for the initial release. The marketing VP advises on channel strategy, while the CFO helps introduce some structure and process around the billing and cash flow cycle. The ex-software entrepreneurs advise on all of the above, and also make introductions to potential investors. Finally, the Pets.com veteran brings domain expertise and helps the young firm navigate around pitfalls (learning from those who tried and failed can be just as valuable as learning from those who’ve succeeded).

Recruiting Advisors

There is no real trick to recruiting advisors-- you simply ask them. Most people are flattered by the request and by the lure of being associated with a new successful company. It's a soft sell, and taps the ego-drive for recognition as an expert. More challenging is finding and screening the right ones.

Finding them is a function of first identifying your needs--deep introspection required-- based on where your founding team is weak, or by what near-term goals you are aiming to accomplish. Next comes scouring your existing network and the open web to find the right folks. Social networks like LinkedIn can be invaluable here, but don’t neglect using Google. Searching on phrases like "former VP of Operations at Google" may turn up articles or interviews with a potential target candidate.

After working your network for an intro (or if necessary, searching online for their email address), a simple introductory note stating what you do and that you're seeking to build an advisory board is usually enough to get the conversation rolling. Include a link or two if you have a beta site or demo up.

Screening and Filtering

Screening the candidate pool, however, takes a bit more effort. I would advise you to filter based on their overall level of interest in your concept and their willingness to actively participate. You want people who are genuinely motivated to help your business—free riders need not apply.

A good way to evaluate this is by how quickly they respond to your emails or phone calls. Many times, an advisor's greatest value comes during a critical moment-- "should we accept this term sheet or keep hunting?" or, "we have a national chain interested in purchasing our software, but they want steep discounts--what do we do?" You don't want to be waiting a week for an advisor's input.

Another criteria, of course, is whether they are willing to get materially involved for the level of compensation you are proposing (more on this later). It makes no sense to overpay and incur unnecessary dilution to your company's equity—there are plenty of fish in the sea. Also avoid those who are well-known, but who are likely to be "advisors" in name only. These types seek to benefit from the startup’s success without actually contributing to it. While their implied endorsement may look good on your investor pitch deck, it's usually not worth the cost in equity to the company.

Care and Feeding of Advisors

Once you've built your rock-star advisory board, what do you do with them? The short answer is: use them as much as you can-- but not more than you agree to. Keep in mind that advisors are not employees; their role is generally to provide introductions and guidance on product and company strategy. They may endorse and/or evangelize your company-- but their role stops short of actively marketing your company. In other words, you should not expect them to do the 'heavy lifting' of building your business, nor be responsible for routine operating tasks.

The best way to manage advisors-- and get the most out of them-- is to invest upfront whatever time is required to accurately set expectations. A 'reasonable' scope for an advisor role might be something like the following: i) 6 month duration, with option for extension; ii) primary responsibility is to introduce the company to 8-10 relevant investors; iii) secondary responsibility is to participate in monthly strategy meetings with the rest of the advisory board; iv) tertiary responsibility is to advise on key decisions or product input via periodic conference calls or emails.

Work It Into Your Company DNA

Curiously, despite all the effort expended to build a great advisory team, one of the more common mistakes startups make is to under-utilize their advisory board. This is rarely intentional—running your business sucks up all your available time and capacity, and trying to "herd cats" (while respectfully wrangling in only their best feedback or ideas) can feel like a distraction.

To help keep this valuable resource from falling by the wayside, I suggest, at a minimum, having a standing quarterly or monthly meeting—say, the third Thursday of each month—for the duration of the advisors’ contracts. This helps keep your company in the forefront of their minds, and it also introduces an element of “communication discipline” for the founders—in other words, knowing you have a meeting coming up will force you to review your progress over the previous month, identify things you need help with, and set new goals going forward. This is also good training for the day when you’ll have a formal Board of Directors to report to.

Advisor Compensation

So, having built a great advisory team and having charted out a realistic gameplan with each, how do you compensate them? This is more art than science, and the real answer is "it depends"-- on their level of involvement, the reach and relevance of their network, and yes, on their name brand. But I dislike fuzzy answers, so let's try to pencil in some guidelines.

I posed this question recently to my good friend and colleague Diana Benedikt who runs Venture Insight Advisors. Diana and I have worked together on numerous startups over the last ten years, and I respect her opinion. Her take, based on many years of experience as both advisor and consultant, is that a reasonable range is 0.25% to 0.5% of the company’s total equity (though up to 1% is not unheard of) for approximately 4-8 hours of involvement a month.

This corroborates with others' views on the subject; most published ranges are between 0.25% and 1.5% per advisor, or 1% to 4% for the total advisory board. Amounts may vary—you don’t need to give everyone identical stakes—but you do need to codify each arrangement in a simple contract, detailing their roles and tasks, the duration of their involvement, and a vesting schedule (generally, monthly over the term of their contract).

Non-Equity Issues

Other items to include are an out-clause (where either party can terminate the contract with written notice, usually 30 days) and the type of currency to compensate their efforts (generally, restricted stock, which has tax benefits for the advisor). To note, not all advisors demand equity—sometimes a few nice lunches, repayment for any expenses incurred, and some heartfelt gratitude and recognition will suffice.

Diana also notes that from the advisor's perspective, the challenge is in holding down the amount of work he or she will end up putting in. Although ideally, if you have done the upfront work of carefully selecting and screening who you bring in, your advisors will be emotionally invested in the business, and will work beyond the contracted level—simply because of passion for the idea. (Indeed, many advisors even take it a step further and invest in the seed round.)

Hybrids and Other Animals

Alternative approaches to a standard 6- or 12-month advisory role are many, and include contracts that are structured around specific deliverables or results. For example, here at VentureArchetypes, we tend to initially engage with a startup around a finite task—developing a business plan, financial model, partnership proposal or pitch deck. Then, following this “dating period” where we get to know the company (and vice versa), the relationship evolves into either a traditional advisory role as described above, or into an interim operating role.

Structuring it in this manner helps avoid the ambiguity that can sometimes accompany the role of "advisor" since compensation is directly tied to specific actions/results. It also affords greater flexibility in terms of the currency used for remuneration. For example, while we typically require a cash retainer for document deliverables, deferred compensation is sometimes used for interim CFO or business development work, and equity can be in the form of options or warrants.

Interim Roles

This type of interim operating role is like a bridge between bringing on advisors (devoting 1-4 hours per week) and full time staff (devoting 40-60 hours per week). The advantage for startups is that it moves headcount expense to more of a variable cost that can be dialed up or down depending on need—for example, a company may need additional, temporary support around a deal or transaction. Conceptually, it is similar to using an outsourced IT development shop, and thus it is a structure that many startups are already familiar with.

Regardless of the specific structure, the aim with any deal should be to align the interests of all parties in the direction of a common goal, and remove any ambiguity about what constitutes reaching that goal. It should also pass the gut-test of being ‘fair and reasonable’—or, at a minimum, both parties should wince equally at the pain.

Remember the Fun

A final piece of advice-- one that echoes the Vator.tv article that originally inspired this post-- is to make the process of being an advisor fun. Be appreciative of their efforts. Make sure they have ample opportunity to socialize with the other advisors on the team. Hold your monthly or quarterly meetings at a restaurant or bar. Take them sailing or to a ball game. One of the companies we worked with sent us on a winery tour, and then sent us bottles of wine periodically-- it was a great gesture.

In short, most advisors are motivated more by being in the startup game than they are by the potential of financial gain. Recognizing their help, and keeping them involved and informed beyond the duration of their tenure will pay exponential returns over time.

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