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Advisory Agreements: Exercising Options

Posted by rbpasker on March 5, 2008

When one of my advisory board positions recently ended, I received notice from the CFO of the company that I had to exercise the options within 30 days after the termination date or lose them.

I had been an active advisor to the company, got paid zero in cash, and now I had to lay out a five figure check. Since the company had recently raised money, the valuation of the company had gone up, so the underlying shares were now worth more than they were when the grant was made. According to the IRS, I would have to pay capital gains tax on the difference between the option strike price and the current value of the underlying shares. This would amount to another five-figure check

This did not make me happy. Here I was, paying the company, not the other way around. And if the stock eventually became worthless, I had not only risked my own time (which I was fully prepared to do), but my money, too (which I was not prepared to do). To add insult to injury, I would also have to pay taxes on non-existent capital gains. If I am going to invest cash in a company, I want preferred stock, not common.

After a bit of research and consultation with my lawyer, I realized I had made a few mistakes.

First of all, at the time the options were granted by the board, I should have received a signed copy of the “Plan” under which my options were granted. That Plan lays out all of legalese that specifies what the circumstances are for granting, vesting and exercising the options. Had I been given a copy of the plan and read it, I might have noticed that the plan stated that the options had to be exercised after 30 days.

Second, I should have added a clause in the Advisory Agreement overriding the 30 day exercise-after-termination provision in the Plan. This would have allowed me to hold the options, cash-free and tax-free, until a liquidation event, before I would have to exercise them.

In the end, things worked out, but it required a lot of effort and caused a lot of angst.

In the next couple of days, I will be writing the CFOs of all the companies in which I have options, to make sure this doesn’t happen again.

And in the future, I will lay all this out during negotiations.

Posted in advisor, My Companies | 2 Comments »

Advisory Agreements

Posted by rbpasker on August 15, 2007

My intention was to blog next about recruiting an advisor, but how can you recruit an advisor unless you know what you’re offering? So first let’s look at the components of a typical advisory agreement. Remember: IANAL and TINLA. I’m just relating my experience and data I have garnered from others in the industry. Please get proper legal advice and proper wording before embarking on an advisory agreement.

The advisory agreement should have 4 main areas: responsibilities, term, protection, and compensation.

The responsibilities section should describe the role as a consultant to the company, who advises the CEO and executive team on matters within the the advisor’s area of expertise. It is important to make sure that the agreement does not confer employment status on the advisor, so your company does not get caught up dealing with employment law issues, benefits, and tax withholding for the advisor. You also want to ensure the advisor is not an agent of the company, someone who is able to make commitments on behalf of the company.

The advisory agreement should set out the term of the agreement. If the the stock package is fixed at a certain number of shares over some number of years, the term of the advisory agreement to be fixed as well and is coterminous with vesting. In my case, I prefer two-year agreements, but in one case I had had an open-ended agreement, and the comp was based on a certain number of shares per month. Even though my agreements have a fixed term, I feel as though I’m on the hook as a stockholder to promote the company’s interests for as long as the company is in business, and the CEOs have never been shy about asking me for stuff after the two years are up.

Here are the main protections in the advisory agreement:
  1. Intellectual property – just as for an employee, any intellectual contributions — ideas, designs, specs, etc — made by the advisor have to become the property of the company. What good would an advisor’s contribution be if it didn’t come with the rights to implement it?
  2. Confidentiality –The advisor has to be bound by the same confidentiality provisions as anyone else who has access to the company’s secrets
  3. Non-solicitation — the advisor should not be able to hire away the company’s employees
Sometimes a company will want additional protections, such as a non-compete clause, but I have personally never agreed to additional provisions. It would be foolish for me to work with two companies that competed directly with each other for the same reason VCs don’t do it: I don’t want to create a situation where helping one company would hurt the other. Also, the confidentiality agreement should cover any non-public information I might possess which would be of use to a competitor. And as I mentioned previously, the agreement shouldn’t include a laundry list of tasks or a minimum number of days/hours. If you want a consultant, hire one. From an advisor, you’re looking for access and advice.

In terms of compensation, an advisor should get a stock option package that is at least the same order of magnitude as a director-level position, vests monthly with no cliff over two years, and provides for 100% single-trigger accelerated vesting. Since every company has a different capitalization structure and is at a different stage, its better to tie the size of the grant to a director-level position rather to a specific percentage or a specific number of shares. And by “director,” I mean a second-level manager who reports to a VP, rather than someone who sits on the company’s Board. Advisors of start-ups typically don’t get any cash compensation, but they do have their direct expenses reimbursed.

As you might notice, the vesting schedule for an advisor is different from a typical employee plan, which is usually 4 years, 1 year cliff, no accelerated vesting. Accelerated vesting means that, under certain conditions, instead of having to wait until the vesting period is over to exercise their options, the options stock vest immediately. Single-trigger means that the acceleration takes places when the company is acquired (or has some other “change of control”-type event, such as an asset sale or merger). Double-trigger vesting means that there has to be a change of control AND the employee is terminated or has their responsibility/pay/status reduced. Since the advisory agreement is always terminated in an acquisition, double-trigger vesting doesn’t make any sense. The reason eliminating the vesting cliff is that, unlike an employee, an advisor doesn’t get any cash compensation. So if the company gets acquired before the cliff is up the advisor should get compensated.

The last thing I like to have in any advisory agreement is a get-out-of-jail-free card: a bilateral no-questions-asked termination clause. If things aren’t working out, either side should have the opportunity to bail. This correlates with at-will employment, which I believe should be the norm.

So now you have the outlines of what an advisory agreement should contain. I have had agreements that were just a letter from the CEO with room for my signature, and others which were actual contracts. Discuss these provisions with your Board of Directors, put together a draft with your legal counsel, and negotiate with your advisor in good faith.

Posted in advisor | 1 Comment »

Choosing Advisors

Posted by rbpasker on August 10, 2007

In a previous post, I covered the advisor role, so lets take a look at finding advisors for your own startup.

As I mentioned, advisors often act as mentors, so the first thing to do is make a list of people you already know who would make good professional mentors. For most people, former bosses and professors seem to make the top of the list, since they already know you, both the good parts and the bad. My friend and colleague, Bill Donner, has played this role for me for 25 years, and a couple of years ago I was honored to become an advisor to his startup. The benefit to having a former boss or professor as an advisor is that they know you well, and will usually give you candid advice, even when others are more circumspect. Mentors are among the easiest advisors to recruit, since you already have a relationship with them.

The second step is to go through your contacts and list the people you know who have been successful entrepreneurs or work in a leadership capacity in a larger company. These people know your industry, have been through many of the same things you are about to go through, have lots of contacts, and carry some weight in the industry. Recruiting advisors from this group is more difficult, as these people are either too busy or possibly retired.

The last category are industry experts in your field. Think about the (technical or business) problems that you are trying to solve in your startup, then figure out who the thought leaders are. Add them to your list. You’ll often find industry expert advisory boards at companies that require very specialized knowledge, such as medical device companies and security companies. You’ll also find industry advisory boards in companies that are building technology for highly regulated or bureaucratic industries, such as military, finance, government, power and health care. In these fields, having advisors who are well connected is crucial. Industry experts are notoriously difficult to recruit because they are always in demand, and if you don’t already know them, you’ll first have to establish a relationship with them.

Now that you have your list, go around to all the rest of the people who are involved with your company: board members, angels, investors, and employees, and even friends and colleagues. Go through the same discovery process with them, adding their mentors, entrepreneurs and experts they know to your list.

You now have to remove a few groups of people from the list: potential customers, acquirers, and angel investors.

You have to remove potential customers because their being on your advisory board could call into question their objectivity when you are ready to sell to that company. Say you are trying to sell to a bank, and your colleague happens to lead a team which could make good use of your product. You recruit your colleague as an advisor to your company. When the time comes to sell to that bank, your friend would probably have to sit out the negotiations, because he has a conflict of interest. Its better to keep your customer friends on the other side of the table, if you think you might be selling to them. After they become a customer, you can always add them to your advisory board.

You probably also have to remove from the list those who work at potential acquiring companies because their company might already be working on something competitive, or they are talking to your competitors. Having a potential acquirer as an advisor could also create a conflict of interest, or worse, hurt your company’s prospects by leaking confidential information. Whether they stay on your list is a judgment call based the level of trust you have with them.

Lastly, you need to remove potential investors, but not completely! I once said to Marc Hedlund “investors were the only people in a company who would give you money and then work for you, instead of the other way around.” So move your angel investors from the advisor list to your investor list. No reason to have them as an advisor if they will pay you instead of the other way around!

Now categorize your list into groups, such as: sales/marketing experts, operations experts, technology experts, etc., based on your company’s needs and goals. Then prioritize your list in two ways: those who are easy to reach and recruit, and those who will be the most help, keeping in mind the list of things you might need done, as I described in my previous post. This grouped, prioritized list should give you a pretty good idea of how to compose your advisory board.

Next up: recruiting advisors.

Posted in advisor, work | Leave a Comment »

The Role of Advisor

Posted by rbpasker on August 8, 2007

As an advisor, I take on a consultative role to provide advice in my areas of expertise, make introductions into my network of contacts, and act as a reference for potential investors, customers, and candidates. This is not universally true, however. Advisors who are very well known sometimes act as “window dressing,” to burnish the company’s image, but they don’t often participate deeply in the company. I try to avoid these kinds of gigs simply because I like to actually be involved. Otherwise, why bother?

What I also find is that some companies are looking for something more fleeting: they are looking for a mentor and a sounding board, someone who they can talk to about the many challenges they face and can help them solve problems. Being a technology person (rather than, say, a financier, or a sales/marketing/bizdev guy), I bond well with founders/CxOs who are also technology people, and I can provide advice on engineering recruiting and team organization, on development processes, technologies, tools, and methodologies, and product strategy, competition, and implementation plans, in a way that investor board members typically can’t.

One of the benefits of having a well-connected advisor is getting access to the advisor’s network. Startups need access to finance (VCs, angels, debt), candidates, services and consultants (PR, legal, accounting, strategy, M&A), customers (F500/enterprise), partners (hundreds of important technology companies), technology providers, outsourcers, etc. I find myself making at least a dozen intros a week, across all these different categories, and I often join the conversations myself to kick things off since I know what each side wants and needs.

One myth about advisors is that they are somehow part of the corporate structure. But advisers differ from Directors – who serve on the company’s Board of Directors – in that Directors are regulatory positions elected by the shareholders to govern and run the company.

Another myth is that advisors have a predefined set of operational responsibilities. I’ve had some CEOs send me a list of tasks as an appendix to the advisory contract, saying “you will introduce us to such-and-such people, go to this-and-that meeting, etc.” Although I’m always thrilled when CEOs have a good idea of what they want me to participate in, I have never agreed to these kinds of task lists as part of the contract (more on contracts in another post) because I don’t think they capture the consultative nature of the role. If you want someone to do specific things, pay a consultant.

Similarly, I have had CEOs who want me to commit to a certain number of hours or days or per month because they’re concerned that I might be spread too thin and won’t spend enough time with them. But companies go through different phases, and sometimes they require much more time than others, such as during product planning, product launch, a financing round, etc. Other times, they may not need me at all for a month or two or more. What benefit is it to have me spend a day at a company when there’s nothing going on that I can help with? Or to leave an offsite on one day of a two-day event, because I’m only on the hook for one day a month? A good advisor will be there when you need him, and not need a specific time commitment.

There’s a good solution to both task list and the time commitment issues, but I’m going to save that for the post on contracts.

Lets look concretely as some of the advisory work I’ve done recently:

Engineering

  1. help hire 3 VPs of engineering. worked on the reqs, made intros to and interviewed candidates
  2. introduced 2 companies to development processes expert so they could do more agile development

Sales

  1. advised on segmenting business model into web sales, inside sales, and outside sales
  2. intros to sales candidates in various regions around the country

Marketing

  1. intros to PR firms
  2. lots of strategy meetings on product launch, positioning, competition, etc

Finance

  1. intros to various VCs, all of which resulted in meetings
  2. advised on deal structure and term sheets
  3. provided recommendations on the companies to VC
  4. made confidential background checks on various VCs
  5. got expert funding help from finance colleagues

Corporate

  1. helped identify and recruit CEOs, outside board members, and other advisors
  2. intros to ibanks to assist with M&A activity
  3. intros to potential acquirers
  4. participated in corporate strategy meetings

Biz Dev

  1. intros to OEMs and partners
  2. intros to technology providers
  3. intros and interviewed outsourcers

As you can see, the list is mostly networking and providing advice, and no operations, save an interview here and there. It also covers a much broader area of the business than just technology, which, for a guy who still thinks of himself as a programmer, surprises even me.

In the next segment, I’m going to talk about finding, recruiting, and hiring advisors.

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The Startup Advisor

Posted by rbpasker on August 7, 2007

If you look at my linkedin profile, you’ll notice that I’m listed as “Member of Technical Advisory Board” to a number of different startups. In fact, at least 1/2 of my time over the past few years has been dedicated to helping startups as an advisor, and it has been a tremendously worthwhile experience, both personally and professionally.

Over the next several posts, I’ll cover most of what you’ll need to know about the advisor role, including defining the role, finding advisors, negotiating compensation, and working with advisors. This should be of interest not only to CEOs and founders, but also to those who would themselves become advisors.

Posted in advisor, work | 1 Comment »

 
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