« VC Perspective on Intellectual Property | How To Get A Job In Venture Capital »

I Cut The Wrong Deal With An Advisor – Should I Kill It?

Q: I am the co-founder of a startup that is currently in the process of trying to raise an early stage venture round. We recently brought on an advisor who has been incredibly successful in our space and has made introductions to dozens of potential partners and VC firms where he is an investor. He has all the right relationships, but we gave him low double-digit equity to get him on board (his demand). The equity vests over a period of time and I stay up at night thinking about (1) if we should kill the deal and (2) what a VC will think of the founders when he/she finds our how much we gave up to get this individual to help. To further complicate the situation, the advisor (who is very wealthy) has taken a pass on investing his own capital and this has been a sore spot for any VC looking at our deal. How do you think we should resolve this situation.

A: (Brad): My immediate reaction is "ugh."  You’ve been taken to the cleaners by your "advisor" – low double digit for introductions – even if they are the right ones – is radically overreaching.

A typical advisor like the one you describe will get around 1% of equity vesting over at least a year (usually two) in exchange for being an active advisor / board member.  As part of this, the advisor should be willing to invest something in whatever financing you raise (at least $25,000 – preferably more) to show some personal financial commitment to your endeavor. 

Since you have a vesting agreement in place, you at least have an option to kill the deal.  I suggest you start with a frank conversation with your advisor.  Explain that you really appreciate his involvement to date.  However, you’ve gotten two consistent pieces of feedback: (1) his ownership stake is much too high for his role and (2) you are getting resistance from the VCs he’s introduced you to because he’s not willing to at least put a trivial amount (for him) of cash into the deal.  Rather than create a conflict out of the gate, you should ask him for help addressing / solving the issue.  At the minimum you’ll force him to address the issue.

If he’s constructive and thoughtful, you might have a chance to modify the deal so it’s more reasonable.  If he reacts emotionally, you know what you are dealing with and have a choice to make. 

April 29th, 2008 by     Categories: Advisors    
  • Ken Feldman

    Oh man! Just reading this made me reach for the Tums. I'm an advisor to several startups, and have never gotten more then 1%. A double digit points deal is outrageous. I've heard up to 10% as a “finders fee” for seed rounds, but that's only if the deal closes. (Though 10% is considered very high, and let's not even start the legal discussions as to whether finders fees are allowed). Any investor who looks at the cap table and sees that big of a chunk of your company owned by someone who is merely advising, plus on top of that has got the scratch to write a check but hasn't, will see red-flags all over the place. Resolve this immediately and do NOT back off. This way you can get a good nights rest and my stomach will settle down.

  • http://www.hightechweekly.com Keith Cowing

    Ouch! You absolutely need to get out of that agreement if at all possible, emphasing that the equity stake will be worth nothing if you can't get VC funding and actually launch the company, and VC's won't invest in an entrepreneur who let loose over 10% of the company to somebody who won't even put in his/her own investment. VC's don't want to throw many at a company that is apt to get strong-armed every time they turn a corner, they want to know that you can be a shrewed business owner and negotiate yourself out of trouble. So that's exactly what you need to do. From the “advisor's” (sounds more like a swindler) point of view, a 1% stake in a successful company with good VC backing will be worth more in the long run than a 10% stake in a company that goes nowhere because nobody trusts it. State that clearly and fight to get back the ownership you deserve in your own company. Good luck.

  • John Holden

    We went through nearly the exact situation and got out of the deal. It relieved a lot of stress. We ended up raising our seed round on our own. We learned that equity is a company resource — scarce and getting scarcer. And now love to say no to consultants and advisors like the one you described. FYI there are more out there and they will find you! Keep your eyes and ears open. All the best.

  • http://www.digispeaker.com Jon Smirl

    How small is your company? If it is tiny you can just reform the corporation if a workout isn't possible.

  • David Oliver

    Obviously double digits compensation is way too high but 1% also sounds very low – maybe that is bias in the other direction from you VCs who don't like to see any “middleman” involved. The fact is that some companies do need help. I have advised some companies (write their presentations, approach investors and do the followup). The best I got was 5% (half cash, half equity) and are currently working on one deal for a 3% success fee. Somewhere in the range of 2-3% is realistic I think.

  • Joker

    Dump the guy immediately!!! It's clear this advisor made his money by being an *employee* of a company and not being an entrepreneur. Otherwise, he would know this. The only reason he probably knows VC's is because his wife hangs out at the same country club as other VC wifes:)

  • rhhfla

    Some further thoughts on financing fees are here. http://sophisticatedfinance.typepad.com/sophistic

  • http://www.alacrablog.com Steve

    You need to get out of this arrangement as soon as possible. For one company I know, this kind of deal was the beginning of the end.

  • Chuck Watson

    What if the adviser is unpaid except for equity? If the company fails, he gets nothing. I also have a written arrangement with an adviser that is 20% equity. He is a great advisor and is well connected but in reading some of the comments, I am very concerned.

    • http://www.feld.com Brad Feld

      Most advisors are unpaid. While I don't know you business at all, I find it outrageous that a part time advisor would ask for 20% of a company in return for his help.

      • Chuck

        The next question is to define part time. He probably spends about 8 hours a week advising my company and has done so for almost the past year.

        I am an “engineer” with some sales and marketing experience. Although I had a business plan when I started my energy management software venture, it needed a lot help to get it to a state that would be acceptable to VC or angel investors. He has been a great help in this area.

        I will add that I previously had some discussions with another “adviser” that wanted 50% of the company y for 6 months of part time marketing help and no investment. My current adviser wanted 20% for 18 months of part time advice and he was VERY HIGHLY regarded in the local investment community. I was often told that I was lucky to have him.

        Through 100% self financing by me, my company now has a functional software product that is servicing initial customers and we are ready to go to the next step. However, the comments above indicate that I may have severely limited my companies chances a year ago with my advisers agreement.

        • http://www.feld.com Brad Feld

          I don't think you have necessarily limited your the chances of success for your company. However, you have given away a lot more equity than appropriate and – in my opinion – have been taken advantage of by an advisor. While it sounds like you've been happy with his contribution, the amount of equity that you have given him for a day / week of work is extremely high.

          Think of it this way – if he came on board full time as a co-founder, what percentage of the company would you give him? The most you would give him is likely to be half of the company (50%) vesting over 4 years. So – 12.5% per year for full time work. You are getting 20% of this guys time. So – 20% of 12.5% is 2.5% / year (or 3.75% for 18 months). Now – this is still a high number since there's a big difference in a startup between one day / week and “20% of your time”. However, the counter argument is that he is bringing more value than just his “8 hours per week of time”.

          While there is no easy answer, my instinct continues to be that you have way overpaid.

  • http://www.zoliblog.com Zoli Erdos

    Kill, immeditely. (the deal or the advisor?)
    :-)