Written by Rajah Lehal
Directors – names are (in most jurisdictions) recorded on the public registrar, role is to protect the shareholders, accept some legal liability, vote on company major decisions. No hands on day-to-day activities.
Executive Director – same as above, but also in an executive role (e.g. President), with hands on day-to-day operational activities.
Advisors – No voting rights, usually are experienced or well-connected business people, guide the founders.
I had previously written in this article that whether a company has a board of directors or a board of advisors, compensation is flexible.
A company may choose to compensate either a director or an advisor in cash, with options, a combination of cash and options, cash only, or the company may even choose not to compensate such directors. This is not a critical factor for choosing a board of advisors over a board of directors or vice versa.
Public company board of director positions can receive seven digit compensation. At the other end of the spectrum, a startup company more likely can offer options for compensation. When offering option-based compensation consider the following:
Advisors should not receive any shares unless they are putting in significant time, or possibly cash. Advisors do not take on legal liability and therefore an advisor should either be extremely active in furthering the goals of the business and “putting in sweat equity” like the company founders, e.g. one or two days of work each week, or should be a cash investor. A cash-investing advisor may put in less sweat equity, but has a natural alignment of his/her goals with the goals of the company.
Ensure that you’re getting value for your shares. Your options have value and when you receive funding from investors there’s a stake-in-the-ground cash value. Ensure that advisors and board members are putting in the time and effort to make their compensation worthwhile. Not only is it a matter of fairness to your investors, it’s the law.
For advisors who ask for percentage point(s) of options, there should be goals (pre-conditions) tied to those options. The goals can be tied to effort and/or leads or connections, and such goals can be documented in an option grant certificate, or within a advisor/consulting agreement. An advisory agreement is useful because it normally includes a list of responsibilities, and if those responsibilities are not fulfilled it can be terminated. If properly structured, any options associated with that agreement would terminate at the same time.
As noted above, in a large organization, the directors are in place to “guide the ship” and protect the shareholders. Minority shareholders have little voice or visibility with which to protect their investment and therefore the board can assist in providing both.
In a startup company, all the investors will know each other and are likely very close to the company’s day-to-day affairs. Therefore the role of the director could be the same as above, to look out for the interest of the investors (for example, protecting angel or seed-stage investor funds, in which case I would suggest that the board compensation be zero – at an early stage the investors should support the business to preserve as much cash as possible for operations.
Or the director may be able to provide other intangible support – credibility and reputation, as well as business advice in period board meetings. For this second scenario, I would recommend two things. First, hold as many meetings as possible (monthly, at minimum) – this will hold the board members to task to support the business, to provide advice, and to provide connections; it will also hold the company to task to ensure that it is setting and achieving monthly stated goals. Second, issue shares that are commensurate to the value you are receiving.
The earlier on the business is, the harder it is to decide what the appropriate value is; as soon as the company has the validation of outside investment to set a price per share, the calculation of board compensation can be straight math, determined by the board member’s normal hourly rate and multiplied by the time they are putting aside for your meetings including preparation time, and possibly a premium for the profile that they add to your business. This article and the embedded Khan Academy video provides good insight on planning out the next several years of the business’s growth and allocating appropriate compensation to the board as well as to other stakeholders.
Takeaways:
Finding great advisors can be as difficult as finding great investors.
Read this article and other similar publications, review the Khan Academy video, calculate your company’s growth and value projections over the next (few) years and suggest an allocation of shares for advisors and board members
Be as careful as possible not to overcompensate – as a startup company, your equity only gets more valuable over time
Ironically, get advice before finalizing advisor compensation. Share your ideas based on your research with fellow company founders, advisors or your counsel to make sure you’re on the right track.
This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos.
Orginally posted at Clausehound.com.
*see individual programs and jurisidictional allowances for accredited hours/requirements for Canadian law societies.