The Guide to Advisor Shares and the Durability Formula for Startups

The Guide to Advisor Shares and the Durability Formula for Startups

Introduction:
When it comes to building a successful startup, two important aspects to consider are the allocation of advisor shares and designing for durability. In this article, we will explore the significance of vesting schedules for advisors and how to choose the right advisors for your company. Additionally, we will delve into the durability formula, which consists of network effects, economies of scale, brand, embedding, and intellectual property, and its role in determining the future value of a startup.

Vesting Schedules for Advisors:
Similar to vesting schedules for employees, having a vesting schedule for advisors is crucial. These agreements typically span two years, with monthly vesting and no cliff. However, before promising equity, it's worth considering if a potential advisor would be willing to invest directly in your company instead. This not only gives them more stake in the game but also sends a positive signal to future investors. When selecting advisors, it is important to treat the process as if you were choosing a co-founder. Advisors can play a critical role in a company's success, but they can also become distractions or liabilities if not chosen wisely.

Types of Advisors:
There are two main types of advisors to consider: the name advisor and the practical advisor. The name advisor brings value through association, while the practical advisor acts as a sounding board and offers expertise in areas where you may have weaknesses. It is not uncommon for advisors to invest their own money in future financing rounds, further solidifying their commitment to the company.

Establishing the Advisor Relationship:
Before formally establishing the relationship, it is essential to determine what you expect from an advisor. Clearly define their domain of expertise and what they will help you with. If equity is involved, decide on the percentage or other forms of compensation. It is crucial to document the agreement and seek legal advice to ensure a fair and mutually beneficial arrangement. Founders should drive the communication cadence with advisors and establish clear expectations.

Advisor Share Granting:
Based on data from 2019, advisor restricted stock agreements (RSAs) ranged from 0.2% to 1% of a company, while advisor non-qualified stock options (NSOs) ranged from 0.1% to 0.5%. Generally, the earlier an advisor joins a company, the higher their fully-diluted amount is granted. It is advisable to avoid a four-year vesting schedule since advisors usually deliver most of their value upfront. Reassess the relationship after a year or two to determine if it should continue.

The Durability Formula for Startups:
To capture long-term value, startups must design for durability from the beginning. The durability formula consists of network effects, economies of scale, brand, embedding, and intellectual property. Network effects occur when one user's presence enhances the value of the service for other users. Creating a multi-player game or marketplace instead of a single-player game can foster network effects. If the value of your product or service increases as new users join, it creates a positive feedback loop.

Building a brand identity is crucial as humans are tribal and emotional beings. Users identify themselves with brands, and a well-established brand triggers psychological switching costs, making it difficult for users to leave for lesser-known brands. Embedding refers to integrating your product or software into a customer's operations, making it challenging for them to replace you with a competitor. Additionally, allowing low or no costs for using your product alongside competing products can enhance customer satisfaction.

Conclusion:
In conclusion, allocating advisor shares and designing for durability are essential elements in building a successful startup. When selecting advisors, consider their investment in the company and choose individuals who can compensate for your weaknesses. Clearly establish the advisor relationship through a signed agreement and document all agreements, especially when equity is involved. To ensure long-term value, follow the durability formula by fostering network effects, leveraging economies of scale, building a strong brand, embedding your product, and protecting intellectual property.

Actionable Advice:

1. When choosing advisors, consider their potential investment in your company instead of solely relying on equity allocation. This shows their commitment and sends a positive signal to future investors.
2. Clearly define your expectations from an advisor and document the agreement. Seek legal advice to ensure fairness and establish clear communication channels and expectations.
3. Design your startup for durability by considering the durability formula. Foster network effects, build a strong brand, embed your product into customer operations, and protect your intellectual property to capture long-term value.

Remember, successful startups are built on strategic partnerships, clear agreements, and a focus on long-term sustainability. By implementing these practices, you can increase the chances of your startup thriving in a competitive market.