Startup business ventures are generally high-growth businesses. This means that the company evolves very quickly as it scales up operations and achieves ever greater growth metrics. Setting the goal of high growth and actually achieving that rapid growth can present all sorts of problems for the business. As such, it is common for startups to look toward experienced industry or business professionals for advice in navigating all aspects of growth and operations. These advisors can come in the form of outside consultants or professional service providers (such as accountants and attorneys) or through bringing the advisor on as an owner of the company. One common scenario for bringing on an experience advisor is through a formal or informal board of advisors.
In this article, we discuss awarding equity to paid advisors and to a member of the companies board of advisors.
Compensating Professional Service Providers with Equity
Professional service providers (such as attorney, accountants, and consultants) who serve companies as independent contractors generally charge an hourly rate or pre-determined fee. Unfortunate for the company, the fee or hourly rate is often very high. For a startup venture, it can be a difficult proposition to afforded the services necessary to get the business off of the grounds. As such, it is increasingly common to see scenarios where the service providers receive a reduce or no fee in exchange for their services. Instead, the service provider receives some form of equity (or equity equivalents, such as options or warrants to purchase equity) compensation. The equity is generally restricted from transfer and may be made subject to specific vesting requirements. This is particularly true when the company-service provider relationship is intended to last for an extended period of time.
When a service provider receives equity in this situation, the amount of equity received is determined by the value of the services rendered and the company’s valuation. This determination is very similar to the determination made when determine how much equity an investor will receive for her invested capital. In these cases, the company and the service provider will use commonly accepted valuation methods to determine the value of the company. Once the value is determined, the company will offer some percentage of company equity that matches the expected value of services rendered to the company. Of course, it may be likely that the company pays less value in equity in consideration of the potential upside of owning company equity. It is also possible that the company will award slightly more equity than the value of services in an attempt to incentivize future services and to compensate the service provider for the lack of liquidity of the ownership interest
Compensating Members of a Board of Advisors with Equity
Startup company are well intentioned to form formal and informal advisory boards. A formal board is provided for in the company governance documents. An informal board is done at the behest of management and is not authorized or mandated in the governance documents. The advisory board is generally made up of a cross-section of industry professionals who can provide value advice and guidance to the startup. They meet on some predetermined schedule (generally monthly) to review company operations and performance metrics. They will provide guidance on any matters of concern or consequence to the company. These individuals do not have any real power over or rights in the company. They simply serve the company in exchange for whatever form of compensation they negotiate with the company. It is not common to pay these individuals a salary or fee for their service. Rather, these individuals either receive no compensation or receive an equity percentage in the startup company. The percentage of equity awarded each individual advisor will vary based upon the advisor’s contributions (or expected contributions) to the company. Most equity awards vary between 0.1% – 1.5% of the company.
LawTrades Understands Shareholders Distributions
Making the decision to use equity to compensate employees or independent contractors implicates all sorts of legal considerations. Most notably, the company must value the equity, make applicable tax withholdings, and report the use of equity compensation to taxing authorities. If you are considering using equity as form of compensation, don’t go it alone. The legal attorneys at LawTrades are experts in equity compensation. They can provide the support and assistance you need to meet all necessary legal requirements.