Thursday, June 24, 2010 at 08:31AM
We got a request from the listserve at National Business Incubation Association (NBIA) for some tips reguarding mentors receiving equity. Before I knew it, we had a list:
- First, make sure the amount of equity is appropriate. A mentor is a key advisor and the appropriate range is 1 – 2%. More than that might be questioned by a future investor. Now if the mentor has the financial means to invest, then obviously, more equity is in order.
- The agreement should be formalized with an attorney’s help. It does not need to be complicated but it does need to be clearly documented…again to avoid a problem with a future investor. It is a good idea to state specifically what the mentor is providing the company in return for the equity. It could be a number of meetings in a year, number of hours, a number of introductions, the completion of the business plan, or whatever but the agreement should state something tangible or measurable that provides value.
- Don’t issue actual stock. There are tax implications. Grant options that can be executed at a future liquidation event such as an acquisition or other type of exit. This also avoids declaring a valuation that does not involve bringing money into the company.
- Consider granting the options over time and according to the delivery of the value stated in the formal agreement. For example, the mentor gets ¼ point equity for each monthly meeting over a year. This way, if it’s not working out, you haven’t given away 2% of your company to a jerk.
- Make sure the fit is good. The company should have profiles of the skills they need but do not yet have on the team. These could be financial, operational, technical, etc. There are also roles that need to be filled like someone who can keep the entrepreneur’s feet on the ground and challenge them when they get off track. A mentor should fill at least one of these roles but it’s best if they fill a couple. Here is a blog post from OutOfTheGarage.com that goes into this: http://www.outofthegarage.com/outofthegarage/2009/7/1/to-board-or-not-to-board-a-primer-for-forming-a-board-of-dir.html
- Realize that equity is an instrument of value. Free advice is worth what you pay for it but as soon a you do, you expect results. In our experience, CEO's tend to attach some pretty strong expectations to their equity. If the mentor is helping raise equity capital, then the CEO expects to get an investment and if it doesn't happen, the mentor gets part of the blame. This goes back to identifying the specific value given in exchange for the equity. CEO's should remember that the person responsible for company success is the CEO...NOT the mentor(s). Choose them carefully but realize their role is to advise, challenge you, make introductions,etc. Growing your company is YOUR job.
- You don’t want to end up with a dozen mentors each owning 2%. This puts a huge burden on the one or two mentors that actually deliver. Select them carefully.
- Make sure the mentor is not soliciting for their consulting business. We have seen service providers offer advice and mentoring only to put the company in a tough position down the road by charging exorbitant fees for their introductions to investors or wanting huge commissions for sales activity. A true mentor would advise the company and offer their skills just for the pleasure of helping to make the company successful. Equity is reasonable compensation.
- Incubators may require equity as well. They have have to have a pathway to sustainability and requesting equity shows they have a long view of company success. Treat this judiciously. We have seen incubators require equity for every company, which can cause problems for all the reasons stated above. An equity arrangement is very personal and each case is different. This should not be institutionalized. Make sure there is an agreement in place that specifies what you get for your equity. If it is merely a connection with a prominent incubator organization, it may be worth it but these guidlines still apply.
- Equity is NOT a part of your soul...but it is a part of your company. Treat it as a thing of great value, expecting great value in return. Remember, equity is a Strategic Management Tool.