I created an entry in wikipedia for advisory capital because I think the discussion following Stowe Boyd’s introduction of the term is interesting and that wikipedia provides a good place to agree on a definition and draw out the distinction between advisory capital and venture capital on one hand and advisor capitalists and advisory board members on the other. This is also a good place to record either existing examples of advisory capital and/or future developments.
[n.b. I didn’t put a definition in wiktionary both because it seems to have only definitions for words and not phrases and because discussion beyond the definition itself would not be appropriate there.]
My definition is drawn directly from Stowe’s post since his was the first use of the term I’ve ever heard: “Advisory Capital is an investment of experience, expertise, social capital, and public authority into a company in return for some form of equity in the company.” Of course, you or any one else are free to edit the definition or any other part of the wikipedia article.
A couple of comments on my post hone in on my suggestion that advisor capitalists (hereafter ACs) be paid in restricted stock. Both Charlie Chrystal and Scott Lawton point out that options are simpler to manage. Charlie, by the way, IS very happy with the advisory board for his company.
During the dotcom bubble, outside board members were compensated mostly or exclusively with options. Both Mary and I agreed to serve on boards of non-public companies where options were our sole compensation. When the bubble burst and it became clear that the valuations used at the time the options were issued were unlikely to be reached again by the companies in their present forms, turned out we had been working as volunteers. OK, fair enough; we gambled; we lost; we wouldn’t have complained if we won. Or you might be even more harsh and say we obviously didn’t add much value if the companies’ valuations were headed south.
Trouble is, from the companies’ point of view, that left us with no alternatives but to resign or stay on as unpaid advisors – which we both did longer than we should have but eventually we did resign. These companies were not dead; they did need significant restructuring or to be sold. Whatever happened, whether recapitalization or sale, would clearly be at prices lower than the strike price of our options. So, if we had stuck around for a year to work out these deals, we would clearly be doing it for no compensation. The VCs on the boards were taking a haircut on their investments but had a clear interest in staying on to salvage as much as possible. The executives had also lost the value of their options but they did draw salaries; traditional consultants got cash. We were volunteers. And we were out of there.
The reason for dragging up this ancient history isn’t to complain about the time we spent or the money we didn’t make – wasn’t the first and won’t be the last bad investment we make. But an outside board member who is NOT an investor is the closest existing role I know to Stowe’s proposed AC. It may well be that ACs are most effective when they are board members just as VCs would be since this is really a horizontal slice from the VC package.
The company needs help both in bad times and good. Options are great for compensating help in good times. But, if options are the only compensation, then the help isn’t incented to stay around when the going gets really rough and the important question is how much value can be salvaged rather than how do we resurrect the original dream. Your VCs will be with you then – in fact, they’ll be all over you – and I think you want your ACs on board, too.
Moreover, we don’t always live in bubbles and not every startup is an instant success. Suppose your company “only” grows its value at 15%/year but it does that steadily. With compounding, that ain’t bad. But you’d have to give an AC too much of a share for a 15% annual increase to be interesting. If the AC gets a relatively small amount of real equity in the company, the potential dilution from AC compensation is LESS than what would be required if the AC were to be paid purely in options. As Scott Lawton also suggest, this can be in the form of shadow stock or stock appreciation rights if restricted stock is too complex for your capital structure.
Bernard Moon responded in a post of his own. He’s had good experience with advisory boards and doesn’t see a need for paying more to ACs.
Jeff Jarvis responded to my question of how companies and ACs meet each other. He has two interesting ideas. One is that VC firms should set up and arrange compensation for networks of ACs. Jeff sees this as being a help with the VCs’ problem of how to keep deal flow going at a time when the initial capital needs of many startups are too small for efficient VC investment under the current model. Jeff also suggests “ACcon: a Demo without cash, in which startups meet experts with experience and they get to know each other and test each other and see whether they want to date.”
Charles Smith responds in his own blog that he already is an AC and that the model works. He makes the suggestion that companies may need ACs even if they have VCs: “At the same time, many VC’s (Union Sq. is certainly an exception here) don’t have the domain knowledge, the time nor the energy necessary to give the company all of the guidance they want and need. Angel investors often don't have the necessary expertise to advise a company all the way through the lifecycle. Filling those gaps is where advice capitalists can provide great value.”
Get money where it is available on the best terms. Get advice where it is best available. If you need both at the same time and can get them from the same place, great. If not, don’t get forced into a bundle. Hmm…