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Disrupting the Venture Capital Industry – Advisor Capitalists

Everyone knows that many businesses can be started with much less capital than used to be required – especially Internet services businesses.  Hosting is cheap; hardware is cheap; blog hosting is free (in some cases); much software is free yadyadayada..  Less money needed for startups means that more businesses can get by without VC money.  In fact, VC money typically isn’t available if you need less than a million dollars.  But, Stowe Boyd asks in an excellent post, what happens if you still need all the other stuff that VCs bring like advice and connections even if you don’t need their money?

Stowe’s answer is that you need Advisory Capital – everything that VCs do minus the money.  He calls it “capital” because he means you to treat it that way.  “Like venture capital, advisory capital is about the investment of a critical resource into a startup. It's not money, however, but the experience, expertise, social capital, and public authority that advisory capitalists invest,” he says.

You would pay your Advisor Capitalist (AC) in equity the way that VCs are paid for their investment although presumably in less equity.  The AC would promise not to take other advisory gigs or presumably consulting contracts which would be in conflict with his or relationship with your company.  It’s a long term arrangement in which the AC earns sweat equity.

Stowe recognizes that many firms have “advisory boards” which are supposed to fulfill at least some of these functions.  But he dismisses them saying: “Advisory boards in principle are a way to involve well-known authorities or business celebrities into the mix of the business, but in practice they have become a PR exercise with flabby results, in general. The minimal levels of involvement -- an occasional call, an annual dinner -- do not lead to great results, because there is not a deep enough investment being made.”

I think I agree with that; I never formed an advisory board for any of my companies although that may have been my mistake.  When I have been asked to be on an advisory board, I’ve usually found that the asking company was more interested in my name than my advice.  Hurt my feelings so I’ve never done it. On the other hand, Bernard Moon has had some success with advisory boards and blogs some good advice on setting them up here.

Venture capitalist Fred Wilson doesn’t think that advisor capitalists are the answer.  In response to Stowe, Fred blogs: “the bottom line for me is that cash at risk is a critical part of the relationship between the entrepreneur and their VCs. It provides the foundation for all the other roles that the VC plays - advice, oversight, connections, etc. Without it you won't get close to what you get with a VC.”

Fred suggests that, if you don’t need enough money to qualify for venture capitalist, you seek an angel instead.  I agree with that IF YOU NEED money and recently posted myself on angel investors.  Moreover, I have raised money from Fred in the past AND gotten good advice so do agree that, when the VC relationship works, it works.

But what if you don’t need money but still need advice and connections?  I don’t think you ought to sell more equity earlier than you have to just to get the advice and connections you want.  I do think that the venture industry, just like so many others, can be horizontally delaminated or micro-chunked like much content is or ought to be.  No packaging of one service with another is sacrosanct.

I must admit I like Stowe’s suggestion as much in my present role as consultant (when I’m not writing murder mysteries) as in my ex-CEO role.  My consulting is too expensive for many interesting start-ups to pay me cash.  Equity is a currency they have.  A best-effort does imply a long-term relationship in which the consultant does not flit from one competitor to another like a cross-pollinating bee.  I think if I have forgone fees and put in time, I WILL begin to think of my sweat equity as if it were actual cash I put in despite Fred’s concern.  After all, most of the entrepreneur’s investment is also likely to have been in sweat if she hasn’t yet raised any money.

I am sometimes asked to serve on the boards of private companies and have sometimes done that.  When I am the first outside board member other than VCs, I am often serving in a quasi-consulting role.  For that I like to get paid in either cash or restricted stock or a combination of the two.  The VC are often unhappy with that idea and think I should get options; that is usually the way it’s done.  But I think stock makes me think more like the entrepreneur.  You want your advisors to be motivated like you (the entrepreneur).  In tough times you want them to think about preserving as much value as possible.  Someone who is compensated only in options is motivated to take enormous downside risk in return for some possibility of an upside since options have only upside value.

The reason I bring this up is that I think ACs ought to be compensated, at least in part, with restricted stock rather than options.  This is similar to the compensation that a VC gets although I’m not sure this stock needs a liquidation preference like angel or VC stock gets.

One question I don’t know the answer to is how the AC relationship gets started if the potential AC doesn’t know the entrepreneur.  Just like a VC, a consultant can’t spend much time evaluating prospects which aren’t likely to pan out.  Similarly, how does the entrepreneur know which AC really can help.  At least money is money when you’re looking for a VC.  Will there be AC firms whose reputation you can trust?  There probably will be AC firms but I can see myself telling entrepreneurs that nothing matters except the skill and personality of the specific AC he will be working with.

Maybe, when there aren’t personal relationships, the AC relationship starts with paid consulting.  Tough on cash flow, though.  Even with kinks like this to be worked out, I think Stowe Boyd is on to something – if you don’t need the money a VC or angel would bring or if you are a consultant looking to live a little more on the edge.

I wrote an earlier post on disrupting the VC business here.

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Listed below are links to weblogs that reference Disrupting the Venture Capital Industry – Advisor Capitalists:

» ADVISOR CAPITALISTS?... 1% OR MORE? HELLS NO! from Junto Boyz
So I came across Tom Evslin's post in response to Stowe Boyd's "Advisory Capital: A New Basis For Strategic Involvement" post. Being cynical at times... well, a lot of the time, I see Stowe's post as part of his pitch to drum up business in advising... [Read More]

» Advisory Capital- I'm an AC and proud of it from The Ineo Group LLC
There’s been a lot of talk about Stowe Boyd’s Advisory Capital post- I read it on Buzzmachine, commented on it earlier in the week, and have now read Fred Wilson’s response (Also via the Union Square Ventures blog), and Jeff [Read More]

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» Thoughts on Advisory Capital from Thought Leadership
I just clicked publish on today's blog entry when I ran across an article by Stowe Boyd on the notion of advisory capital. I am curious if my thoughts and his are on a collison course... [Read More]

» Advisory Capitalists - My Two Bits from MidMarketMaven
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Comments

condom

I wish everybody do his job like you do http://condom2.cars-search.org/

Chris Yeh

I sit on a couple of advisory boards, and I've also invested in a couple of startups.

I'm honest enough to admit that I devote a lot more thought to the companies I have money in, than the ones where I simply hold some advisory board options.

Call me old fashioned, but I think that skin in the game makes a difference.

Of course Jeff Clavier (http://www.softtechvc.com/) has done a fantastic job of advising the companies he works with, so maybe you just have to find the right guy!

Shannon Clark

As an entrepreneur and consultant some perspectives and suggestions:

- advisory boards can be useful, though in the past I have found that a single, reliable, ongoing mentor can be even more useful than a full board

- some of the best advice and support can be through peers (especially peers at various stages)

- I have recently moved from Chicago (land of the 2nd city syndrome and very few tech startups) to the Bay Area - land where the random person at the table behind more times than not is a VC (or a recovering one). One of the big reasons I moved is that here in the bay area it is extremely easy to meet with and connect with other people working on similar problems.

Among the crowd of people I know in the Bay Area, there are many many times people get together - both in public and in more private dinners, breakfasts, drinks, and coffees. These meetings, often between entrepreneurs who might be seen from the outside as competitors, are crucial to helping everyone in the community figure out the next steps and grow.

I'm one of three people co-organizing a monthly networking event in San Francisco for Web Innovators (SFWIN - google for the wiki to sign up - next event is March 23rd at Microsoft's offices in San Francisco). A major reason we organized these events was to give people who are working on new web projects - no matter their stage of funding (or lack of funding) a chance to interact, hang out and connect with each other. As a result, we've started to build up a community of people who are each doing something - and around that community people are finding and connecting each other (at least one CIO was hired directly as result of our networking events)

In a few weeks I will be participating in a gathering a friend of mine is organizing. In it a group of people including some VC's and Angel investors will sit down and analyze a specific business idea - and together see if we can make it work. Some of us, like myself, would most likely be only loosely involved (probably as outside advisors/consultants) while others might be directly involved as investors or full time staff.

But this process is being repeated many times over - both in the for-profit and very interestingly in the non-profit/social investing spaces. Another group of us is going to be meeting once a month to connect around how to literally change the world (though technology in many cases) all brought together by a common interest in social change as well as technology.

These gatherings and sharings of connections, ideas, and experiences are what help make the Bay Area a vital and invigorating place to be.

And in many cases the conversations which start in these semi-public forums continue in more private discussions, where at times direct forms of compensation are offered. But the social capital and bonds which are being formed between people are, perhaps, more valuable than a few shares of restricted stock.

It is these bonds and relationships which then very directly lead to recommendations, introductions, speaking gigs, consulting projects (when a company gets funding or revenues) etc.

It is also these types of relationships that help get blogger coverage, traffic, links and referrals, and numerous other activities that often can very directly translate into the next steps for many new companies - for much more valuable to ANY business than advice (words) or raw basic cash is the feedback and value that comes from real (ideally paying) customers.

Shannon

Darren Herman

Excellent post. AC (advisory capital) is a great concept, but how can you put a price tag on it? Also, as an entrepreneur, I do not want to give a consultant or advisor equity early on, when essentially, their value diminishes over time as the company grows. There has got to be a better fit for the company/advisor. I do not have an answer here, but this surely rings close to home as an entrepreneur.

Another thing to ponder is how do your Series A investors look at advisors who have equity in the company. Are they frowned upon? Does their equity dillute the same way?

Scott Lawton

Some excellent points (as always). One thought: for an early stage startup, I don't see any benefit to stock over options. If the options turn out not to be worth anything, I think it's rare that the stock would be any different. Is there a case I'm missing?

Also, some early stage companies are LLCs, in which case "phantom stock" may make sense. That avoids the hassles of having LLC "members" who have a relatively small share, and who may come and go.

charlie crystle

I disagree with Boyd about advisory boards. It depends on who sets them up, who's on, and how you intereact. My advisory board is fantastic except for one of them, who isn't as proactive as I'd like. And yes, we issue options but not as incentive, more as courtesy and compensation, however tiny of huge it might become. And isn't restricted stock more complicated/expensive to administer? ISOs are cleaner, right?

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