Advice on Advisor Option Grants

We often are asked by clients about common terms for stock or option grants for advisors. Advisors are typically business or technical people that lend their time and expertise to a company in exchange for equity. Here are some things to consider:

1. Vesting. Vesting for advisor grants is typically monthly without any cliff. I advise clients to determine a certain number of monthly basis points that you think someone is worth, then grant them 12-24 months worth of options at this rate that would vest monthly over that same period. A 24 month option would normally cover between .15% and .75% of the Company’s fully diluted stock, depending on (1) how active the advisor will be, (2) how critical the advisor is to the success of the Company and (3) how mature the Company is.  Make sure to consider whether the grant is made based on fully diluted stock or only the stock that is then issued and outstanding (see my other Cooley GO post Option Grants: Fully Diluted or Issued and Outstanding).

It is technically OK to vest someone over a longer period (36 or 48 months, for example), so long as you keep the same monthly rate and make a larger up-front grant. However, I don’t typically advise this for a couple reasons. First, most advisors seem to have a shelf life of less than 2 years. I think this is because advisors tend to be helpful for advising a company that is at a certain stage (either from a business or technical standpoint) and once the company moves past this stage, the company tends to rely less on the advisor. If the advisor continues to vest after they’re providing good value, you’d need to terminate them in order to stop vesting, something that people don’t like to do with friends and mentors. Also, some advisors do request acceleration in the event the company is acquired. It would be reasonable to agree to this, particularly if you believe the advisor will be a valuable addition to the Company. It would be better to have 24 months worth of options accelerate instead of 36 or 48 months.

2. Exercise Period. Many advisors don’t realize that most startup option plans require that vested options be exercised within 3 months of termination of the advisor agreement or else they expire. This is a requirement of Incentive Stock Options (ISOs) and not of Non-qualified stock options (NSOs), but most plans apply the 3-month exercise requirement to both types of options. (I won’t get into the difference between ISOs and NSOs here.) Advisors will receive NSOs (because they are not employees) and therefore can negotiate to have the 3-month exercise period extended for some longer period. This is very helpful to the advisor who might not want to (or have the ability to) come up with the exercise price to exercise the option, and is faced with losing his or her vested shares. In addition, there is potentially a tax bill due at the time of exercise for an NSO, which can be another unwelcome surprise for the advisor. So giving the advisor the ability to delay this day of reckoning until there is a liquidity event on the horizon is a great benefit, albeit not one that many companies are willing to offer.

“But wait,” you might ask, “isn’t it better for the other shareholders if an advisor’s grants terminate? That leaves more equity for me and everyone else.” This is true — and certainly a valid position that many companies take. However, in my experience the advisor relationship is typically beneficial (or at least neutral) for the company and the company usually wants to play nice with the advisor. If the advisor relationship was beneficial but the advisor is terminated because they are no longer very involved, the exercise period becomes a ticking time bomb that companies want to address, usually in a mad scramble. And often the advisor and the company simply gloss over the exercise period, the options expire and you have a disappointed (or worse – angry) friend and mentor.

To help avoid this potential relationship snafu, after the advisor agreement terminates the company might consider sending the advisor a note that includes the effective termination date of the agreement and a brief explanation that the advisor has 3 months from that date to exercise his or her options. While there is no obligation to do this under many option plans, some companies do this as a matter of good corporate housekeeping.  This also creates a record that will help in the event that the advisor and company disagree on the effective date that the relationship terminated (if, for example, the advisor is still listed on the company’s website or AngelList profile as an active advisor).  This also may be required by the termination provisions of the advisor agreement that the company is using, so be sure to review that or discuss with counsel.

3. Consistency. It is inevitable that one advisor will find out what you paid another advisor. Try to be consistent and fair with all of your advisors that are brought on at similar stages so one doesn’t become disillusioned.  This is not a rule of course, just one consideration.