Wednesday, July 31, 2013

Angels on Portfolio Company Boards: Should they be Compensated? Yes, But How Much?

To stimulate discussion, we propose the following guidelines for Angel Groups to use in compensating Angel Group members or others who serve as outside (non-employee) directors.

·        Angel Group members should be compensated when serving as outside directors,
·        Compensation should be  common stock options vesting over two to four years,
·        0.25% to 1.50% of stock on fully-diluted basis,
·        Single trigger acceleration on change of control,
·        Clear understanding as to how the vesting will work if the board member leaves the board.
·        No direct cash compensation,
·        Reimbursements for reasonable expenses,
·        Opportunity to invest in the most recent financing,
·        Advisory Board members to receive 0.25%,
·        Board observers not compensated unless they have specific company building duties,
·        VCs and state sponsored fund directors are paid by their  employers and should not also be compensated by the company,
·        Exceptions for Angels filling management roles.


From our Editor: roughly a decade ago, I decided our group, the eCoast Angels Investment Network, needed some guidelines for compensating Directors serving as board members for our portfolio companies.  Through the still-emerging Angel Capital Association, I had a number of contacts around the country with angels whose experience was greater than mine.  I asked the advice of Luis Villalobos (Tech Coast Angels), James Geshwiler (Common Angels), Ralph Wagner (Walnut Ventures), and Rick Holdren (Houston). Among VCs I recalled conversationswith Bill Congleton (AR&D, Palmer), Stu Greenfield (Oak), and George Middlemas (Apex),as well as documents posted online by VC and author Brad Feld.

After a few years of keeping this document up to date, I posted a final version in February of 2006 which was also posted on the ACA web site for many years.

Lately I have been getting inquiries again.  The number of angels and angel groups having increased dramatically,  I find that the number of opinions has increased even more quickly.

The following is a rationale for each item proposed above.
Our general rule is that our members are not compensated for locating deals, performing due diligence, negotiating terms, or pulling together the financing. As a group, we all share these burdens. After we close a financing, however, we expect to contribute significantly to the value of the investment. The individuals who assume this task should be compensated.

Granting common stock options  aligns the board members’ incentives with all shareholders (presumably they are getting the options at a low strike price and will be motivated to increase the value of the stock while minimizing dilution over future financings).  These options should come out of the employee option pool and should be thought of equivalently to the employee base (e.g. if there is an option refresh due to a down round financing, the board member should be included in the refresh). I favor making the vesting parallel to the employees vesting: typically, 25% on the first anniversary, with the remainder vesting monthly thereafter.

There are two key ways to determine the amount of the options to be granted. Brad Feld, a VC who writes extensively, recommends 0.25% to 1.00%.  James Geshwiler supports this range.  At one of our first NE Regional meetings that I attended Ralph Wagner mentioned that Walnut allows compensation to Angel Board members; typically one per cent. We here at eCoast Angels have been using the one per cent as a guideline.

From other advisers I hear varying opinions, but not a percentage.  The late Luis Villalobos favored picking a value. Thirty years ago Stu Greenfield from Oak Investment Partners told me that a director should have the opportunity to make $250K over five years, assuming success.  George Middlemas from APEX told me ten years ago that $500K was more appropriate.  I feel comfortable that today a proper range would run from $750K to $1 million.

Our problem as Angels is that in seed deals the VC amounts would cause the directors to own too much of the company.  Assuming good VC returns, an investment of $150,000 today would be valued at 5X in five years, or $750,000. Therefore if the post money value of the company at the most recent financing is $10,000,000, 1.5  per cent satisfies both our percentage and value guidelines. Higher valuations are even easier.  Our problem as Angels lies in seed deals.  Assuming a post-money valuation of $1,000,000, $150,000 per director is unrealistic.

Today, many new companies coming out of accelerators such as Techstars are raising less money than previous companies and are using convertible debt as an investment mechanism.  This makes it hard to determine the current value or to impute a future value for the stock. At the start there may be very little stock authorized, making our original one per cent guideline a bit low.

 Thus I propose the following:

For post money evaluations of $10,000,000 or less, director compensation should be about one to 1.5 per cent, but can vest more quickly, say two years. Assuming the value of the company increases after two years, compensation can be revisited then.

For valuations above $10,000,000, the guidelines above apply.

Please note that the discussion above relates only to the potential value of the stock in the future, not its value today.  I’m recommending that the director be offered options to purchase restricted common stock  on a basis similar to the employees, but that the number of these options be such that they would  represent  $150,000 if the same number of preferred stock shares were purchased today (assuming 1:1 conversion).

Single trigger acceleration on change of control: Acceleration on change of control is often a hotly negotiated item in a venture financing.  Feld thinks single trigger acceleration in change of control is rarely appropriate for management, but will always accept it with regard to board members since 100% of the time they will not be part of the company post acquisition.  By providing 100% acceleration on change of control, you eliminate any conflict of incentives in an M&A scenario.

Clear understanding as to how the vesting will work if the board member leaves the board.  In the case of Angels who guide and build a company up sufficiently to attract a VC round, they are very likely to be replaced although still willing and available to serve. In these cases, I believe their vesting should accelerate: I recommend full acceleration.  Since Director Options are non-qualified, and the Directors are unpaid, they should be allowed the full term of the option plan (approx. 10 years) to exercise them.

In other cases it should be clear – in advance – that the vesting on the options ends if the person is asked to leave the board or voluntarily leaves the board. This seldom creates an issue when it is discussed up front.

No direct cash compensation for directors before a company is cash positive.  If someone insists on cash compensation for board service in an early stage company, they are not qualified to be a board member since they simply don’t get it

Reimbursements for reasonable expenses: Board members should always be reimbursed for expenses they incur on behalf of the company.  However, these should be “reasonable” and should conform to the company’s expense policy

Opportunity to invest in the most recent financing: I strongly believe that all board members should be given an opportunity to invest on the same terms as the most recent Angel round.  Looking backwards, this might be difficult, but  at a minimum the board member should be invited to invest in your next round.  While we should always encourage this investment, I don’t view it as mandatory – I think it’s a benefit an outside board member should have for serving on a board, not a requirement.

Advisory Board members should be compensated near the lower range of the guidelines about, say 0.25%, vesting as described above.

The involvement of board observers varies greatly, from company to company as well as from person to person.  Some observers essentially function as a full-fledged board member except for voting privileges. Thus compensation for observer roles should be expected to vary accordingly. 

VCs and state sponsored fund directors are paid by their  employers and should not also be compensated by the company

Exceptions for Angels filling management roles; we all know of cases where Angels have filled in and played an active working role in their companies.  In seed deals, this is often required for the company to be successful.  Feld’s thoughts are as follows. “In seed stage companies - especially pre-funding – an early board member might receive founder status depending on his involvement in the company.  When I was making angel investments, I’d occasionally commit to a much higher role than simply “a board member” – occasionally I’d be chairman and/or an active part time member of the management team.  In these cases, I’d typically get an additional equity grant (usually founders stock) separate from my board grant.  As with other members of the founding team, I’d have specific roles and responsibilities associated with my involvement (usually financing, strategy, and partnership related) and – even though I was a board member – I was often accountable to the CEO for these responsibilities.”

As is our custom, we have run this post informally by a few colleagues.  James Geshwiler (Common Angels) and Christopher Mirabile (Launchpad Venture Partners) have been comfortable with one percent for Directors.  Jeff Hermann (Walnut Ventures), comments "the ranges you give are reasonable and justifiable, but you may be a bit too dogmatic in tone.  Everything is adjustable based on the specifics of a situation, including the valuation of the company, the expected contribution and involvement of the board members, the amount of "adult supervision" that the company will require, the anticipated timeframe to exit, etc."

 What do you think?

The original DEC Board, with Bill Congleton fourth from left.  My recollection is that he was  very well compensated for  his service. To his left is Harlan Anderson, perhaps the first of our modern Angel Investors.

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