Several people have recently asked me variants on the question “How should I compensate a board member in my young private company?” I’ve experienced this question from all sides, having been the entrepreneur with an early stage company, a board member of an early stage company, and an investor / VC in companies that had board members at early stages, so hopefully my answer is balanced and a function of the law of large numbers (I probably have over 100 direct data points at this point in my life).
In general, I have a set of simple rules for board member compensation:
- 0.25% to 1.00% vesting annually over four years
- 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
Following is a detailed explanation of each item.
0.25% to 1.00% vesting annually over four years: While the ask from sophisticated board members will vary widely here, I’ve found that most people will accept the argument that they are getting between 25% and 50% of what a typical VP will receive (1% – 2%). It’s always better to grant more options that vest over a longer period of time then to do annual grants early in the life of the company – that way the board members’ incentives are aligned 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).
Single trigger acceleration on change of control: Acceleration on change of control is often a hotly negotiated item in a venture financing. I’ll discuss it in greater detail in a future post in the term sheet series. I rarely think single trigger acceleration in change of control is appropriate, but I’ll 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 most cases, board members serve at the will of a particular constituency, which could range from a particular VC investor (e.g. the outside board member might be appointed by the Series A shareholders) to the entire shareholder base (e.g. chosen by a shareholder vote). As a result, a non-VC board member is typically not contractually entitled to their board seat and often leaves the board (either because they chose to due to other responsibilities), is asked to leave (because he is not contributing actively to the business), or is replaced (by the shareholder group that has the contractual right to the board seat). As a result, 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. I’ve never had an issue with this when it was discussed up front; I’ve occasionally had issues when it wasn’t (e.g. the person wants additional vesting beyond their board service, which I think is inappropriate except in the case of the acquisition of the company – see the comment on single trigger above).
No direct cash compensation: Period. If someone is asking for 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. If the board member is also doing specific consulting for the company beyond the scope of a typical board member, you’ll occasionally see some cash comp for the consulting services. However, the bar for this should be high and well defined – a “monthly retainer” for “helping the company” is inappropriate.
Reimbursements for reasonable expenses: Board members should always be reimbursed for expenses they incur on behalf of the company. However, these should be “reasonable”, should conform to the company’s expense policy (e.g. if execs travel coach, board members should only be reimbursed for coach tickets), and board members should be respectful of cash in early stage companies (for example, if a board member travels to several companies during a trip, he should only charge a company for the segment(s) pertaining to them).
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 VC investment. Depending on the characteristics of your most recent financing, this might be difficult (check with your lawyers) – at the minimum the board member should be invited to invest in your next round. While I 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.
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.
In addition to a board of directors, many early stage companies have an advisory board. I’ll dedicate a longer post to how to make sure these are effective (as they rarely are) – in any event, advisors typically have a much lower commitment to the company and, as a result, should receive a much lower equity grant. In addition, advisory boards tend to come and go so it’s better to compensate members on an annual basis. A good proxy for the amount is an annual grant of 25% to 50% of the four year grant you’d give a junior engineer (so 1x – 2x a junior engineer if the advisor stays engaged for four years). Obviously, there are exceptions to this, but if you want to get meaningful, sustainable involvement from an “advisor”, consider giving him a more significant role.
Finally, VCs should never get additional equity for board service in private companies. The VC has already purchased his equity and his board involvement is a function of his responsibilities associated with his investment. I’ve been on the receiving end of this and it has always felt weird. In a public company, it’s typical to compensate all board members – including the VCs – equivalently, but private companies are a different matter.