Seven Deadly Sins in Selecting Advisors for a Startup: And The Path to Redemption

“Sometimes an outside perspective is the clearer perspective.” ― Shannon A. Thompson, Seconds Before Sunrise

Advisors can make the difference between success and failure of a startup venture. The challenge for founders in selecting advisors is the enormous range in value that different advisors can add to a startup. Experienced and knowledgeable advisors can add enormous value. Inexperienced or misguided advisors can sink a startup very quickly. So how to choose?

Here are seven deadly sins to avoid and a suggested path for picking strong advisors.

Picking friends, family and the first expert who shows up

Too many startups follow the “path of least resistance” in selecting advisors. They reach out to family members and friends who have any modicum of relevant experience, or not. 

There is comfort in selecting advisors you know well and trust. But consider the following. If you were having open heart surgery, what are the chances you would select a relative or friend to perform the operation—unless, of course, your friend or relative is a good heart surgeon.

What is the equivalent in the world of startup companies? There are some professionals in the “startup” world that, like the surgeon who has performed dozens or hundreds of procedures, has worked with dozens or hundreds of startup companies across a broad spectrum of technologies, products, and markets. The most obvious candidates are venture capitalists who have been active directors on dozens or boards of directors of startup companies. Some serial entrepreneurs may also have extensive hands-on experience that makes them attractive advisors.

One way to think about the difference between your friends and family verses an individual who has worked with dozens of companies is that: When confronted with a difficult business situation, there is very little chance that your friends or family have dealt with it previously. On the other hand, a professional who has worked with dozens of companies will rarely experience a situation that is not at least similar to a situation he or she has dealt with in the past.

Lots of advisors, but where are the “company-builders?”

Too many startups follow the “path of least resistance” in selecting advisors. They reach out to family members and friends who have any modicum of relevant experience, or not. 

There is comfort in selecting advisors you know well and trust. But consider the following. If you were having open heart surgery, what are the chances you would select a relative or friend to perform the operation—unless, of course, your friend or relative is a good heart surgeon.

What is the equivalent in the world of startup companies? There are some professionals in the “startup” world that, like the surgeon who has performed dozens or hundreds of procedures, has worked with dozens or hundreds of startup companies across a broad spectrum of technologies, products, and markets. The most obvious candidates are venture capitalists who have been active directors on dozens or boards of directors of startup companies. Some serial entrepreneurs may also have extensive hands-on experience that makes them attractive advisors.

One way to think about the difference between your friends and family verses an individual who has worked with dozens of companies is that: When confronted with a difficult business situation, there is very little chance that your friends or family have dealt with it previously. On the other hand, a professional who has worked with dozens of companies will rarely experience a situation that is not at least similar to a situation he or she has dealt with in the past.

Startup founders often assume that executives with extensive experience in large, successful companies should be good startup advisors. But there is a very important distinction between “management experience” and “company-building” experience. Many skills are required to build a startup company that managers of established companies never experience. Some examples include:

• Hiring the right corporate lawyer
• Writing a business plan for the first time
• Creating an accounting or finance department
• Forming a corporation
• Allocating equity shares to a founders group
• Creating an investor “pitch deck”
• Raising capital

These are just a few examples, but they illustrate the point; it is almost impossible for an advisor to be experienced in these tasks without having participated in multiple startup companies. Large-company executive experience is not a good training ground for a startup advisor.

The best advisors have been involved in building many successful startups, and they are experienced at sensing “what has to happen next.” Building a startup company requires many “what should we do next?” decisions. This is what “leadership” is about. The best advisors help the founder/CEO of a startup “lead.”

Brownian Advisors; lots of independent action, but no central control or leadership (NMR) No guiding light; no central plan to “cohere” advisors

Some companies assemble an extensive panel of advisors that operates as what I would call a “Brownian Advisory Group,” as in “Brownian Motion,” the erratic random movement of microscopic particles in a fluid. Each advisor provides input in his or her areas of expertise, but there is no coordination of the inputs.

Having lots of advice is not helpful if it is not coordinated and focused on the critical problems the startup has to solve. Someone—preferable the CEO or founder—has to play a strong leadership role in constantly saying, “Exactly what problem are we trying to solve? What are the most critical issues facing the company, and where should we be focusing our efforts?

When I see a startup company with a long list of advisors, my first questions are, “What has each advisor contributed? How much time has each put in? When was the last time you spoke to each adviser?” Too often, it turns out that the startup is trying to impress me with a long list of names, including possibly some luminary personalities in their industry. To me, that signals a lack of understanding of how to work with advisors and a lack of understanding about how investors think.

“There is nothing more hateful than bad advice.” —Sophocles

Volunteer labor; you get what you pay for. 

Founders need to learn what it means to “add value” to their company. It’s a little easier to think about “adding value” when your company has a lower valuation, such as $1-2 Million. If an adviser helps you avoid losing $50,000 with an unqualified vendor, he or she has added approximately 2.5-5% to the value of your company. So how much should you be willing to compensate an advisor who has this potential?

Many startups try to avoid compensating advisors with stock. But “you get what you pay for.” Advisors who have the potential to add 5-10% or more to the value of a company can reasonably expect to receive 1-2% of the company’s equity. Some founders think this is excessive compensation, but in my experience, this is very near-sighted thinking.

Let’s consider two ways an advisor might add value to a startup.

The value of a company is in the “eye of the investor.” Valuations for startup companies are often in the range of $2-5 million, but if no one invests, the value is essentially $0.00. If an advisor introduces the company to an individual who invests $1 million in the company, how much value has the advisor added?

Suppose a startup is negotiating an agreement with a national distributor and it is willing to give the distributor 30% of sales as a commission. Suppose, further, that an experience marketeer is able to negotiate the commission down to 20%. So, instead of keeping 70% of sales, the startup is able to retain 80% of sales, a 14% increase, which, arguably, leads to a 14% increase in the value of the company.

Before a company receives financing, it is fairly easy for an advisor to add 5-10%, or perhaps $5,000 to $200,000 in value. Suppose, for example, that an advisor negotiates a partnership arrangement that doubles or triples the company’s sales. Or suppose an advisor helps the startup disengage from an incompetent vendor who could easily waste $20-50,000 over a period of several months. In either case, the advisor has added value in the range of 2-5% of the company in a single act.

As a company grows and increases in value, it gets more difficult to add significant value, but an experienced advisor can easily justify compensation in the range of 2-5% of the startup’s equity.

One-hit Wonder Advisors

As we said earlier, most founders’ friends and family have very little experience with startups, so if a founder meets an entrepreneur who has had one big success, the founder may be overly impressed. Not there’s anything wrong with having one big success, but if you accurately measure the “lessons learned” from:

• Having no experience,
• Having experience with one startup,
• Having experience with dozens or hundreds of startups,

there is really no comparison between the value of the first two categories and that of the third. Many angel investors fall into the second category. They are angel investors because they were successful and made a lot of money in one company. But companies can be successful for many reasons, including just being lucky, or being in the right place at the right time. So, being successful once is not a guarantee of additional successes.

I have been on many boards with people who had one previous success, and I have watched as many of them were not knowledgeable about some of the basics of building a company, such as bank covenants, 409-A requirements, the need for a focused strategy, and how to select qualified service providers.

“Advice is like mushrooms. The wrong kind can prove fatal.” —E. C. MCKENZIE, Mac's Giant Book of Quips & Quotes

Getting Advice from Luminaries

A mistake that startups make over and over is to assume that a highly successful senior executive of a fortune 500 company will be a good advisor for a start up company. In my experience, this is rarely the case, for reasons that make sense if you really think it through. Successful executives in large companies are used to having large staffs of people to help make decisions. The processes by which they manage are often highly structured and managed according to schedules and specific procedures.

In contrast, the executive of a fortune 500 company rarely has to make hard decisions by himself, with a little assistance and very little time for analysis. Furthermore, the processes in a startup company are not well-established and must be invented on the fly. Most fortune 500 executives have never had to write a business plan “from scratch” nor have they had to deal with the “what do we do Next? “Question.

Building a successful startup company is very different from managing a fortune 500 corporation. In my experience, there is very little overlap in the lesson is learned or in the skill set required.

There is a significant difference between hiring advisors to “fill-in” for weaknesses in a CEO’s experience, as opposed to hiring advisors to try to make an un-fundable CEO fundable. Investors will be attracted to a strong group of advisors that add to a founder’s skill set. But investors will not invest in an advisory group that is trying to shore up an unqualified CEO/founder.

Advisors Not on the Board of Directors

From my perspective, it is difficult to understand the value of an advisor who is not or who does not serve on the Board of Directors. There is a danger in having a group of advisors that is separate from the Board of Directors. What decision are the advisors making what? How are they contributing? What is to prevent conflict between the advisors and the Board of Directors? How would such conflict be resolved?

The exception of course would be a technical advisory board or an advisory board with some other specific charter. This makes sense to me, but too often companies pay only lip service to this notion. They assemble several advisors and they may put some compensation scheme in place, but then they rarely follow up effectively or make good use of their advisory board. An advisory board can be valuable, if it is organized effectively and with a purpose and managed systematically with periodic meetings.

Some mistakes that startups make send very clear “coded” messages to experienced investors. None is more telling than the company that has a long list of advisors and a poor investor pitch deck. The message is, “The founders have assembled a laundry list of talented advisors, but either they are not involved, or they no idea how to build a successful startup.

Don’t pick advisors to impress investors. Investors don’t invest in advisors. They invest in the CEO and the team he or she has assembled. Advisors can fill gaps in the team’s experience, but they are not a substitute for an experienced management team.

The Path to Redemption

In selecting advisors focus on finding professionals who have:

• A broad range of experience with startup companies
• Extensive experience in “company-building”
• Skills complementary to any shortcomings of the CEO and/or other directors

And make sure that you get maximum value from your advisors. Stay in constant contact with them. Keep them focused on the most critical issues facing your startup. 

Define the specific needs of your company. Be aware of the strengths and weaknesses of your CEO, team, and directors and assemble advisors who can add signigicant value.

Build a fundable startup!