Entrepreneurs: Beware of “Special” Advisors

UNSOLICITED ANGEL ADVICE: Entrepreneurs: Beware of “Special” Advisors

A large part of the New Mexico Angels’ mission is to educate entrepreneurs and investors about raising and deploying capital. You see, it is in our best interests as investors to put money into companies that are well versed and educated on equity investments and the interesting issues that come about in seeking such.

Over the last few years, we have seen the rise of a new and interesting player in the start-up capital realm. The following is our opinion on this new development. As part of this article, we would also like to ask the advice, counsel, and experience of our email readers regarding the role of “special” advisors in angel investing, and particularly within the New Mexico Angels.

The “Special” Advisor

What are special advisors?  Typically, this is an individual who goes to the events where entrepreneurs and startup folks meet and greet. They find the early stage companies that are working on building a company, creating a commercialization and/or business plan and looking for outside capital. Their pitch goes something like this:

“I am a successful start-up person. I have done what you are looking to do and I can help. Look at my resume, look at the other companies I am involved with and look at my experience. I will not charge any cash for my services. Just give me five (5) percent of your company and I will help you and your company become successful.”

If you are entrepreneur and looking to build out your company while preserving capital, this sounds like a pretty good deal, right?

The short answer, no. Have you heard the old adage, “Don’t look a gift horse in the mouth?” Here is why we as angel investors have a problem with this “gift horse”.

Let’s assume a promising startup company has hired a special advisor and provided them with a small piece of the company. Additionally, let’s assume that the company needs to go out and raise capital from the local angel group. Let’s also imagine a pre-money valuation of $1.25 million while looking to raise $250K.

Based on these numbers, the special advisor’s stake becomes valued at $62,500 – all without having to put in cash, spend time or assist the company in creating value (remember last week’s stock vesting article?). As a special advisor they are not a full-time employee nor does he/she add any special skills sets required by the company.

If this shows up in a deal, Angels will have a problem with this arrangement.

It’s all about the math. If an angel investor invests $25K in the company, then the angel investor owns less than the special advisor who has not put on dime into the company. The other unsavory issue is that the angel investors are monetizing the stake of the special advisor.

When we engage with startups, we provide much more than a financial investment. We provide the combined expertise of our 70-plus members, many of whom have started and led successful companies of their own. This “brain trust” and the insight we impart to our portfolio companies should not be under valued.

Please don’t misunderstand – we fully support consultants and advisors and many of us are such in our day jobs, but when we help a company out we provide knowledge, expertise, and take payment or if we take stock our stock is vested against milestones, ensuring that we bring value to the table.

If you are an entrepreneur with an early stage startup and a special advisor approaches you, think about it carefully. While they may provide value—or seem to—it would be a challenge for angel investors to invest in a deal where equity is provided to the special advisor. Just as investors do their due diligence on you, do so for your advisors.

We at the New Mexico Angels take our mission seriously. Special advisors appear, in our eyes, to be in competition/conflict with our mission. However, in the spirit discussion, we invite you to share your opinion and advice on how to deal with this development in the New Mexico entrepreneurial and investment ecosystem.