My recent post, Advisory Capital: A New Basis For Strategic Involvement, drew a range of commentary and critique. One theme I saw many times is that this is not an innovative idea, many people are doing it already. Indeed, several folks stated that this is the business model for their companies. Maybe I just the first to articulate it the way I did. Maybe it’s just timing.
I have read a dozen or more responses, and here I am pulling out the ones that strike a chord:
Fred Wilson of Union Square Ventures wades in:
[from Advisory Capital]
I think Stowe is right that advisors have a growing role in the startup equation for many of the reasons that he articulates. But I think it isn’t possible to completely replace the role of the VC for a couple of reasons.
1 - Unless you have capital at risk or some other form of “skin in the game” like sweat equity, you cannot and will not feel the thrill of victory and agony of defeat that binds the VCs and entrepreneurs in startups. Capitalism works for a reason. Greed and fear are powerful forces. I have worked with many “independent directors” over the years. And they are often incredibly good directors who add value in all sorts of ways. But they don’t feel it in their gut the way the entrepreneur does. VCs, particualarly the best ones, do feel it in their gut. And so they are there for the entrepreneur when they need it most, joined at the hip with the risk/reward belt.
2 - There is a growing market of angel money that is sophisticated and acts a lot like VCs. There are even “super angels” like Pierre Omidyar, Mark Cuban, and the like who can invest as much or more than most VCs in a deal they like. These angels bring most of what a VC firm can bring to the table if they so choose and can write smaller checks. I’d suggest before entrepreneurs give equity to advisors for no cash, they think about angels instead.
The bottom line for me is that cash at risk is a critical part of the relationship between the entrepreneur and their VCs. It provides the foundation for all the other roles that the VC plays - advice, oversight, connections, etc. Without it you won’t get close to what you get with a VC.
I agree with Fred about “skin in the game,” and that’s why I push my clients to step up their typical advisory board stock grant from 0.25%-0.5% to something larger, so that the stake is enough to make a difference in my future. Regarding the cash, many times the founder themselves are not putting in hard cash: they are forgoing pay in order to invest sweat equity. That’s why I provide a 50% or more discount of my consulting rates when working with Advisory Service clients. I am investing the difference.
If entrepreneurs can get the knowledge, connections, and experience that an advisor like me brings to the table from an angel, great! Take the deal, take the money, and strap that angel to the harness. In the meantime, I play more of the role of a part-time founder.
Jeff Jarvis makes the best counter to Fred’s arguments:
[from The VC Olympics]
I think the point of Stowe’s post is that equity gives advisors the sense of material involvement in a startup that is better than consultation, and that by making such arrangements, one can get advice, connections, and expertise from people who are, in many cases, at least as qualified as the people who happen to have money.
Or here’s another way to put it: Money is a commodity, nobody’s is better than anybody else’s. But knowledge and connections are uniquely valuable. And in an time when startups need less money, then the relative value of knowledge increases.
Note that this is precisely the example that Publicis’ new Denuo is following. Now in their case, Publicis is a giant company that could, indeed, also invest capital. But so far as I know, Stowe Boyd isn’t filthy rich (yet). And yet his advice would be very valuable to many startups and they should find the way to get it without requiring him to invest.
The larger story here is that venture capital is not escaping the explosion of business models that is also hitting media, advertising, retail, and many other industries. So VCs, too, need to explore new models. Perhaps they need to find ways to involve — and compensate — networks of advisors to bring that knowledge to startups and to spread their own work and risk in finding and helping and managing relations with companies, so they can get involved with more companies at a smaller scale than they can afford to today. If you can no longer bring $5 million to 10 companies but can’t afford to manage 50 $1 million investments — because it stretches your real assets, which are attention and time — then maybe the way to scale is via Stowe’s model.
Fraser Kelton read my post and Fred’s response, and thinks we are both missing the middle:
Stowe argues that VCs can’t/won’t support start-ups with incubator-like services. Fred claims that VCs are vital for reasons other than nontraditional VC value-adds. (Fred, you don’t explicitly discuss your thoughts on a VC adding non-traditional VC value to a firm, which is the underlying idea of Stowe’s arguement. Where’s your mind on that?).
Why can’t an innovative VC firm compete, and gain a competitive advantage by realizing this trend in tech start-ups and adjust their service offering to fill the gap?
David Hsu, from The Wharton School, published a paper in the Journal of Finance, in August 2004, titled “What Do Entrepreneurs Pay for Venture Capital Affiliation?”. It’s an academic article - here’s the summary:
In the minds of entrepreneurs working to grow their fledgling technology companies, the intangibles brought to the table by their investors – experience and contacts – often are worth more than money itself… David found that offers from more reputable venture capitalists are three times more likely to be accepted by entrepreneurial companies and that, on average, these favored investors acquire start-up equity in the companies at a 10-14% discount.
“Reputation” is defined as the intangibles brought to the table by the investor, and are mainly limited, with respect to the study, to experience and contacts. Fair enough.
Personally, I think VCs are not the only ones in the world with social networks. A good advisor brings that to bear, as well.
Over at Cyclical, we are told that ideas are cheap:
Having been both a consultant, a founder of several businesses, and heavily involved in startups, I have to say that I disagree with some of Stowe Boyd’s analysis of Advisory Capital. Stowe’s description of how a good advisor (or consultant to the business) should operate is bang on, but his expectations for reward with respect to ownership are way off.
Put simply, advisors or consultants who are working for salary (or a slightly reduced salary) are not taking significant risk in their role, and therefore should not expect much participation in the upside. Stowe writes:
A consultant is unlikely to want to part with a strategic concept that could make a client into a $100M player, potentially, in exchange for a per diem and the possibility of some downstream consulting, maybe, if you’re lucky.
IMHO, in a world where ideas flow extremely quickly and first-mover advantage is truly rare, simply having an idea or concept is worth little. If the ideas are that brilliant and worth that much and the advisor wishes to truly participate in the upside, then he or she should either work for deeply discounted rates (or for free), or start their own company to pursue the idea. Ideas are cheap, execution is the tough part. Quite simply, risk = potential reward.
I was trying to contrast the short term kind of relationships that I have experienced in the past, where clients seemed to want two days of intensive consultation — vetting their product, helping them lay out a go-to-market approach, assessing competitors’ products — rather than a long-term investment on both sides, which is what I think is the basis of advisory capital. They wanted a $100M dollar insight for a few thousand in consulting fees.
Nearly all the critics of the model I propose stress the need for investment, and that’s exactly what I am pushing for, as well: the long-term investment of the advisor’s attention to the challenges of the company.
Peter Caputa notes that the AC approach may solve a different problem in VC:
[from comments on the initial post]
The AC concept may be able to eliminate what has been a structural problem with the VC model: that the desires/needs of the VC are not aligned with those of the founders when it comes to cashing out. Paul Graham, and others have written extensively on this.
The cause is in large part due to areas unrelated to the founders or the start-up but rather to the business model of the VCs: their need to have a certain rate of return so they can continue to raise funds and the model where they expect the returns from one or two super star performers to in effect pay for the losses or mediocre results of the rest of their portfolio.
yes, the AC and the client — once the deal is struck, anyway — have the same interests, and the same payoff.
[Update: 27 Feb - I managed to miss an articulate detractor, Bernard Moon, who howls in his ADVISOR CAPITALISTS?… 1% OR MORE? HELLS NO!
Being cynical at times… well, a lot of the time, I see Stowe’s post as part of his pitch to drum up business in advising startups and position himself in a better light. After reading his post, I really don’t see much of a difference between an “advisor capitalists” and a regular advisor.
If I was building an advisory board, why would I give someone like Stowe 1% or more and others the typical .2%-.5% worth of equity (initial equity structure)? This can create a disincentive for the other advisors to put in their sweat since there would be such a large gap between an “advisor capitalist” and themselves in terms of equity but probably not in terms of time and effort. I’m speaking from my own experiences with advisors. As I posted before, some advisors you get to sit and be pretty on your board while others you have to play an active role in building your startup.
Even in my current role as an advisor to a mobile social networking play, I received the typical amount of equity (.2%-.5%). I communicate at least once a week with this startup, active in introductions, and active in their strategic development. Should I ask for more equity? No. From my own experience with advisory boards, I don’t think such activity warrants more equity. Stowe goes as far to state:
I believe we will see this boosted 5X, 10X, or more, to attract and retain powerful ACs.
Again I see this as positioning, and I also see this as crazy. Why would I give any advisor 2.5%-5%+ of my initial equity? Maybe if a contract was created where this advisor devotes 20+ hours per week. Even then would I sign up someone like Stowe who doesn’t have significant capital raising experience? Who cannot advise me on deal structure and provide their personal insights into the capital raising process? Hells no!
Yes, you are cynical. But, yes, I have significant capital raising experience: directly involved in raising over $20M since 1988, and indirectly, much more. Regarding the disencentives to other traditional advisors, I proposed that companies would increasingly have a small number of more involved advisors. If the existence of other players with more stock is a disencentive to advisors, then the differential between their tiny slice of stock and the monster shares of VCs and founders might be the reason that companies generally get so little out of them.
I also overlooked Tom Evslins exuberant posts on the subject. In the first, he agrees with the concept, and in the second recaps some of the debate swirling around it. And here’s a first: he has created a Wikipedia entry for advisory capital, saying
I created an entry in wikipedia for advisory capital because I think the discussion following Stowe Boyd’s introduction of the term is interesting and that wikipedia provides a good place to agree on a definition and draw out the distinction between advisory capital and venture capital on one hand and advisor capitalists and advisory board members on the other. This is also a good place to record either existing examples of advisory capital and/or future developments.