Micro-advisor programs and overcoming the myth of messy cap tables

Hey founders et. al. This is part 1 of a series of articles I am writing to demystify micro-advisor programs, long cap tables, and the legal mechanics behind it all. Big thanks to everyone who’s helped out writing and reviewing this article, including Eric Broad, Maria Worley, Zach Levin, Andrew Avorn, Yin Wu, and Brian Murray.

Intro

I recently read and listened to a few articles and podcasts discussing the idea of a micro-advisor program where, instead of granting large chunks to a small group of advisors, companies split equity amongst a larger pool of “micro-advisors” to foster a more inclusive and more diverse advisory pool. Advocates of this new wave, like direct mailing platform Sendoso, believe that the old way of structuring an advisor program — i.e. reserving advisor equity for a few strategic advisors — could leave companies overly dependent on the fruits of only a few advisor relationships. A micro-advisor program reduces the risk of having large chunks of dead weight on your cap table and increases your chances of having that home-run contributor that pulls 100x their weight. This is fairly intuitive and makes sense to me.

However, my lawyer brain was uncertain about the actual mechanics and worried about the potential implications of creating an advisor program with hundreds of participants, from both a legal and operational perspective. Would investors be turned off by this type of program? Could this screw up my cap table? Would it impose a massive operational burden on my tiny company? To answer these questions, I decided to take a deeper dive into understanding how lawyers and investors might react to the idea of a micro-advisor program.

Types of objections

Based on my research and conversations, objections to this type of program appear to fall into two main camps - optics objections and operational objections. Below I share some of my findings in order to shine light on why this type of program shouldn't cause so much heartburn, and where you should focus your attention if you plan to build a similar program in the future.

Optics Objections

You’ll hear a lot about the pitfalls of a “messy” cap table as you begin to add large amounts of investors and advisors to the equation, but a long table ≠ messy cap table. To me, these high level cap table concerns are mainly concerns around optics, and optics problems are illusory. They don’t need to be “solved” as much as they need to be explained, so you should have a narrative to guide concerned lawyers/investors as to why it won’t be an issue. I touch on some of the objection responses below:

Optics Objection #1: “It is harder to attract future venture investment because a long cap table is generally seen as a red flag.”

There are some valid reasons investors are fearful of long cap tables, but long cap tables are not intrinsically bad. In-fact, many industries view a long cap table as a value-add. The concept that one investor should set the market is antiquated from a time when companies would only raise from angels if they couldn't get a lead venture commitment. Now, the lines are blurred. You can have angels, professional angels, small checks from VCs, etc.

The antiquated fear around long cap tables stems from the fact that it could be an indicator of a more deep-seated mismanagement of the company’s equity. However, this would not be the case with an advisor program proactively designed to give very small portions of equity to strategic advisors and assigning very clear responsibilities to these advisors. Make a plan, make sure you understand the mechanics of how it works in practice, and move forward. We discuss the mechanics a bit in the next section.

Optics Objection #2: “Long cap tables are complicated! How are you going to keep all of this organized? How are you going to make sure you collect signatures when necessary, and coordinate collective action when necessary?”

This is a fair point. We dive into the operations side of things next... but a high level “optics” objection should be responded with a high level response. “We are proactively designing this advisor program to prevent operational hang-ups.” The specifics of how we are doing this are discussed in the next section.

Optics Objection #3: “There is a risk of dead equity (advisors who no longer add value to the company): it is harder to keep passive advisors to a minimum when you have a lot of them (even if they don’t start as passive).”

Well, as the manager of your own advisor program, this one is up to you. Are you going to terminate an advisor relationship if they are in-fact “dead equity”? For ours, I would be willing to take that hard stance. If an advisor relationship has gone cold, we will terminate the relationship. I am willing to risk the possibility that many advisors won’t turn into home-run hitters because I also know we will see outsized contributions from a few all-star advisors. Venture capital should understand this approach well, we are taking a page out of their book.

A true “messy cap table” is one that could prevent you from raising future rounds. If a crowded cap table means you're over diluted, that could be a problem. One example of this is if the founders are over diluted such that investors are concerned that the founders won’t remain properly incentivized for the required time horizon. A micro-advisor program would not lead to such dilution. 

Operational Objections

As opposed to the “optics” objections above, the following operational objections are in-fact issues that need to be addressed. However, they aren’t roadblocks by any means. I outline the operational problems below and discuss how to resolve them proactively.

Operational Objection #1: “A long cap table complicates your ability to model exits, dilution, distributions, etc.”

If this were 5 years ago, I would have agreed with this objection. Today, there are amazing cap table software providers out there like Pulley and Carta that anyone can use, at low cost, in conjunction with a lawyer, paralegal or operations specialist, to properly account for the complexity. I think this part is overplayed. There is no excuse not to manage your cap table on one of these tools from day one. Additionally, founders should actively manage advisor grants to make sure that if an advisor is no longer involved, their vesting terminates.

Operational Objection #2: “With a cap table that is so long, it will be impossible to provide proper notice of shareholder meetings, and track down votes and signatures when you need your shareholders to take action.”

Private companies based in the US (mostly in Delaware) almost never call shareholder meetings – instead doing everything by written shareholder consents. Further, almost no corporate actions ever require unanimous consent or agreement. Large corporate actions like mergers or acquisitions generally only require a majority or supermajority. Considering only 1-2% of outstanding shares should be devoted to an advisor pool under this structure, this is likely not going to be an issue, and drag along rights should cover the final few percentage points of shareholder consents you need. You should discuss setting up proactive measures to ensure voting rights are accounted for in your stock plan so that your advisors automatically vote alongside the majority shareholders via proxy or drag-along rights.  

If you’re establishing this program later on in your company's maturity curve, you could choose to offer option grants and not restricted stock. This would mean that the option holder has no rights as a shareholder until they actually exercise their options and purchase your company’s stock. As a result, your advisors will not be called upon to vote on a corporate action (such as a merger or acquisition), attend shareholder meetings, or sign an agreement that is required of shareholders.

Operational Objection #3: “It’s going to be harder to keep accurate records of all your shareholders, hard to stay organized, and harder to send updates. I have to update all my shareholders on company progress, etc, and this creates more people to keep track of.” 

Whereas cap table management like Pulley, Carta or similar are the answer for the cap table management concern, Cabal is the answer for stakeholder communications and organization. I would check out what Cabal is building and see for yourself how you would keep investors and advisors in the loop before you rule out a micro-advisor program.

Operational Objection #4: “All these people on your cap table will get expensive, no? Don’t cap-table management software providers charge per person?” 

Yes, a common pricing model for cap table software is to charge per stakeholder (or do tiered pricing based on seats). However, not all of the cap table software providers charge this way, and I think it will change as party rounds and micro advisor programs become more prevalent. Pulley has recognized this and is not penalizing early stage companies for long cap tables. My hope is that the rest can adjust their pricing model to account for the changing times.

With all of that said, it’s a marginal cost and it’s one I am willing to incur to set up the optimal advisor program for our company.

What’s next?

Having started digging into this topic, I’ve realized there’s a few subtopics that could use a little fleshing out. In the coming weeks, I plan to cover some of the following:

• How does Rule 701 relates to compensating micro-advisors with equity?

• What’s in it for the micro-advisor, and how should advisors be thinking about these programs?

• Micro-advisor program operations 101. How does is all actually work?

• What will HeyCounsel’s micro-advisor program look like?

I’m excited to continue diving into this area. Have any commentary or feedback? Drop a note in the comments or reach out me. 

Stay lawyerly,

Brian