Managing company equity is a crucial part of a founder’s job duty. In the early days of building a business, chances are there will be countless advisors, investors, peers, etc. that help a business. However, most early stage businesses do not have the cashflow to compensate every advisor along the way. Founders need to get crafty with how they compensate their earliest advisors and experts — enter: advisory shares.
We always recommend consulting a lawyer before taking further action on advisory shares. Learn more about advisory shares and how you can leverage them for your business below:
What Are Advisory Shares?
As put by the team at Investopedia, “One common class of stock is advisory shares. Also known as advisor shares, this type of stock is given to business advisors in exchange for their insight and expertise. Often, the advisors who receive this type of stock options reward are company founders or high-level executives. Advisor shares typically vest monthly over a 1-2 year period on a schedule with no cliff and 100% single-trigger acceleration.”
Advisor Shares vs. Regular Shares (or Equity)
Advisor shares come in different shapes and sizes. There is not a technical definition of advisor shares but is rather any form of equity in a business. Learn more about the characteristics of advisory shares below:
Characteristics of Advisory Shares
As mentioned above, advisor shares typically vest monthly over a 1-2 year period with no cliff. Advisory shares are typically granted as stock options but not every company grants their shares in the same way. This generally comes in the form of Non-Qualified Stock Options (NSOs).
Related Read: The Main Difference Between ISOs and NSOs
How Do Advisory Shares Work?
While advisory shares can take on different forms, they typically can be boiled down to a few similarities. Of course, these can change depending on your business.
- Exchanged for advice or expertise
- Typically offered as NSO stock options
- Follow a shorter vesting schedule
Learn more about how advisory shares typically work below:
Implement a Startup Advisor Agreement
As put by the team at HubSpot, “A startup advisor agreement is a contract between a startup and its advisor. This agreement outlines the terms of the relationship, including the responsibilities of each party and the compensation the advisor will receive.”
There are countless advisor agreement templates online to get you started. The Founder Institute offers a free template called the FAST Agreement.
Determine the Vesting Schedule
As advisor shares are for advisors that offered their expertise, they are typically granted on a shorter vesting schedule because their value is given over a shorter amount of time.
This is typically a 1 or 2 year vesting schedule (as opposed to the 4 year vesting schedule traditionally used for startup employees).
Benefits of Advisory Shares
Advisory shares come with their own set of pros and cons. Properly maintaining and distributing equity is a critical role of a startup founder so understand the benefits, and drawbacks, of offering advisory shares is a must.
Related Resource: 7 Essential Business Startup Resources
Learn more about the benefits of offering startup advisory shares below:
Access to Real Experts
When setting out to build a business, chances are most founders lack expertise in certain areas when it comes to building a business or in their market. However, most early-stage companies are typically strapped for cash and are unable to afford the defacto experts in the space.
With advisor shares, startup founders can attract real experts to get guidance and strategic support in the early days in return for shares in the business.
Related Resource: Seed Funding for Startups 101: A Complete Guide
Better Network Credibility
If hiring the right advisor, chances are they will be able to help beyond strategic advice or their expertise. They will be able to expose your business to their network and will be able to make introductions to new business opportunities, partnerships, investors, and potential hires.
As we previously mentioned, most businesses that benefit most from advisors are unable to offer them a salary or cash compensation. With advisor shares, startup founders are able to offer shares as compensation and conserve thei cash to help with scaling their business and headcount.
Drawbacks of Advisory Shares
Of course, offering advisor shares is not for everyone. While there are benefits to offering advisor shares, there are certainly drawbacks as well. Weighing the pros and cons and determining what is right for your business is ultimately up to you.
We always recommend consulting with a lawyer or counsel when determining how to compensate advisors.
The biggest drawback for most founders will be the diluted ownership. By offering shares to advisors, you will be diluting the ownership of yourself and existing shareholders.
As advisors are fully vested in 1-2 years, they will potentially not be invested in future success as other stakeholders and could be costly when taking into account the diluted ownership.
Potential Conflicts of Interest
Advisors might not have the same motivators and incentives as your employees and other shareholders. As their ownership is generally a smaller % and their shares vest early, they are potentially not as incentivized for the growth of your company as employees and larger % owners will be.
Getting in front of these conversations and making sure you have a good read on any potential advisors before bringing them onboard is a good first step to mitigate potential conflicts.
Extra Stakeholder to Manage
Chances are most advisors are helping other companies as well. This means that their attention is divided and you will need to ensure you are getting enough value to warrant dilution.
This also means that you are responsible for managing a relationship and communication with another stakeholder in your business — what can be burdensome on some founders.
The 2 Variations of Advisory Shares
Advisory shares are generally offered in 2 variations — restricted stock awards and stock options. Learn more about each option and what they mean below:
Restricted Stock Awards
As put by the team at Investopedia, “A restricted stock award is similar to an RSU in a number of ways, except for the fact that the award also comes with voting rights. This is because the employee owns the stock immediately once it is awarded. Generally, an RSU represents stock, but in some cases, an employee can elect to receive the cash value of the RSU in lieu of a stock award. This is not the case for restricted stock awards, which cannot be redeemed for cash.”
As we mentioned, NSOs (Non-Qualified Stock Options) are commonly used for advisor shares. As put by the team at Investopedia, “A non-qualified stock option (NSO) is a type of employee stock option wherein you pay ordinary income tax on the difference between the grant price and the price at which you exercise the option… Non-qualified stock options require payment of income tax of the grant price minus the price of the exercised option.”
Who Gets to Issue Advisory Shares?
Issuing advisory shares is typically reserved for the founder or CEO of a company. Having a decision-making process and gameplan when issuing advisory shares is important. This might mean offering no shares at all, having an allocated amount of advisor shares from the get go, or something inbetween.
Making sure your board of directors and other key stakeholders are on board is crucial to make sure that interest and strategy stays aligned for all stakeholders.
How Many Shares Should You Give a Startup Advisor?
Managing the balance between sufficient incentives and managing equity dilution is crucial for any business. Determining the number of shares to offer an advisor is subjective to the founder and advisor. When determining the number, a couple of things to keep in mind include:
- Advisor’s experience
- Time commitment
- Expected contribution
As put by the team at Silicon Valley Bank, “An advisor may receive between 0.25% and 1% of shares, depending on the stage of the startup and the nature of the advice provided. There are ways to structure such compensation that ensures founders get value for those shares and still retain the flexibility to replace advisors, all without losing equity.”
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