Typically advisors can receive a form of equity comp called advisory shares that are standard to be granted the early stages in startups. In this blog post, we will explore the definition of advisory shares and learn about their pros & cons as well as how they are exercised and why it is a necessary part for many startups.
What Are Advisory Shares?
Definition
Advisory shares, often referred to as advisor shares or simply equity advisors, are a special category of stock options given out by companies to individuals who serve in advisory roles. Advisors are typically individuals with specific industry expertise within finance, marketing, technology or business development who provide strategic guidance to help the company scale.
Types of Advisory Shares
There are various sub-types of advisory shares, like:
Stock Options: Agreements with the advisor to buy at a pre-specified value. Most often these are non-qualified stock options (NSOs) which tax-wise and eligibility-wise differ from incentive stock options (ISOs).
Restricted Stock Awards (RSAs): Shares given to advisors subject to certain restrictions and vesting.
RSUs (Restricted Stock Units): Shares are granted but do not convert to common stock until certain vesting conditions have been met.
How Do Advisory Shares Work?
Vesting Schedules
Advisory shares have shorter vesting schedules than ordinary employee stock options.
Standard Vesting Schedules
Time-based Vesting: Advisors vest over a period, usually 1 to 2 years with no initial cliff.
Milestone-based Vesting: Shares vest once particular tasks or milestones are met that benefit the company.
Hybrid Vesting: Multi-year + the time ones.
Issuance Process
The issuance of advisor shares requires the company entering into a legal agreement with the advisory. The agreement will detail the terms of this equity compensation (the number of shares, vesting schedule, etc.). Such agreement also usually contains confidentiality and non-disclosure provisions that enhance the necessity of secrecy as to any sensitive, proprietary information concerning the company.
Benefits of Advisory Shares
Attracting Top Talent
Advisory shares can help a startup to bring on best advisors and in some cases, it gives the opportunity for these advisors to have more skin in the game. Equity – Especially when cash money is tight, an advisor who receives some amount of equity will be much more likely to “buy into” the needs of success of your company because simply put they now have skin in the game.
Aligning Interests
When shares are issued, companies establish common interests with advisors. The equity in the company will only go up as a result of this and advisors want to get paid, so they are motivated by using their expertise and networks to help the company succeed.
Cost-Effective Compensation
Startups can always opt for equity deals instead of cash payouts, especially on those times when budget does not permit. That helps a startup save cash for other key areas like product or marketing.
Drawbacks of Advisory Shares
Dilution of Ownership
Advisory Shares: When the equity for advisors does not have value attaching to them when they are issued, this means that existing shareholders such as founders and employees will be affected due to their ownership being diluted. This is a danger, particularly if the company has to issue more shares down the line as another avenue of raising capital.
Management Complexity
The details and administration surrounding advisory shares can be difficult and sometimes challenging to keep track of the vesting schedule and exercise rights for each advisor. Funds must not be oversold and every term should be the terms in writing.
Conflicts of Interest
The interests of the company may not be aligned with those of advisors. For example, they may be given advice by an advisor from a competing company that may have biased suggestions. They are minimized by locking clear agreements, big and bright round conflict-of-interest policies.
Advisory Shares in Practice
Case Study: Facebook
If you want to see the power of what advisory shares can do when used successfully, look no further than Facebook and Sean Parker. A veteran entrepreneur, Parker was able to offer advice and industry connections in those early Facebook days. As the company progressed, his advisory shares went on to have a lot of value showcasing Win-Win for both him and the Company.
Also Read: Understanding Candlestick Patterns in Stock Trading
Conclusion
Advisory shares are a powerful weapon to attract battle-scarred vets. Through this understanding and skillful use of issuance, a company can hire the best candidates for their executive team while aligning interests at every pay grade to drive optimal outcomes in value creation. Yet the essential element is to be mindful of these cons and take charge of them in advance so that punishment can arise best-fit for both business owners as well their advisors.