In an ever-changing financial environment, the importance of proper mentorship and guidance received by startups is not understated. Advisory shares provide a strategic manner to align a company’s advisors’ interests with that of the firm. They allow greater collaboration and foster better connections with visionaries. These shares give advisors a part of the company’s success, incentivizing them to see its growth.
Advisory shares, also referred to as advisor shares, are a form of equity compensation given to company advisors in place of (or in addition to) a professional fee. They serve as a means of rewarding advisors for providing valuable insights, guidance, and connections to a startup, especially during the early stages.
They provide no formal ownership rights like voting or dividends but allow advisors to benefit from the future success of the company. Advisory shares can be stock options or other forms of equity, and they are often used when startups require expertise but are low on funds.
Advisory shares are typically granted to business advisors, consultants, or outside board members in exchange for their guidance and skill. Startups often issue advisory shares when they require expertise but have limited funds, making it an attractive incentive for advisors who believe in the company's potential.
Advisory shares allow advisors to share in the company's success and align their interests with the company's long-term growth. They can also be used to incentivize advisors to offer ongoing advice and support, contributing to the company's development over an extended period. However, it is essential for both the company and the advisors to carefully negotiate the terms of advisory shares, considering factors such as equity allocation, vesting schedules, and associated rights.
Not only do advisory shares allow firms to attract the cream of the crop, but they also help retain great mentors for the team. It creates a symbiotic relationship, a bond towards long-term commitment, inspiring them to utilize their expertise and large networks to support the firm. Advisory shares allow stakeholders to become a more integral part of the decision-making systems, without giving out traditional voting rights.
This progressive model allows firms to promote transparency, improve the organization's resilience, while nurturing relationships that benefit the firm's growth. Advisory shares allow the perfect intersection of collaboration and expertise, creating a new manner to look at corporate governance whilst putting the firm first.
There are two types of compensation provided to advisors: Restricted Stock Awards and Stock Options.
1. Restricted Stock Awards (RSAs)
Restricted Stock Awards (RSAs) represent a form of equity compensation that provides employees with company stocks under specific conditions. Upon accepting the grant and fulfilling any necessary payment obligations, individuals become owners of the shares on the specified date.
Advisors often prefer RSAs over the stock options, as the first one requires less cash, as the advisor simply owes income taxes on the value of the shares, without the need for cash to exercise stock options.
However, these shares usually remain subject to vesting conditions, meaning they cannot be easily transferred or sold until these conditions are met.
2. Stock Options
Stock options refer to the right to buy or sell shares at a predetermined strike price. There are two types of options: Incentive stock options and non-qualified stock options.
Incentive stock options can only be issued for employees working in the U.S., whereas non-qualified stock option is applicable for all, however, it does get taxed when the options are exercised and sold.
It is crucial to keep in mind that the vesting schedule for advisors must differ from that of employees, solely because a company’s needs will vary with different growth stages, insinuating that the firm will need different types of advisors.
Advisory shares typically follow three types of vesting schedules: time-based, milestone-based, and hybrid vesting.
1. Time-based vesting requires the advisor to stay with the company for a specified period to claim rights to their shares. For example, a four-year vesting schedule with a one-year cliff means that all shares will vest after four years, with the advisor required to work for at least one year for any shares to vest, and the remaining shares vesting increasingly on a monthly or quarterly basis.
2. Milestone-based vesting is not time-based, but rather tied to completing a task that adds value to the company, triggering the stock or option to vest.
3. Hybrid vesting is a combination of time- and milestone-based vesting, where the advisor must stay for a specific time and complete certain milestones.
The vesting period for advisory shares is typically two years without a cliff, meaning the shares vest or are issued in monthly installments over two years. This structure is designed to incentivize advisors to remain with the company for a specific period and align their interests with the company's long-term success.
It is vital to have documentation of any decisions reached, with your advisor, especially if the conversation involves equity. A lawyer can prove to be extremely beneficial in the process, as they could help advise if the agreement is indeed mutually beneficial. Ultimately, the effectiveness of the decision will come from how the firm plans on using the advisor, which can only be done through proper communication of the firm’s needs and expectations.
For seamless and streamlined equity management, Qapita is the perfect platform for early-stage companies with great benefits and trials.
The allocation of advisory shares is usually determined by factors such as the advisor's level of expertise, the progress and risk exposure of the company, and the company's equity plan. It is common practice for startups with advisory boards to grant those advisors collectively 5% of the total company equity. These shares can be issued as common stock options, with a typical allocation ranging between 0.25% to 1% of the company's equity based on the advisors' contributions to the company growth.
The issuance of advisory shares is governed by the company's board of directors, and the terms and conditions are outlined in the shareholders' agreement.
Advisory shares and equity are not the same, as they serve different purposes and have distinct characteristics. Here are the key differences between the two:
1. Purpose: Equity represents ownership in a company, while advisory shares are a form of non-cash equity compensation given to advisors, consultants, and other experts who provide valuable insights and guidance to a startup.
2. Voting Rights: Equity shares typically come with voting rights, allowing shareholders to vote on matters affecting the company, such as electing the board of directors and approving significant corporate actions. Advisory shares, on the other hand, typically have limited or no voting rights.
3. Stake in Company's Profits: Equity shares grant shareholders a stake in the company's profits, while advisory shares do not provide a stake in the company's profits.
4. Rights and Entitlements: The rights and entitlements associated with advisory shares can vary depending on the specific terms and conditions agreed upon by the company and the advisor.
5. Vesting: Equity shares are typically granted to employees, contractors, consultants, and investors, while advisory shares are specifically granted to advisors and align their interests with the company's success.
Yes, advisory shares can get diluted. Whenever a company issues additional shares, the existing shareholders' stake in the company gets diluted, including advisory shares.
Dilution of ownership can impact the control of existing shareholders over the company's decision-making. The percentage ownership of existing shareholders decreases when new shares are issued to advisors, potentially impacting their control over the company's decision-making.
As startups stay private longer, advisory shares will continue to grow as a strategic tool for obtaining world-class expertise without significant upfront cash outlays. In conclusion, advisory shares offer an effective way for startups to incentivize and compensate expert advisors who can provide invaluable guidance during the early stages of growth. By granting advisors a stake in the company's future success, advisory shares align interests and help attract top talent to contribute to the startup.
However, founders and advisors need to carefully structure advisory share agreements to outline fair compensation, vesting schedules, distribution of shares, and handling of dilution. With clear expectations set through diligent planning and legal documentation, advisory shares can facilitate mutually beneficial relationships between advisors and startups.