Between the entrepreneur, the startup founder, and the U.S.-based investor, one might have heard references about advisory shares and asked the question, “What are advisory shares?” This is because understanding this topic is very important: advisory share often support a company in its growth phase and motivate key advisors.
In this comprehensive take, we shall cover what advisory shares are and why they’re important; how they work; and things to look out for in the U. S. for businesses and investors. So, let’s get into it.
What Are Advisory Shares?
Companies, usually startups, give advisory shares as equity to their advisors. More specifically, companies grant these shares as compensation to reward advisors for their guidance, expertise, connections, and support.
Unlike stock options granted to employees or shares granted to founders, advisory shares are generally given to an individual who dispenses strategic advice, rather than being involved with daily business operations. Among these advisors are industry specialists, mentors, investors, legal or accounting professionals, and other persons who bring value to the company.
Why Do Companies Offer Advisory Shares?
Offering advisory share is a common practice among startups and early-stage companies in the U. S. Primarily, they do so because:
- Attract and Retain Top Talent
The saying goes that startups do not generate enough cash flow to shell out large consulting fees. Hence, granting equity in terms of advisory shares means that companies can bring in highly experienced advisors without that experience immediately translating to a cash expense.
- Align Incentives
By giving advisors equity, companies ensure that advisors have a vested interest in the company’s success. Hence, this alignment encourages advisors to provide their best advice, which helps the company grow and thrive.
- Leverage Expertise and Networks
Advisors bring in specialized knowledge and valuable industry networks. Hence, by awarding advisory shares, companies incentivize these experts to use their knowledge and connections for the company’s benefit.
How Do Advisory Share Work?
Granting Advisory Shares
Typically, advisory shares are granted under the provisions of a formal agreement, which clearly sets forth the following terms:
- Amount or percentage of shares to be awarded
- Vesting Schedule (how/when shares become fully owned)
- Roles and Responsibilities of the Advisor
- Term and Length of Advisory Relationship
Vesting Periods
Generally, companies vest advisory shares over a schedule of 1-2 years. This means advisors progressively earn shares based on their continued service, which helps keep them engaged with the company over time. However, if an advisor leaves prematurely, the company reclaims any shares the advisor has not yet earned.
Percentage of Equity
Companies normally allocate advisory shares as a small percentage of their total equity, commonly between 0.25% and 2%, depending on the advisor’s role, the company’s stage, and the negotiations.
Tax Considerations
In the U. S., there could be tax consequences with advisory shares. For example, the advisor may pay taxes when the shares vest or when they are sold. Because of this, it is very important for one to properly structure their arrangement and work with a tax professional in order to adequately comply with IRS rules.
Types of Advisory Shares
Generally, advisory shares may manifest themselves in different forms, depending on the company’s structure:
- Common Shares
Most of the advisory shares are common shares, which simply give ownership to the advisors but usually have no special voting rights.
- Stock Options
Stock options are sometimes issued by companies to their advisors instead of actual shares. This provides the adjuncts to buy these shares at a set price, and this is often used to defer tax liability and promote long-term commitment.
- Restricted Stock Units (RSUs)
Restricted Stock Units are a stock grant that entitles the holder to receive shares of the underlying stock after a set time period or other conditions are met. RSUs are seldom offered to advisors; however, some companies use RSUs for this purpose.
How Many Advisory Shares Should You Offer?
The exact amount depends on a number of variables, such as the valuation of the company, the expertise of the advisor, the time commitment, and surface-level influence.
Typical Ranges
- Early-stage startups: 1%-2% per advisor
- Later-stage startups: Less than 1% per advisor
- Specialized or highly influential advisors might negotiate an even higher percentage
Dilution Considerations
The issuance of advisory share dilutes the ownership of existing shareholders. Therefore, a company ought to judiciously choose when to grant advisory shares to ensure that those incentives do not overly dilute the equity ownership of the founders or investors.
Legal and Documentation Considerations
Once advisory shares are issued, proper legal documentation must be put in place. This typically provides for:
- Advisory Agreement: Addressing duties, compensation, confidentiality, and non-compete terms
- Stock Purchase or Grant Agreement: Governing the rights and obligations of the parties with respect to the shares, including vesting and transfer restrictions
- Board Approval: Share issuances customarily require approval by the company’s board of directors
Seemingly adhering to U. S. securities laws is of utmost importance when granting shares in order to avoid regulatory issues.
Benefits of Advisory Shares for Advisors
Advisory shares can be quite lucrative for advisors, especially since they appreciate the valuable chance to:
- Potentially make large financial gains if the company is a success or goes public
- Participate in decision-making processes of the company (depending on attached rights)
- Build rapport with founders and entrepreneurs
- Enhance personal brand and portfolio by association with promising startups
Risks and Challenges of Advisory Shares
While Advisory Share offer many benefits, they are not without their risks:
- Founder dilution: Too many advisory shares could diminish founder control
- Advisory engagement: Advisors may not always deliver the value for which they were engaged
- Valuation uncertainty: For early-stage companies, valuation scoring is uncertain, and, thus, hard to put a price on advisory shares.
- Tax complexities: Advisors should fully understand the tax implications before accepting shares
How to Find the Right Advisors
Offering advisory share is only one step. To derive the most value:
- Looking for advisors who have relevant experience and contacts in your industry
- Clearly define the roles and expectations of advisors
- Follow with regular communication and updates
- Periodically review contributions by advisors
Real-World Examples
Many successful U. S. startups have used advisory shares to grow bigger in a short time period. For example:
- Technology startups often dispose of advisory shares to experienced entrepreneurs or industry veterans that would open doors to funding or partnership.
- For entirely different purposes, biotech companies may, in fact, issue shares to prominent scientists or regulatory experts, who then help direct the course of product development.
Conclusion: What Are Advisory Shares and Why They Matter in the U.S.
The upshot: Advisory shares are an important tool for U. S. startups and growing companies to attract, motivate, and retain expert advisers without having to pay those experts immediately in cash. These shares create alignment of interests for strategic aid that can then assist a company to scale at a much greater speed.
Hence, as an entrepreneur or investor, understanding what advisory shares are and how they work is key to becoming an informed entity within the startup environment.
So, if you are involved in a U.S.-based startup or thinking of submitting advisory roles, it would be best to carefully structure advisory share agreements, consulting with legal and tax professionals to ensure that you get the most out of them, while minimizing potential risks.