Startups often face the challenge of attracting experienced and knowledgeable advisors to help them grow and succeed. However, these companies may not have the resources to pay high salaries or consulting fees. To bridge this gap, startups and other young companies offer advisory shares to potential advisors. In this blog post, we will delve deeper into what advisory shares are, how they work, and the potential benefits and drawbacks.
What are Advisory Shares?
Advisory shares, also known as advisory stock or founder shares, are a form of equity compensation given to advisors, consultants, or early-stage employees who provide valuable services or expertise to a company. This form of equity compensation allows advisors to share in the future success of the company and potentially receive a portion of the company's future profits.
Advisory shares may be in the form of actual shares of common stock or stock units. These shares may have different vesting schedules, purchase prices, and time of exercise. The vesting period is the period of time an advisor must work for a company before they can exercise their right to receive the shares. The purchase price, also known as the grant price or strike price, is the price an advisor will pay to purchase the shares at the time of exercise. The purchase price is typically lower than the fair market value of the shares at the time of exercise.
Advisory shares are often used by startups and other young companies to attract experienced advisors who can provide strategic insights, technical advice, or product development expertise. By offering advisory shares, companies can incentivize advisors to provide valuable services and advice, while also aligning their interests with the long-term success of the company.
Types of Equity Compensation
Advisory shares are a type of equity compensation, which refers to the different types of shares, options, or units that companies can use to compensate employees, advisors, or board members. The most common types of equity compensation include:
Restricted Stock Agreement: This is a type of equity compensation that grants shares of stock to an advisor, but the shares are subject to restrictions, such as a vesting period or performance targets.
Stock Options: This is a type of equity compensation that gives an advisor the right to purchase shares of stock at a certain price, known as the strike price, at a future date. There are two types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs).
Stock Awards: This is a type of equity compensation that grants shares of stock to an advisor, similar to a restricted stock agreement, but with fewer restrictions.
Stock Units: This is a type of equity compensation that grants the right to receive a certain number of shares of stock in the future, usually after a vesting period or performance targets are met.
Benefits of Advisory Shares
For startup founders and business owners, offering advisory shares can be a good idea for several reasons. First, it provides financial incentives to potential advisors who may not be able to afford to work for the company in lieu of regular income. Second, advisory shares can be used to attract industry experts, senior executives, or portfolio managers who may not be interested in working for a startup without the potential for equity compensation. Third, advisory shares align the interests of the advisor with those of the company, ensuring that the advisor is motivated to provide high-quality advice and support.
Drawbacks of Advisory Shares
However, there are also potential drawbacks to offering advisory shares. First, advisory shares can dilute the company's total equity, reducing the amount of equity available for future investors or key hires.
Second, offering advisory shares can lead to conflicts of interest or potential tax obligations for the company and the advisor.
Third, offering advisory shares requires a legal document known as an advisory agreement, which can be complex and time-consuming to draft and negotiate.
Fourth, advisory shares can also lead to potential conflicts of interest between the advisor and the company's management teams, as advisors may have access to sensitive information and may be involved in key decisions.
Additionally, advisors may not always provide the expected level of support or expertise, or may not be the right fit for the company's needs. Therefore, companies should carefully consider the potential benefits and drawbacks before offering advisory shares and should take steps to ensure they are selecting the right advisors.
How to Offer Advisory Shares
Before offering advisory shares, companies should determine the amount of equity they are willing to offer and the type of equity compensation they will use. Companies should also consider the vesting period, purchase price, and other terms and conditions of the advisory share agreements.
To offer advisory shares, companies typically enter into advisory agreements with individual advisors or advisory boards. These agreements should specify the rights and responsibilities of the advisor, including their expected services, the amount of equity they will receive, and any vesting or performance targets. The agreements should also specify the type of equity compensation, the purchase price, and the period of time in which the shares may be exercised.
Companies should also consider the potential tax implications of offering advisory shares, as the Internal Revenue Service (IRS) may view advisory shares as income for tax purposes. Therefore, companies should consult with a financial advisor or lawyer to ensure they are complying with all relevant tax laws and regulations.
Advisory shares can be a useful tool for startups and other young companies to attract experienced advisors who can provide valuable insights and support. However, companies should carefully consider the potential benefits and drawbacks of offering advisory shares and take steps to ensure they are selecting the right advisors and complying with all relevant laws and regulations. With the right advisor and the right form of equity compensation, advisory shares can help companies succeed and grow over the long term.