Advisory shares are a type of stock option given to company advisors rather than employees. They may be issued to startup company advisors in lieu of cash compensation. Advisors are usually granted options to buy shares rather than given the actual shares. Advisory shares can help ensure confidentiality while preventing conflicts of interest. However, they can also prove costly for a young company. A financial advisor can help you answer questions about advisory shares and other financial concepts for your needs and goals.
Advisory Shares Explained
Advisory shares, also known as advisor shares, are typically financial rewards in the form of stock options. Advisors who receive advisory shares are usually businesspeople with previous experience as company founders or senior executives. They exchange their insight and contacts for equity in a young company.
These advisors are different from accountants and attorneys. Those professionals are likely to be paid a fee for their services. Advisors who might get advisory shares won’t likely be expected to give companies technical guidance on taxes or contracts. Rather, they will be expected to supply strategic insights and access to networks of contacts.
How Advisory Shares Differ from Regular Shares
Regular shares are common stock units bought and sold on public markets like the New York Stock Exchange or NASDAQ and are available to all retail investors. Advisory shares, on the other hand, are non-qualified stock options that experts receive as payment for their insight or expertise. They are not incentive stock options given to employees.
Two Types of Advisory Shares
Advisory shares come in two varieties, stock options and restricted stock units.
Restricted Stock Units (RSUs)
An RSU is a form of common stock that a company promises to deliver to an employee at a future date, depending on various vesting and performance conditions. RSUs are not received until these restrictions are over or conditions are met. An employer will promise to give an employee stock under certain conditions, such as meeting particular work goals or being at the company for a particular amount of time.
Taxes on RSUs apply when the shares are delivered – at the time of vesting. They require you to pay ordinary income tax on their market value when the shares are delivered to you (usually as soon as they vest), even if you do not sell them at that time. This includes federal, state and local taxes. Sometimes companies allow employees to sell a portion of the vested shares in order to cover the amount in taxes.
Following that, the employee can choose between holding the rest of the shares to sell later, or selling them right away. Selling the shares of course means paying any capital gains taxes on any appreciation, or increase in value between the selling price and the fair market value when the person vested.
Stock Options
This type of compensation, which is granted to employees, contractors, consultants and investors, is a contract. It gives the recipient the right to buy, or exercise, a set number of shares of the company stock at a preset price, also known as the grant price.
This offer doesn’t last forever, though. You have a set amount of time to exercise your options before they expire. Your employer might also require that you exercise your options within a period of time after leaving the company.
The number of options that a company will grant its employees varies, depending on the company. It will also depend on the seniority and special skills of the employee. Investors and other stakeholders have to sign off before any employee can receive stock options.
How Advisory Shares Work
Advisors are usually granted options to buy shares rather than given the actual shares. That helps avoid a potential tax obligation if the company grants advisory shares worth a considerable amount.
Advisory shares are often used as incentives for advisors to invest in a company’s long-term success. Company executives and managers, on the other hand, may receive shares instead of options. Stock options will usually vest within a year or two. That allows the company to delay transferring ownership to advisors while keeping them focused on the company’s long-term success.
Who Issues Advisory Shares?
Most companies that issue advisory shares are startups. The company may be little more than an idea at the time. The issuer also may be in the later seed capital stage or even later when it is an active, growing concern. Equity given to advisors can vary considerably. An advisor’s expertise and role can determine if they receive advisory shares. It could also depend on how long the advisor and company expect to work together.
Up to 5% of the company’s total equity could be given to advisors. Sometimes a young company will form an advisory board and allocate equity as an incentive for board members. Individual advisors may get anywhere from 0.25% to 1% of the company’s equity. The exact figure may depend on how much the advisor contributes to the company’s growth.
For instance, an advisor who offers insight at monthly meetings might receive a smaller amount of 0.25%. An advisor who introduces a prospect that becomes a sizable customer could get 1% for this more concrete contribution.
The more mature the company is, the smaller the percentage of equity advisors can expect to receive. For instance, a company in the idea stage might give 0.25% of equity to an advisor who attends monthly meetings. A company that is a past startup and is in the growth stage could cut that to 0.15% for the same advisor.
Advisory Shares: Pros and Cons
Many startup businesses use advisory shares. They can attract experienced advisors during a crucial stage in a company’s development. However, they do have some potential drawbacks. Advisory shares can help protect a company’s confidentiality. Advisors are likely to see product development and marketing plans that businesses want to keep secret. For this reason, advisors may be asked to sign confidentiality and non-disclosure agreements.
Meanwhile, advisors may be working with a number of companies. Companies that issue advisory shares may not be able to restrict advisors from working with rival firms. They can find out in advance if advisors have pre-existing arrangements that could affect their ability to give impartial advice.
Young companies must also take care not to over-compensate advisors with advisory shares. Founders may find it easy to give away fractional percentages of equity in a young company with few assets. Those slices could get much larger as the company grows. This is one reason the equity given to individual advisors shrinks as the company ages.
Experts suggest companies considering using advisory shares take their time before offering equity in exchange for advice. Even experienced business leaders may not make good advisors. It is best to do some research before parting with equity. Some advisory share agreements call for a three-month trial period. During this time the deal can be terminated without any options being transferred to the advisor.
Bottom Line
Advisory shares can let young companies motivate savvy experts to help them on their growth path. They’re not appropriate for all companies or all advisors. But they can let founders tap valuable contacts and insight without letting go of scarce cash. Entrepreneurs who are willing to part with equity and exchange for advice should do some homework first. Cheap advice in the company’s planning stages can get quite expensive as a company grows. It’s easy to give away 1% of nothing, but much harder to part with 1% of a multibillion-dollar market cap.
Business Tips
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