Stock options for advisors, often called advisor stock options, provide a new and complex idea. These equity-based incentives, given to individual advisers or advisory groups, affect equity, expertise, trust, and strategy dynamics. It's normal for new businesses, especially those still in the seed money investment phase, to need help making ends meet. Instead of paying consultants a large sum of money upfront, they offer them a stake in the firm, usually between 1% and 2%.
This raises the question: why do advisers buy stock in startup companies? The answer is potential. In exchange for their time and expertise, early-stage advisors—often successful businesspeople or veterans of the industry—tend to expect a significant portion of the company's future earnings for share allocation. This article explains advisor stock options and their structuring in a comprehensive way.
Example of Advisor stock options
Getting advisor shares would not obligate advisers to provide legal or tax assistance to firms. Instead, they must provide high-quality information and facilitate easy access to relevant networks.
Let's say Sol Tech is a pre-Series A stage business that wants to consult with John, who has years of expertise in the field. Sol Tech gives John advisor stock options, which amount to 2% of the business. At the current valuation of $2 million, John's advisor shares are worth $40,000 in equity.
A couple of years afterward. Due to its rapid expansion, Sol Tech is seeking a Series D fundraising round at a valuation of $100 million. John's 2% equity holding has grown dramatically due to his advisor shares' performance. The value of his shares is now $2 million. Let's say Sol Tech goes public in the future with a market valuation of $1 billion. Initially worth $40,000 in advisor shares, John's 2% stock is now worth $20 million.
This exemplifies how stock options in startups may provide an alluring incentive for advisers by giving them a financial interest in the success of the firm they are advising. But, as advisor stock options have the potential to account for a significant portion of the company's future valuation, founders should consider the long-term effects of providing them.
Stock options in Startups across several funding stages
The following equity allocations are available at the various finance stages of the development process:
Typically, the CEO and other key players get an 8%-10% share.
Equity compensation for the adviser might range from 0.25% to 1% of the company. At each stage of the fundraising process, the CEO will determine the corresponding stock allocation.
When a company is ready to launch, the amount paid to critical stakeholders and executives typically ranges from 6-10%.
The following are the new methods through which more managers and employees might obtain stock:
Vice presidents and directors may get between 2 and 6% of the company's equity.
There is a 2–4% range for employee stock options in startups.
The next step is to hold the first seed financing.
By now, the reduction in the executives' stock has reached around 3–8%.
There is a 1-3% dilution of the board of directors and the vice presidents.
Managers earn 1% to 2%, while workers receive 0.5% to 1.0%.
At this point in the capital raising procedure, the advisors' shareholdings would come down to 0.25%.
Now comes the accelerating phase. This is a crucial stage in the financing process since it occurs just before the company issues its last stock options in startups.
The executives' share is gradually decreasing at a rate ranging from 2% to 6% per year.
Directors and VPs now hold ownership of 0.5% to 1%.
The equity stakes for employees are between 0.1% and 0.5%, while those for managers are between 0.25% and 0.75 %.
These percentages will go down across the board in the company. Depending on the company's size, a 0.5% stake could correspond to a significant quantity of money.
Why are Advisor Stock Options Important?
Several factors make advisor stock options an attractive option for businesses. Stock options in startups provide the following advantages:
Advisors provide business entrepreneurs with a wealth of knowledge and experience. Startups may draw in seasoned advisers who would not otherwise be willing to engage with a new firm by providing advice shares.
Value for money
Value for money Buying advisor stock options could be a more affordable alternative to employing a full-time CEO or consultant. Startups can save money on talent acquisition without sacrificing quality by not paying advisers a salary or providing perks.
Source of Motivation
Advisor stock options are a powerful incentive tool because they give advisers a financial interest in the company's development and success. It may be particularly helpful for startups still in the early stages of their struggle for success.
How do you determine Advisor stock options in Startups?
At most, a company's advisers should get 5% of its stock options in startups; nevertheless, this number may be significantly lower. To assist with this, a business may also establish an advisory board. Payment to advisers might vary with their level of involvement in the company's early stages. Compared to an adviser offering a monthly brainstorming phone call, an advisor acting as a resource for prospective clients could earn more.
Likewise, this may change as the firm develops. If an adviser puts in the same amount of labor for a Series A business, the early-stage pre-seed company could give them more stock. Put simply, it is simpler to give up 1% of a firm with no actual valuation than it is to give up 10% of a company with a $10 million or higher worth.
Founders should know that advisers may have overlapping interests with other firms, even those in direct competition. For advisors to provide unbiased guidance, entrepreneurs must be aware of who they will collaborate with and, more significantly, whom they can rely on.
How Do Advisor Stock Options Vest?
Vesting for advisors is crucial, but it works differently than it does for employees. Due to the rapid pace at which businesses develop, the advisors who helped you in the early stages will differ from those who helped you in Series B and beyond.
Advisory share agreements may include a monthly vesting schedule over two years with no cliff. Most firms only vest schedules up to four years since most advisers will offer the bulk of their value upfront. You may choose to be separate after two years.
A three-month stipulation in specific contracts gives the parties enough time to evaluate whether or not they will benefit from working together. Many advisers also agree to have their vesting schedules accelerated upon the occurrence of a single trigger event, at which point they would own 100% of their stock options in startups. This might be a business sale or the company terminating the working agreement.
Disadvantages of Granting Advisory Stock
Before deciding to use equity compensation, weighing the pros and downs of issuing advisor stock options is essential. The decision to issue advisory shares comes with the risk of diluting the ownership stake of key employees in the business. The potential issues include the following:
Cap table advisor stock options
Potential investors may have concerns about a company that issues advising stock options in startups. Picture yourself in the position of raising a fresh round of funding. You've created a pipeline of possible investors, and now they can check out your cap table. And when they do, they wonder how these people got so much equity because they've discovered various stockholders with no invested money.
When that time comes, you'll want to be ready to defend the equity-based contributions of your advisers. Having exceptional advisers appropriate for your current development level, competent, insightful, and helpful. It might turn off prospective investors if that's different. Why? Dilution is one of the causes!
Effects of Advisory Stock Dilution
Advisor stock options have the potential to dilute the ownership of current shareholders. Adding a new adviser to your cap table early on may not have a major effect. Shareholders will feel the effects of dilution when a relatively small fraction of their company's stock is suddenly worth a lot of money.
Monitoring the potential for further equity dilution from fresh issuance is essential. You can undertake scenario modeling and transaction simulations. You can keep an eye on your equity and prevent a potentially devastating surprise like dilution by keeping track of it.
When your business matures and you have more capital, you may pay your advisors in cash. Reducing dilution is possible with such a reorganization of adviser compensations. As adviser remuneration shifts toward cash, the number of shares offered to the public will decrease.
What Founders Must Consider While Issuing Advisory Stock Options?
Giving out advisor stock options in your company may have positive and negative effects. One positive aspect is that it facilitates access to previously inaccessible, crucial strategic information and contacts. When recruiting advisers, offering them equity pay in exchange for their time, expertise, and connections might be helpful.
Balancing Confidentiality and Advice
In addition, it may help protect the privacy of your business. Confidentiality and non-disclosure agreements are standard practice in the advisor-startup relationship and serve to protect your company's intellectual property. Advisors often need access to internal corporate data to provide useful recommendations.
Considering the Long-Term Impact
Entrepreneurs should proceed with caution, however. You may give up more control of your business than you think if you provide advisor stock options. Giving up 5% of your firm before Series A may seem like a small sacrifice, but that stake might be worth much more when the company has raised more money or gone public.
Addressing Conflicts of Interest
It is also important to remember that advisers often work with more than one company at a time. Although this is typical, you should ensure everything will be fine because of your advisor's other responsibilities.
Documentation for Clarity
A well-documented set of promises and objectives is crucial for a trouble-free process. Advisors need the same structure that provides job descriptions and KPIs to workers. Customers who aren't sure what to expect may be less willing to dedicate time to your business.
Advisor Stock Options: Paving the Path to Startup Success
Having advisers is common among new businesses since they may pave the way to success and expansion. Founders will probably have to provide advisor stock options in return, so it's essential to comprehend their specifics and how to set up the partnership.
By offering advisor stock options, startups may incentivize seasoned advisors to guide their development. Not every business or advisor needs them. However, they may provide access to helpful resources without requiring the founder to part with their limited capital.
Before offering stock in return for advice, entrepreneurs should conduct their research. Inexpensive counsel from the planning stages might become quite costly when a business expands.