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What are Advisory Shares? Ultimate Guide

When it comes to building a successful startup, having the right guidance and expertise can make all the difference. This is where advisory shares come into play. Advisory shares, also known as advisor shares, are a form of equity compensation that startups offer to advisors in exchange for their invaluable advice and support. In this comprehensive guide, we will explore what advisory shares are, the different types of advisory shares, how they work, and the benefits and considerations for startups.

Understanding Advisory Shares


Advisory shares are a type of equity compensation given to advisors in lieu of or in addition to cash compensation. They are a way for startups to reward advisors who provide strategic insights, industry knowledge, and valuable connections. By offering advisory shares, startups align the interests of the advisors with the long-term success of the company. This equity compensation can be in the form of stock options or restricted stock awards.


Difference Between Advisory Shares and Regular Shares


Advisory shares differ from regular shares in several ways. While regular shares are commonly issued to employees and investors, advisory shares are specifically granted to advisors. Advisory shares often come with certain restrictions and vesting schedules, ensuring that the advisors stay committed to the company's growth. Additionally, advisory shares are typically non-qualified stock options (NSOs) rather than incentive stock options (ISOs) given to employees.


What are Advisory Shares

Types of Advisory Shares


There are two main types of advisory shares: stock options and restricted stock awards. Let's take a closer look at each type.


Stock Options


Stock options are a common form of advisory shares. They give the advisor the right to purchase company stock at a predetermined price, known as the strike price. The advisor has the option to exercise these stock options at a later date, usually when the company reaches a certain milestone or liquidity event. Stock options often come with a vesting schedule to incentivize the advisor to stay with the company.


Restricted Stock Awards (RSAs)


Restricted stock awards are another type of advisory shares. Unlike stock options, RSAs are actual shares of company stock that are granted to the advisor upfront. However, these shares are subject to certain restrictions and vesting requirements. The advisor may have to fulfill specific conditions, such as staying with the company for a certain period of time, before fully owning the shares. RSAs can provide the advisor with immediate ownership and potential voting rights.


How Advisory Shares Work?


Advisory shares work by providing advisors with a stake in the company's success. When a startup grants advisory shares to an advisor, it establishes a mutually beneficial relationship. The advisor contributes their expertise, industry knowledge, and network connections, while the startup rewards them with equity compensation. The specifics of how advisory shares work can vary depending on the terms outlined in the advisory agreement.


Vesting Schedule for Advisory Shares


A vesting schedule determines when an advisor's advisory shares fully "vest" or become fully owned by the advisor. Vesting schedules are essential for startups to ensure that advisors stay committed to the company's growth over a certain period of time. Unlike employee vesting schedules, advisory shares often have shorter vesting periods, typically ranging from one to two years. These shorter vesting periods align with the expected timeframe of an advisor's contributions.


Determining the Amount of Equity for Advisors


Deciding how much equity to allocate to advisors can be a challenging task for startups. The amount of equity given to advisors depends on various factors, such as the advisor's level of expertise, the stage of the company, and the expected contributions of the advisor. While there is no set formula, it is common for startups to allocate between 0.25% to 1% of the company's total equity to individual advisors. The allocation can vary based on the advisor's role and their anticipated impact on the company's growth.


Benefits of Advisory Shares for Startups


Issuing advisory shares can offer several benefits for startups. Let's explore some of the key advantages:


  • Alignment of Interests: Advisory shares align the interests of advisors with the long-term success of the startup. When advisors have a stake in the company, they are motivated to provide valuable insights and guidance.

  • Conservation of Cash: Startups often have limited cash flow, especially in the early stages. Offering advisory shares allows startups to compensate advisors without depleting their cash reserves.

  • Access to Expertise: Advisors bring a wealth of knowledge and industry experience to startups. By offering advisory shares, startups can attract and retain top-tier advisors who can provide strategic guidance and valuable connections.

Considerations for Startups


While advisory shares can be beneficial, startups should carefully consider a few factors before issuing them. Here are some key considerations:


  • Dilution: Issuing advisory shares can result in a dilution of existing shareholders' ownership. Startups need to balance the equity granted to advisors with the interests of other stakeholders.

  • Confidentiality and Conflicts of Interest: Advisors often gain access to sensitive information about the startup's operations and plans. Startups should have clear agreements in place to protect their confidentiality and prevent conflicts of interest.

  • Documentation and Expectations: It is crucial to have clear advisory agreements that outline the roles, responsibilities, and expectations of both the startup and the advisor. This helps ensure that both parties are on the same page and can avoid potential misunderstandings.

How to Issue Advisory Shares?


Issuing advisory shares involves several steps to ensure a smooth and transparent process. Here's a general framework for issuing advisory shares:


  1. Identify the Right Advisors: Find advisors who have the expertise, industry knowledge, and network connections that align with your startup's needs.

  2. Negotiate Terms: Discuss the terms of the advisory relationship, including the amount of equity compensation, vesting schedule, and any additional terms or conditions.

  3. Document the Agreement: Create a comprehensive advisory agreement that outlines the terms, responsibilities, and expectations of both the startup and the advisor. Seek legal guidance to ensure the agreement is legally binding and protects the interests of both parties.

  4. Track and Manage Equity: Use equity management software or platforms to accurately track and manage the issuance of advisory shares. This helps ensure compliance, transparency, and accurate reporting.

  5. Regular Communication and Review: Maintain open lines of communication with advisors, providing updates on the company's progress and seeking their advice when needed. Regularly review the advisory relationship to assess its effectiveness and make any necessary adjustments.

Finding Startup Advisors


Finding the right advisors for your startup is crucial for success. Here are some tips on how to find and engage with startup advisors:


  • Define Your Needs: Identify the specific areas in which you need guidance and expertise. Determine what skills and experience would complement your team.

  • Leverage Your Network: Tap into your existing network and seek recommendations from trusted contacts. Utilize professional networking platforms like LinkedIn to connect with potential advisors.

  • Industry Events and Conferences: Attend industry events and conferences to meet experts in your field. Take advantage of networking opportunities to engage with potential advisors.

  • Startup Incubators and Accelerators: Join startup incubators or accelerators that provide access to a network of mentors and advisors. These programs often have established frameworks for connecting startups with experienced advisors.

  • Pitch Competitions and Hackathons: Participate in pitch competitions and hackathons to showcase your startup and attract attention from industry experts who may be interested in advising.

Examples of Advisory Share Agreements


To provide further clarity, let's explore a couple of hypothetical examples of advisory share agreements:


Example 1: Startup A


Startup A, an early-stage technology company, is seeking guidance on product development and market strategy. They approach an experienced industry professional, John, to advise their team. After negotiations, Startup A offers John 0.5% of the company's total equity in the form of non-qualified stock options (NSOs). The NSOs will vest over a two-year period, with a one-year cliff. The advisory agreement also includes confidentiality and non-disclosure provisions to protect Startup A's proprietary information.


Example 2: Startup B


Startup B, a biotech startup in the seed stage, is looking for an advisor with expertise in regulatory compliance. They engage with Sarah, a seasoned industry professional, to guide them through the complex regulatory landscape. Startup B offers Sarah 1% of the company's total equity in the form of restricted stock units (RSUs). The RSUs will vest over a three-year period, with no cliff. The advisory agreement includes provisions for termination notice periods and intellectual property protection.


Frequently Asked Questions (FAQs)


Q1: Can advisors receive cash compensation alongside advisory shares?


Yes, startups can compensate advisors with a combination of cash and equity. The specific terms of the compensation should be negotiated and documented in the advisory agreement.


Q2: How do advisory shares affect a startup's cap table?


Advisory shares can impact a startup's cap table by diluting existing shareholders' ownership. Startups should carefully consider the amount of equity granted to advisors to manage dilution effectively.


Q3: Can advisors sell their advisory shares before they fully vest?


The ability to sell advisory shares before they fully vest depends on the terms outlined in the advisory agreement. In most cases, advisors will need to wait until the shares fully vest before selling them.


Q4: Can advisors be granted advisory shares after the startup has received funding?


Yes, startups can grant advisory shares at any stage of their growth, including after receiving funding. The specific terms and conditions of the advisory shares should be negotiated and agreed upon by both parties.


Conclusion


Advisory shares provide startups with a powerful tool to attract, compensate, and align the interests of advisors who can contribute valuable insights and expertise. By offering equity compensation, startups can tap into the collective wisdom of experienced advisors and accelerate their growth. However, issuing advisory shares requires careful consideration of the amount of equity granted, the terms of the advisory agreement, and the impact on the startup's cap table. With a well-structured advisory program and strong relationships with advisors, startups can leverage their knowledge and guidance to achieve long-term success.

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