What Are Advisory Shares and Who Gets Them?

Advisory shares are equity-based compensation given to company advisors rather than traditional employees. They may take the form of stock options, restricted stock or other equity awards and are often issued by startups in lieu of some or all cash compensation. Advisors commonly receive the right to acquire or earn shares over time rather than receiving unrestricted shares immediately. Advisory shares can align an advisor’s financial interests with the company’s growth, but they can also dilute existing owners and create tax, securities-law and contractual considerations.

A financial advisor can answer questions about advisory shares and other investments.

What Are Advisory Shares?

Advisory shares, also known as advisor shares, are typically financial rewards in the form of stock options. Recipients of 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.

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Advisory Shares vs. Equity

Advisory shares are not a separate asset class from equity. Instead, the term generally describes equity or equity-based compensation granted to an advisor in exchange for services. Advisory shares are typically granted to advisors or mentors in exchange for their strategic guidance, industry connections or expertise. These shares are often structured as stock options or restricted stock units (RSUs) and usually vest over time, similar to employee stock options.

The rights attached to advisory shares depend on the type of award and the company’s governing documents. An option holder, for example, generally does not become a shareholder merely by receiving an option; ownership rights typically arise after the option is exercised and shares are issued. Restricted stock or other equity awards can have different voting, dividend and ownership rights.

On the other hand, equity refers to actual ownership in a company, which founders, investors or employees can hold. Equity holders, especially common or preferred shareholders, generally have more substantial rights, including voting power and claims on profits through dividends or liquidation events. While advisory share awards involve equity or the right to acquire it, they are typically used as a compensation tool for non-employee contributors rather than as a means of significant ownership or control in the company.

Types of Advisory Shares

Advisory shares can take different forms depending on how they are structured and issued. The most common types of advisory shares include stock options and restricted stock units. Here is what you need to know about each of those two types.

1. Restricted Stock Units (RSUs)

An RSU is an equity compensation award under which a company promises to deliver shares or their cash value at a future date if applicable vesting or other conditions are satisfied. RSUs can be granted to employees and, depending on the plan and applicable law, other service providers such as advisors or consultants. The shares or cash generally are delivered only after the award’s vesting or other conditions are met. The award agreement may require continued service, achievement of performance goals or satisfaction of other conditions.

Taxes on RSUs generally apply when the award vests and the shares or cash are transferred, although the timing can depend on the specific arrangement. The value recognized as compensation is generally taxable as ordinary income. For a nonemployee advisor, the reporting and employment-tax treatment can differ from that of an employee.

After receiving the shares, the advisor may generally hold them or sell them, subject to any trading restrictions. Selling the shares may result in capital gains tax if their value has increased above the recipient’s tax basis.

2. Stock Options

This type of compensation, which is granted to employees, contractors, consultants and advisors, is a contract. Stock options give 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. The option agreement may also require an advisor to exercise vested options within a specified period after the advisory relationship ends.

The number of options a company grants varies based on factors such as the advisor’s role, expected contribution, company stage and the value of the company. The grant also must receive whatever corporate approvals are required under the company’s governing documents and applicable law.

Advisors generally receive nonstatutory stock options rather than incentive stock options because federal tax law reserves incentive stock options for employees. For a nonstatutory option whose fair market value was not readily determinable when granted, the recipient generally recognizes compensation income when the option is exercised based on the difference between the stock’s fair market value and the exercise price.

How Advisory Shares Work

Advisory shares function similarly to other equity instruments but come with distinct characteristics tailored to the advisory role. Here’s a closer look at their key features:

Vesting schedules: Advisory shares are typically subject to a vesting period, which means that advisors earn their shares over some time. This aligns the advisor’s interests with the long-term success of the company. A common vesting period for advisory shares is between one to four years, often with a cliff period during which no shares vest until a specified duration has passed.
Performance milestones: In some cases, advisory shares are tied to specific performance milestones. These milestones could include achieving certain business objectives, securing funding rounds, or reaching revenue targets. By linking shares to milestones, companies can tie some or all compensation to specific results described in the agreement.
Equity dilution: Granting advisory shares inevitably results in equity dilution, meaning the percentage ownership of existing shareholders decreases. However, the trade-off is the potential value that advisors bring to the company through their expertise and networks. Companies must carefully balance the benefits of advisory shares against the impact of dilution on their overall equity structure.

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.

There is no universal percentage of company equity that must or should be reserved for advisors. Companies sometimes create an advisory pool or make individual grants. The size of those awards can vary substantially based on the company’s stage, valuation, expected time commitment and the advisor’s contribution. Percentages such as 0.25% or 1% may appear in startup compensation discussions, but they are not regulatory standards.

For instance, an advisor who offers insight at monthly meetings might receive a smaller amount than an advisor expected to provide extensive ongoing services or make substantial introductions. The appropriate grant depends on the agreement rather than a fixed percentage.

The more mature the company is, the smaller the percentage of equity advisors can expect to receive. That can happen because later-stage companies generally have higher valuations and more established resources, although compensation arrangements vary from company to company.

Private companies may be able to issue securities to consultants and advisors under SEC Rule 701 when its requirements are met. Among other conditions, an eligible advisor or consultant generally must be a natural person providing bona fide services. The services cannot be connected with raising capital or promoting a market for the company’s securities. Securities issued under Rule 701 are restricted securities and generally cannot be freely resold unless they are registered or another exemption is available.

Pros and Cons of Advisory Shares

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 themselves do not protect a company’s confidential information. 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 several companies. Whether a company can restrict an advisor from working with competing businesses depends on the advisory agreement and applicable law. Companies can review an advisor’s existing commitments and address conflicts of interest, confidentiality and competing engagements in the contract where appropriate.

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.

How to Create a Startup Advisor Agreement

Creating a startup advisor agreement is a crucial step for any new business seeking guidance from experienced professionals. This agreement outlines the terms and conditions under which an advisor will provide their expertise in exchange for advisory shares. It serves as a formal contract that protects both the startup and the advisor, ensuring clarity and mutual understanding.

The agreement typically includes details such as the advisor’s role, the scope of their responsibilities and the compensation structure, which often involves equity in the form of advisory shares.

The first step in drafting a startup advisor agreement is to clearly define the advisor’s role within the company. This involves specifying the areas where the advisor will contribute, such as strategic planning, marketing, or developing a minimum viable product. It’s important to outline the expected time commitment and the nature of the advisor’s involvement, whether it’s attending regular meetings, providing feedback on business plans, or leveraging their network for business development.

Compensation is a key component of the startup advisor agreement. It often involves granting advisory shares. These shares represent a portion of the company’s equity and serve as an incentive for the advisor to contribute to the startup’s success, as they now have a personal stake. The agreement should specify the number of shares or the percentage of equity being offered, as well as any vesting schedule.

The agreement should also specify the form of the equity award, exercise price if options are involved, vesting conditions, treatment of vested and unvested awards after termination and any applicable transfer restrictions. Companies and advisors may also need to consider securities and tax rules before the grant is made.

Finally, the startup advisor agreement should outline the conditions under which the agreement can be terminated. This includes specifying the notice period required for termination and any circumstances that might lead to an immediate end to the agreement, such as a breach of contract or failure to meet agreed-upon responsibilities.

Bottom Line

Advisory shares can help 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 help founders tap valuable contacts and insight without disrupting cash flow. Entrepreneurs who are willing to part with equity in 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 company with a multibillion-dollar market cap.

Business Planning Tips

If you have questions about giving away advisory shares or other parts of your young company, a financial advisor could help you put a financial plan together for your business. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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