Advisory shares are a type of equity compensation given to company advisors in lieu of (or on top of) a professional fee. Similar to employee stock options, issuing advisory shares to those key inception-phase advisors are common practice for early-stage startups.
Finding subject matter experts who are willing to help a company succeed is extremely valuable; particularly for pre-seed to series A+ startups. Cashflow may be tight, but absorbing and executing on the wisdom and insights of seasoned advisors is invaluable. Our recommendation? Reward them with a slice of cake!
The good news is, many experienced company advisors prefer equity compensation over cash. Not only are they familiar with the startup capital situation, they also know the potential financial gains of getting in on the cap table of your company its early stages.
With that said, we tackle in this article:
- What are advisory shares
- Who gets advisory shares
- What are the types of advisory shares
- How do advisory shares work
- How much equity should you give to an advisor
- How to manage advisory shares
Learn more real life insights about how to find and engage with startup advisors from the first episode of Startup Equity Matters where we discussed all things advisory shares with Founder Institute director, Ben Chong.
Advisory shares, explained
What are advisory shares
Advisory shares (or advisor shares) are a form of non-cash equity compensation given to advisors in exchange for their time and expertise, strategic insights, experience, and network.
Advisory shares are a type of equity ownership that don't come with voting rights or a stake in the company's profits. Instead, they grant the holder the right to provide advice and guidance to the company's management team. Advisory shares are often used as a way to compensate advisors, consultants, and other experts who provide valuable insights and guidance to a startup typically in the early stages of growth.
Equity vs advisory shares
Equity grants, stock options — all these can get confusing, especially when its used interchangeably and mean different things depending on context, the country you're in and who you ask!
In general, equity is a share of ownership in a company. Advisory shares is simply the term used when talking about for equity given to advisors.
Regular shares vs advisory shares
Another important distinction to make is the difference between regular and advisor shares.
Regular shares or stock are a unit of ownership that you can acquire in either a publicly traded company (by trading on an exchange), or in private companies (issued to investors through private transactions or to team members). These usually come with voting rights, shareholder rights, and other protections.
Advisory shares, on the other hand, are given to part-time advisors and, depending on the class of shares, typically don't include the right to vote. Advisory shares are also often subject to vesting schedules based on the period of time the advisory services are needed.
Who gets advisory shares
Advisory shares are given, as the term implies, to startup advisors. Typically not full-time employees, advisors are professionals with industry expertise, business knowledge, and vast networks that can help founders like you fast track you learning (and reduce mistakes).
From former founders, to angel investors, or venture capitalists , startup advisors can come in many forms. Usually they have specialized skills in various fields such as HR, software development, sales, operations, or even marketing.
The types of advisors you might engage with may change over the course of your startup's lifecycle. In the early days, you might need more help with product. As you get a bit larger, you might need help with how to position my business to be able to expand to international markets. And as your business gets even more progress, you're thinking, how do Ibuild a high performing team around me. So [you ask], what are those experiences, what are those gaps that our team could benefit from an advisor?
— Ben Chong, Co-director at Founder Institute
The point is, these advisors have been in your shoes and possess deep expertise in areas that could take you years to learn. So why not leverage it?! Finding the right advisors is pivotal to your success and knowing how to compensate them fairly is a skill in and of itself.
What are the types of advisory shares
There are two types of advisory shares:
Restricted stock awards
Restricted stock awards or a restricted stock agreement (RSA) are shares of common or ordinary stock that are granted to someone, paid for by cash or through the provision of services. Generally, these shares are also subject to vesting requirements.
RSAs are usually issued in the early stages of a company. It gives advisors the opportunity to be shareholders upfront (at the time the grant is accepted) and receive the shares in exchange for their services.
The fair market value is very low at this point, which means a lower and more favourable tax outcome for the advisor. Assuming you use a standard agreement, they're also practically free to give away ie. you won't be burning cash (win-win).
Stock options
Stock options are the right to acquire stock at predetermined strike price.
If you're familiar with employee stock options, you've probably heard of non-qualified stock options (NSO) and incentive stock options (ISO). Advisory shares are almost always categorised as non qualified stock options due to the contractor / service provider relationship that advisors have with a company. (Take note that ISOs can be granted to employees only.)
The amount of company's equity granted to advisors may vary considerably depending on their experience, influence, and role. It also depends on how long the advisor and the company plan to work together.
How it works
How do advisory shares work
Just like any equity-related transaction, you will need the details of the agreement in writing.
Startup advisor agreement
When you and your advisors finally agree on the details (amount of shares or options, their value, any vesting schedules etc.), an agreement is signed and becomes a binding contract between both parties.
There are many startup advisor agreement templates available out there that you can customise. Just remember that this is a legal document and you want to make sure that it serves its purpose of mitigating the right legal risks and issues. The important, and not-so-boilerplate provisions that you should check for are:
- Roles responsibilities and expectations ie. a clear scope;
- Type of shares and percentage of the company's total equity;
- Vesting schedules and/or length of service;
- the conversion mechanism (if using options);
- Confidentiality; and
- Intellectual property agreements and non-disclosures of other proprietary information.
It's important to note that during their time as advisors, they will likely have access to sensitive information such as financial documents, marketing plans, product development roadmaps or growth strategies.
Well written advisor agreements are a way to protect company confidentiality and prevent conflicts of interest. You may also like to consider a side deed of confidentiality... but that's a bit OTT in this day and age, IMO.
The Founder/Advisor Standard Agreement template
The Founder/Advisor Standard Agreement, or “FAST”, was developed by the Founder Institute to make the advisory agreement process more efficient for startup founders.
With the FAST agreement, founders and advisors can agree on how to work together, what to accomplish, and the right amount of equity compensation in a short and simple 5-pager. It really doesn't need to be much longer than that! or take much time (pun intended).
The template is free to download from the Founder Institute website and recommended for use with Cake when issuing founder equity.
Advisory shares vesting schedule
The vesting period is the time individual advisors must wait to exercise their right to convert the option into a share or stock in the company.
Placing time or performance based vesting ensures that the recipients are both financially and strategically incentivised through a commitment to the overall performance of the company, creating alignment between the two parties.
There are three types of vesting schedules:
Time-based vesting
An advisor will have to stay with your company for a specified time to claim rights to their stock or option. For example, a four-year vesting schedule with a one year cliff means that:
- All stock will vest after four years of service by the advisor.
- The advisor must work for at least one year for any stock to vest.
- The remaining stock will vest increasingly on a monthly or quarterly basis.
Milestone-based vesting
This type of vesting is not time-based, but rather based on completing a task that adds value to your company, which triggers the stock or option to vest.
Hybrid vesting
This type is a mixture of time- and milestone-based vesting. The advisor will have to stay for a specific amount of time at your company and complete certain tasks in order for the stock or option to vest.
How much of the company's total equity should you give to advisors?
Typically, individual advisors can expect to receive anywhere between 0.25% to 5% - but the exact percentage ultimately depends on how much the advisor contributes to the company's growth, the advisor's expertise, and how much you're willing to give away!
An advisor sitting in monthly meetings to give advice during pre-funding stages might be given .25% to .5% equity, whereas an advisor with a huge network of contacts that could become future customers might have a bigger piece of the cake.
When the first seed funding takes place, an advisor's stock might be diluted to .5%. At this point the advisor no longer attends monthly meetings anymore and might just be on-call. When another round of financing happens, an advisor's stock is further diluted to .25%, and so on.
These percentages will continue to reduce throughout the company’s lifetime. Now .25% might not look like much, but depending on the valuation of a business - that thin slice of cake might be worth a ton!
This article is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.
