In this guide we will explore what advisory shares are, their significance to companies—especially startups—and the expected benefits for the advisors in terms of reimbursement.
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What are advisory shares?
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Which companies issue advisory shares?
For the most part, advisory shares are issued by start-up companies. The company may be in the idea stage at the time. Alternatively, in the later seed capital stage or even much later, when there might be an active, growing need to bring on experts.
The equity provided to advisors can vary notably. It depends on a particular advisors’ expertise and role within a company and how long they are expected to work together.
How much equity is offered to advisors?
Up to 5% of a company’s total equity can be allocated to advisors. Sometimes a young company may form an advisory board to distribute equity to incentivize board members. Individual advisors can expect anywhere from 0.25% to 1% of the company’s equity, depending on their contributions and the growth of the business.
For example, an advisor who provides counsel at monthly meetings might receive a more modest amount of 0.25%. On the other hand, a beefier slice of 1% might be presented to an advisor who introduces a prospective client that becomes a sizable customer.
The more mature the company, the smaller the equity percentages advisors can expect to collect. For instance, a company in the idea stage might give 0.25% of equity to an advisor who attends monthly meetings, compared to a company past its startup phase, giving a cut of 0.15% for the same work.
How are advisory shares different from regular equity shares?
The primary difference between regular and advisory shares is that regular shares are standard stock units that are sold on the open market, as opposed to advisory shares, which are stock options given to experts in exchange for their business insights.
Advisor shares fall under NSOs (non-qualified stock options), which differ from ISOs (incentive stock options) usually given to company employees.
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NSO vs ISO: Tax treatment
Taxes need to be paid only once you sell your shares. If the shares are kept for a certain holding period (keep ISOs for at least one year after exercising and two years after your options were granted), they will qualify as capital gains instead of ordinary income, and therefore are taxed at a much lower capital gains tax.
*Exercising a stock option means purchasing the company’s available stock at a price set by the option (grant price), no matter the stock’s worth when you exercise the option.
Vesting schedules
A vesting schedule is an incentive program instituted by the employer to give the employees the right to specific asset classes. It is used to incentivize employees to remain with the company for longer.
A vesting schedule lets employees gain full ownership of employer-provided assets only over time. It can also allocate profits, equity, and stock options to employees. Employees surrender their unvested portion of securities if they leave before being 100% vested.
Vesting schedule for advisory shares
Vesting does not work the same way for advisors as it does for regular employees. In addition, because young companies can go through a fast transformation, the advisors needed at the seed stage will likely differ from later stages of the company’s evolution.
Common advisory shares vesting schedules are often two years with no cliff. Therefore, advisory shares vest or are granted in monthly increments over two years. However, the company will not owe an advisor the entire vesting schedule if they stop providing advisory services per the advisory agreement.
Cliffs in vesting schedules
Cliffs are periods without stock vestments, commonly occurring in one year. This vesting schedule is usually a prerequisite of employee stock options and is not part of the advisory shares vesting schedule.
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What are advisory shares on Shark Tank?
Shark Tank is a famous American business reality television series that features aspiring entrepreneurs making business propositions to a panel of investors or “sharks” and persuading them to invest in their company.
In exchange for their investment, ‘the sharks’ generally require a stake in the business – a percentage of ownership plus a share of the profits. In return, the entrepreneur gets funding, but more importantly, they get access to the sharks, their expertise, network of contacts, and suppliers.
On top of a percentage of ownership in the business, investors are also often offered advisory shares. These can be a safe option for the sharks as they merely grant them the opportunity to buy equity instead of being offered the actual shares, which helps avoid any foreseeable conflict of interest.
Squatty Potty example valuation
For example, Squatty Potty asked for $350,000 from the sharks for a 5% stake in their company, meaning they believe their company is valued at $7 million in sales (5% of 7 million is 350,000). The sharks, in this case, agree with the valuation but are interested in a higher ownership percentage in the company. Lori Greiner’s counteroffer at 10% for $350,000 eventually seals the deal.
Settling on an amount to invest in the company and the percentage of stake in the business each is open to considering comes down to estimating revenue and applying a valuation to the company. But, of course, the sharks ultimately want to get their investment back and earn a profit.
See the video: Squatty Potty Makes The Sharks Say “Holy Crap!”
Pros
- Can provide crucial help in a business’s development, whether in the early seed stage or much later;
- They can help protect a company’s confidentiality. Advisors are often asked to sign confidentiality and non-disclosure agreements (NDAs) since they are likely to witness product development and marketing proposals that companies want to keep secret.
Cons
- Advisors may be working with several companies. Firms that issue advisory shares may not have the power to restrict advisors from working with rival companies. Therefore, it is essential to clarify in advance if advisors have pre-existing arrangements that could affect their ability to give impartial advice;
- Companies can frequently over-compensate advisors with stock options. Management might be comfortable with giving away fractional equity percentages in a start-up with few assets. Those cuts could get much more prominent with the company’s growth.
In conclusion
For startups, offering advisory shares is an effective way to attract and compensate top-tier talent when cash is limited. It aligns the advisors’ interests with the company’s success, ensuring their commitment and active engagement.
For advisors, these shares represent a valuable opportunity to invest expertise and guidance in a promising company while gaining equity that could potentially yield significant returns.
It’s important to approach this equity arrangement with a clear understanding of the terms, rights, and obligations involved. Both parties should recognize the potential and the risks associated with advisory shares, making informed decisions to foster a mutually beneficial relationship that contributes to the company’s growth and success.
Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
FAQs about advisory shares
How do advisory shares work?
Advisory shares are equity compensation awarded to company advisors for their expertise and services. These shares are issued based on an agreement outlining the share quantity, vesting schedule, and specific conditions, ensuring advisors earn their shares over time. Unlike standard equity shares, advisory shares may have no voting rights and unique sale restrictions, linking advisor compensation to the company’s performance and encouraging long-term commitment.
Who are the advisors in a company?
Advisors in a company are typically experienced professionals or industry experts who provide strategic guidance, expertise, and mentorship to the company’s management or founders. They are chosen for their knowledge, skills, and networks that can help in the company’s growth and development. Advisors are not usually involved in the day-to-day operations but offer valuable insights and connections to aid in decision-making and strategic planning.
Who gives out advisory shares?
Advisory shares are typically issued by a company’s founders or its board of directors. In startups, founders, often in consultation with investors or the board, decide on allocating these shares. In more established companies, the board of directors approves their issuance.
How much can advisors expect?
Up to 5% of a company’s total equity can be allocated to advisors. Individual advisors can expect anywhere from 0.25% to 1% of the company’s equity, depending on their contributions and the growth of the business.
What does advisory shares mean on Shark Tank?
In ‘Shark Tank’, advisory shares are equity compensation given to a Shark for both their investment and advisory role in an entrepreneur’s business. These shares acknowledge the Shark’s contribution of expertise, guidance, and connections, going beyond mere financial input. Distinct from traditional equity shares, which represent a simple ownership stake, ‘Shark Tank’s advisory shares value the Shark’s continuous mentorship and strategic input to the entrepreneur’s venture.
What's the difference between advisory shares vs. equity shares?
Advisory shares are a unique equity form awarded to company advisors for their expertise and guidance. Differing from regular equity shares issued to investors or employees, these shares come with special terms, conditions, and often distinct vesting schedules and rights. While both share types signify company ownership, advisory shares are specifically designed for advisors and may have attributes that set them apart from standard equity shares held by other stakeholders.
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