Summary
Startups typically rely on the valuable insight of advisors but often lack the capital to compensate them for their expertise. Enter advisory shares, a form of equity compensation given to company advisors as opposed to employees.
In this arrangement, companies usually grant advisors options to buy shares. It’s also possible for companies to distribute advisory shares in the form of restricted stock awards (RSAs) and restricted stock units (RSUs).
Advisory shares explained
Advisory shares, also called advisor shares, are a type of equity compensation that early-stage startups offer trusted strategic mentors and consultants in lieu of cash. This remuneration comes in the form of stock options that these advisors can exercise or in the form of restricted stock awards (RSAs) or restricted stock units (RSUs). These shares typically vest overtime during the advisor’s working relationship with the company.
You can learn more about stock options and RSUs in our two guides:
How do advisory shares work?
Companies typically grant advisors options to buy shares in the company rather than distributing actual shares to them. Stock options typically vest within a year or two (sometimes over four years), which allows the company to delay transferring ownership to advisors. This timeline incentivizes advisors to be invested in the long-term success of the company so that their strategic insight can boost the company’s performance and thus the value of their shares. Some companies do issue restricted stock awards (RSAs) or restricted stock units (RSUs) to advisors.
The equity a company gives to an advisor can vary depending on the development stage of the company and the exact nature of the advisor’s role and expertise. A company can decide to allocate up to 5% of its total equity to advisors. An early-stage company may determine it’s best to form a board of advisors and issue 0.25% to 1% of the company’s equity to each advisor. Typically the further along a company is in its maturity, the lower the percentage of equity an advisor will get.
Types of advisory shares
Advisory shares come in three forms: stock options, restricted stock awards (RSAs) and restricted stock units (RSUs).
Stock options
Stock options are a form of equity compensation a company can offer advisors that allows them to purchase shares of the company’s stock at a pre-set price known as the grant price, strike price, or the exercise price within a specific timeframe. Advisors can gain the right to exercise the option to purchase shares as shares vest over time. Once an option has vested, the advisor can sell or transfer the option provided it is permitted under the company’s option plan. Stock options typically carry an expiration date.
Restricted Stock Awards (RSAs)
Restricted stock awards (RSAs) are grants of stock, not stock options. With RSAs, advisors may be required to satisfy a fair market value (FMV) purchase price when granted shares.
Restricted Stock Units (RSUs)
Restricted stock units (RSUs) are a form of equity compensation employers can offer advisors that require a vesting period before they are converted to common stock. Because they are not distributed up front, this form of equity compensation is said to be “restricted.” Recipients have RSUs issued to them according to a vesting plan and distribution schedule typically based on tenure milestones with the employer or performance accomplishments. Because RSUs are grants of stock, there’s no need to purchase them as with exercising stock options.
Who issues advisory shares
Early-stage companies, typically startups, issue advisory shares. This allows these often money-conscious enterprises to incentivize advisors to lend their expertise and stay invested in the growth of the company without having to shell out cash as compensation for their services.
Pros of advisory shares
Start-ups are typically lean on cash, and advisory shares allow them the ability to receive strategic advice from experts without having to endure a large cash outlay.
Another major benefit to advisory shares is the ability to protect a company’s confidentiality during the especially sensitive moment of its early development. Advisors who are granted advisory shares are typically asked to sign confidentiality and non-disclosure agreements given the likelihood they’ll be exposed to strategic plans related to product development and marketing.
Cons of advisory shares
One disadvantage to advisory shares: in issuing advisory shares, companies may not have the ability to prevent advisors from consulting for competitors.
In addition, start-ups can risk allocating too much equity to advisors at an early stage. It may seem all too easy to distribute fractional shares in the company to a ready team of strategic advisors, but founders must exercise discretion and restraint. (Equity given to individual advisors does get smaller as the company grows.) Even the most experienced business leaders may not meet a particular company’s needs from a strategic standpoint, so though it can seem easy to compensate advisors in a non-cash capacity, it’s important for companies to consider the true value-add a particular advisor may bring to the table before parting with precious equity that can one day be worth a lot.
What’s the difference between advisory shares and regular shares?
Regular shares, simply put, are units of common stock that can be bought and sold on public markets like the Nasdaq or the New York Stock Exchange. These shares are available to standard retail investors. By contrast, advisory shares are non-qualified stock options (NSOs) or sometimes restricted stock awards (RSAs) and restricted stock units (RSUs) that companies grant to advisors in exchange for their guidance and expertise.
Can you sell advisory shares?
Yes, it is possible to sell advisory shares provided it is permitted under the company’s option plan. If such a sale is permitted, strategic advisors for a company can sell these shares either in a private sale or on the open market. If you are thinking about selling your advisory shares, consider meeting with a trusted financial advisor.
Advisory shares: Bottom line
Advisory shares are a form of equity compensation given to company advisors who offer strategic insight to help the company’s growth. Instead of cash, companies usually grant advisors options to buy shares, though they sometimes distribute advisory shares in the form of restricted stock awards (RSAs) and restricted stock units (RSUs). Startups, which are typically cost-conscious operations, can avoid burning through cash by offering advisory shares to those lending valuable guidance to the organization. Founders, though, must exercise some discretion to make sure a particular advisor’s insight is worth parting with precious equity.
