What are advisory shares?
Discover why growing companies are offering advisory shares as a form of equity and compensation to field experts for their expertise.
Summary
Advisory shares allow growing businesses access to consulting professionals without digging into the immediate cash flow.
They encourage long-term involvement from the expert, who helps grow the business.
Advisory share agreements should include performance metrics and defined terms for vesting, cliff, and exit scenarios.
A financial advisor can help you choose the right share options and provide expert financial advice.
What is an advisory share?
Advisory shares, or advisory equity, are company shares granted to external advisors instead of cash compensation. These advisors are often industry experts or seasoned entrepreneurs who offer valuable guidance to the company. Aside from acting as compensation, advisory equity aims to align the advisor's interests with the company's short- and long-term success.
Let's look at the following example: A startup tech company wants to expand its market reach and enhance its product development. They approach a respected industry veteran with a successful track record in the technical sector to serve as an advisor. The startup offers the expert an advisory share instead of a cash consulting fee, preserving financial resources.
How do advisory shares work?
An advisory agreement between a company and the external advisor outlines the latter's role, responsibilities, and the equity percentage granted. An advisory share includes a vesting period, where the advisor earns the right to the shares. The agreement could also have a period for accelerated vesting to encourage the advisor's long-term commitment.
The agreement also includes exit terms for scenarios like mergers or acquisitions to outline the terms for treating advisory shares. Typically, legal counsel is involved in drafting agreements to ensure protection and clarity for both parties.
Continuing with the previous example, the terms of the advisory agreement between the startup and the expert state that they will receive 0.5% of the company's equity as an advisory share. This equity will vest over two years, with a one-year cliff. This means that the expert must remain actively involved as an advisor for at least one year before any shares vest. After that, the remaining shares will vest gradually over the next year.
Who issues advisory shares?
Companies that issue advisory shares to external advisors are typically startups or growing businesses. Their advisors could be industry experts, successful entrepreneurs, or specialist professionals with knowledge relevant to the company's goals.
The issuance of advisor shares helps startups and growing companies compensate advisors for their contributions without using immediate cash payments. This allows the advisor to gain a stake in the company's equity, which they help to grow through advisory services.
To continue with our example, with legal counsel, the startup and expert negotiate fair equity (in this case, 0.5%) and other agreement terms. For example, the agreement also outlines the expert’s role, which includes providing strategic guidance on market expansion and product development.
In the event of a successful exit, e.g., a merger or acquisition, the expert’s advisory share may be subject to certain conditions to ensure their contribution is recognized in the company's success.
What is the difference between advisory shares and regular shares?
Advisory and regular shares are similar in many respects but differ in a few respects, too. The table below summarizes the differences between the two:
| Differences | Advisory Shares | Regular Shares |
|---|---|---|
| Purpose and recipients | Issued to external advisors, typically individuals offering expertise and guidance to the company but not necessarily employed by it. | Typically issued to employees, founders, or investors who directly contribute to the company's operations and capital. |
| Compensation model | Compensate advisors for their strategic input and advice, often in lieu of cash payments. | It may be part of an employee's compensation package, a founder's equity stake, or investor shares obtained through investment. |
| Vesting and cliff periods | Advisory shares are often subject to vesting schedules and cliff periods to incentivize long-term engagement. | Employee stock options or founder shares may also have vesting schedules, but the structure can differ. |
| Roles and responsibilities | Agreements outline the advisor's specific roles, responsibilities, and contributions to the company. | Generally tied to the ongoing work or initial contribution of employees, founders, or investors. |
Three similarities between advisor shares and regular shares include:
Equity ownership: Both share types represent ownership in the company, providing the holder with a stake in its success and potential financial gains.
Legal considerations: Advisory shares and legal shares involve legal agreements that specify the terms and conditions of ownership, including responsibilities and vesting rights.
Impact on company valuation: The issuance of both share types can impact the company's valuation, affecting the overall ownership structure.
What are the pros and cons of advisory shares?
When considering advisory shares, interested companies and individuals must weigh the pros and cons before agreeing. Some pros and cons are outlined below, but conducting thorough research and understanding the agreement terms is always advisable.
Pros:
Here are three pros of dealing with advisory shares:
Access to expertise: Advisor shares provide companies with access to the expertise of external advisors with specialized knowledge, industry experience, or a successful track record. This allows the company to benefit from valuable insights and guidance without incurring immediate cash expenses.
Alignment of interests: By granting advisor shares, companies align the interests of advisors with the business's long-term success. Advisors become company stakeholders, fostering a sense of commitment and motivation to contribute to its growth and prosperity.
Conservation of cash: Offering advisory shares instead of cash compensation helps startups and growing companies conserve their cash resources. This type of agreement is advantageous for companies with limited budgets, allowing them to secure the services of experienced professionals without the immediate financial burden of high consulting fees.
Cons:
Next, here are three cons when dealing with advisory shares:
Dilution of ownership: Issuing advisor shares can dilute the ownership stake held by existing stakeholders, e.g., founders and early investors. As new shares are granted to advisors, the overall percentage ownership of existing stakeholders is gradually reduced, potentially impacting their control and influence over the company.
Uncertain value contribution: Quantifying the value of an advisor's contribution is challenging and sometimes subjective. If the advisor's impact on the company's success is less than expected, equity issuance may be perceived at a disproportionate cost. This is especially risky if the shares were granted without clear performance metrics.
Potential for disputes: Parties may disagree over the terms of the advisory share agreement. These issues could relate to vesting, the advisor's actual contributions, or the treatment of shares in the event of an exit. An agreement must be better defined to avoid misunderstandings about expectations and result in disputes that may require legal resolution.
Are advisory shares right for you?
While not suitable for everyone, advisory shares can be a powerful tool for people seeking strategic guidance and collaborative partnerships. Advisory shares can provide startups and growing companies with access to expertise without the immediate cash expenses. However, potential drawbacks like ownership dilution require careful consideration. Therefore, agreement structuring and due diligence in advisor selection are essential.
If you're considering offering or accepting advisor equity, let Unbiased match you with an SEC-regulated financial advisor to learn more about this share option and for expert financial advice.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.