What Are Advisory Shares – Indinero

Advisory shares are equity stakes issued to advisors in lieu of (or in addition to) cash.

Startups might use advisory shares when they require expertise but are low on funds. Conversely, advisors accept equity when they believe in a startup’s potential and their ability to guide them to success.

Here’s what we’ll cover in this guide:

For guidance on how to issue equity to advisors, or anything related to startup taxes and accounting, consider speaking to an indinero expert on taxes for startups.

What Are Advisory Shares?

Startups often need help navigating the challenges of early-stage growth, but they may lack the financial resources to pay for that help outright.

Advisory shares are an innovative solution. By offering equity instead of cash, startups can compete with established companies for skilled and well-networked talent.

There are many ways a company may offer advisory shares; the most common are stock options, followed by restricted stock awards (RSAs). The former provides the right to purchase a stock at a predetermined price while the latter is awarded at the time of vesting.

Additionally, stock options are taxed at the time of exercise, while RSAs are taxed at the time they’re granted. Because of this, advisors often prefer stock options to RSAs because they can time the purchase date with low-income years to minimize personal tax consequences. Conversely, an RSA may be preferred when the advisor doesn’t have the cash to fully exercise a stock option. In that case, a grant of stock, despite coming with immediate tax consequences, is preferred.

Advisory Shares Vs Equity: What’s The Difference?

There isn’t one. An advisory share is simply equity issued to advisors. It’s a catch-all term that can refer to various types of equity.

However, there is a difference between employee stock options and the kinds of stock options advisors receive. Employees receive incentive stock options (ISOs) which do not incur tax liability when exercised. Advisors receive non-qualified stock options (NSOs), which do.

Who Is Typically Granted Advisory Shares?

Startups seek out advisors who can fill key gaps. Broadly speaking, they fall into two categories:

The subject-matter expert
The recognizable industry veteran

A subject-matter expert brings a skillset that founders and early employees may lack. For instance, a founder who is an expert in computer programming may need a marketing advisor, while an adept salesman may seek someone with technical expertise.

The value an industry veteran brings, over and above their expertise, is their network and reputation. A well-known name can raise the profile of a startup among the investor community, make introductions, and open doors that would otherwise be closed.

Additionally, such an individual may be offered a higher equity stake than a subject-matter expert, because their contributions directly impact the rate of new business for the startup.

How Do Advisory Shares Work?

No two deals are alike. That said, there are a few industry norms:

Companies and advisors agree on terms, scope, time commitment, and percentage of equity granted
Equity vests over time, usually over two years. Some advisory share deals will include a short cliff of ~3 months, where no equity vests to test the relationship. If the advisor and a startup aren’t a fit, this probationary period makes an amicable parting of ways easy.
Startups typically grant between 0.1-1% equity to an individual advisor and 5-10% to their board of advisors. Early-stage startups tend to give larger percentages, while mature companies give less.
Typical arrangements include 5-10 hours of work over 1-2 days per month. However, It’s important to consider the advisor’s contributions in terms of the value they bring rather than the time they spend.
In scenarios where many stakeholders own equity, startups use a cap table to account for who owns what stake of the company.

Pros And Cons Of Issuing Advisory Shares

Aside from saving valuable liquid capital and gaining access to expertise and industry-relevant networks, the largest benefit to issuing advisory shares is that it aligns with incentives. The advisor makes money only when the business makes money. Because advisors have skin in the game, they will be highly motivated to guide the business to greater success.

But there are also some drawbacks to consider before trading equity for advice:

Dilution: Issuing equity dilutes existing shareholder ownership percentages. This makes attracting new investors and raising future funding more difficult.
Complexity: Legal and administrative frameworks need to be put in place. This takes valuable time and resources.
Lack of control: Advisors with equity have voting rights and a say in company decision-making processes.
You’re selling equity: If your company becomes successful, what once felt easy to give away may be incredibly valuable.
Confidentiality: You may share sensitive information with advisors who could share a network with your competitors. Keep this in mind when drafting your advisory agreement.

You can get more financial guidance for your growing business by checking out our guide to Accounting for Startups.

How Do I Find An Advisor For My Startup?

Before beginning a search for an advisor, first, define your needs. What areas could you most benefit from guidance and expertise?

If you’re a growth-stage startup, you may need help raising capital. You probably need help finding your first customers if you’re a seed-stage startup. Each situation will call for a different type of ideal advisor.

If you’re having trouble envisioning that, consider this advice from Eric Migicovsky, whose startup was eventually acquired by Fitbit. He argues that the best advisors work in the same industry, three to five years ahead of where you are in the startup lifecycle.

Once you’ve settled on the kind of advisor you’re looking for, begin tapping your network as you might look for a job candidate. Reach out to incubators, accelerators, and attend networking events. Finally, here is a list of eleven websites to connect startup founders with advisors.

Conclusion

Most successful businesses have diverse experts working to keep the business growing. Startups typically need the most guidance, but with limited capital, they typically cannot afford a full-time expert hire.

But startups that make good use of advisory shares can receive expert guidance at a price they can afford, and advisors get a shot at guiding a company to becoming wildly successful (and reaping the financial benefits when they do).

Indinero can help growing startups rise to success, too. Our fractional CFO services give startups access to specialized financial expertise at a much lower cost than full-time help.