There are so many financial mechanisms, products, and nuances when it comes to company shares that it can seem like a bit of a minefield. Most information about shares also relates to those listed on the major stock exchanges (public companies). Advisory shares are a little different.
Advisory shares are primarily relevant to startup companies and scale-up companies at a relatively early stage of maturity. Let’s take a look at the detail…
Advisory shares are share options given to company advisors in return for their expertise. This is a form of payment that doesn’t cost the company anything to give (apart from a share in the company’s total equity) and which doesn’t show up on any documentation.
This gives early-stage companies the advantage of bringing in first-class advice and expertise, without it costing any liquid capital, or alerting their competitors to who is giving them advice.
An advisory share will almost always take the form of a share option. This means that, at the point of issue, the business advisors or consultants who are offered them will not actually own shares in the company. Rather, they will have a legal option to those shares, should they choose to realize them.
Giving advisor shares has become increasingly popular as smaller companies have become more aware of the startup funding options available to them. Startup culture has also made founders more resourceful. Issuing advisor shares rather than actual shares can be a highly effective way to do more with less, especially if the business idea is time sensitive or very competitive.
If you own shares in a company, that means you own a specific part of those shares. This is where it gets a little complicated. there are many different types of actual shares and an almost unlimited number of options for how a company can structure its shareholdings. However, the important factor to understand is that if you own shares in a company, you own a part of that company – which may come with additional benefits (dividends, etc.) or it may not. This information is then publically available if someone wants to look into it (a competitor, for example).
Advisory shares, in contrast, are only options for shares. What this means is that the holder will not own actual stock in the company, but rather have the option to realize stock in a company. In real terms, the two are likely to have very similar levels of value for the advisor. This is because the advisory shares agreement is a legal document that is binding. In most cases, there is no way a company can stop an advisor from realizing their share options in the company after the time period has elapsed.
It’s a reasonable question to ask why it would be necessary to issue advisor shares as opposed to full shares in a company. Though there could be a range of reasons why a company would choose to do things this way, the most common and likely reason is confidentiality.
If a public business figure or industry expert is advising your startup it can give you a significant competitive advantage. In some cases, this could also take the form of a board or company.
Advisor shares mean that there is no paper trail to suggest that the advisor, board, or company has any connection with the startup in question. This can be crucial for some startups in terms of retaining IP, timings, and maintaining their competitive advantage.
Another way that advisory shares can help protect both the company and the advisor is by avoiding any conflicts of interest, or legal issues arising from it.
Like any stock options, they can be diluted. As startups grow the equity that each share holds becomes less. Though this may seem to be a negative thing, it’s usually very positive. This is because it will usually only ever happen at a secondary funding round where the company’s valuation will be considerably higher than it was previously.
Put simply, though your shares will mean you are entitled to a smaller percentage of the company’s equity, your stock options are likely to actually be worth far more in real terms, and the financial rewards of being involved in the project are likely to be far greater.
The actual number of shares and stock options that individual advisors should be entitled to will vary wildly. As outlined above, this will depend on the share structure of the individual company. When we talk about how companies issue advisory shares, it’s most productive to discuss it as a percentage of total company equity.
In most cases, individual advisors are unlikely to be able to negotiate more than 5% of total company equity. However, if a company or board of advisors is involved the advisory share (and resulting financial rewards) could be significantly greater.
How much equity should I give an advisory board?
Equity should always be measured and distributed based on value. In most cases, founders will always approach this from the point of view of giving away as little equity as possible. However, this can sometimes be counterintuitive.
Though negotiating an advisory share down to 2%, for example, might feel like a win for the founders, it can actually be negative. Yes, you would technically have an advisor who has agreed to help you for only 2% of company equity, but will they really be ‘bought in’ to help your company succeed?
Negotiating advisory shares should be purely value-based. What’s the maximum value this advisor can bring to your company? This should be a calculation that includes not only the time, knowledge, and expertise they can bring, but also their contacts, direct referrals, and any other assets they could mobilize to help you grow. If they were to deliver this value, what would that be worth to you? By what multiple would your revenue increase?
In some cases, though it may seem counterintuitive, it can often be better to give the advisor MORE equity than they ask for, rather than less. After all, it’s much better to have a slightly smaller piece of a much bigger pie, right?
What are the advantages of an advisory board?
Though working with a single advisor can be extremely worthwhile, you can often get greater value from a board of advisors.
In these cases, you would benefit from a board of senior executives who would each have their own strategic insights and areas of expertise.
The downside of having a board of company advisors rather than a single advisor is that you will end up giving away more advisory shares in total. However, as we discussed above, giving away more equity is OK if you are likely to get greater value back in return.
The obvious downside of advisory shares is that you are giving away a stock option in your precious company. In time, and if the company is a success, this stock option could end up being worth significantly more than if you simply paid company advisors for their time.
Another disadvantage of advisory shares for the company issuing them is that the business advisors you give them to are likely to be working for many different companies. Because you are only giving the stock options, and no cash compensation, they are probably relying on other sources for their day-to-day income. Though the stock options you give them might be very valuable one day in the future, right now it is unlikely to give you enough bargaining power to dictate who that advisor can work with, or what other business activities they engage in. In some cases, this could result in a situation where you feel there is a conflict of interest in your advisor’s business activities, even to the point where they are working with a competitor of yours, but there would be nothing you could do about it. Of course, you can make sure you have non-disclosure agreements and other paperwork in place to preserve the company’s confidentiality, but this will only protect you so much.
Other disadvantages include the legal paperwork involved and the delays that can be caused by negotiations with advisors.
Do advisors get paid?
Advisors do not receive any direct financial rewards for their advisory shares. However, there is nothing stopping an advisor from providing supporting services or support in other areas, which they could be paid for.
The only scenario in which an advisor would get paid directly as a result of their advisory shares is if they realize and then sell their shares in the company, or if the type of shares they are given entitle them to company dividends.
How many people are usually on an advisory committee?
There really is no set answer to this. As we’ve discussed previously, the level of advisory shares that are given to an advisor or board should directly correlate with the value given and their power to influence the company’s growth. When it comes to a committee, you might argue that the greater the number of people involved, the greater the level of advisor’s expertise – especially if the board is comprised of experienced senior executives.
However, this is rarely the case. There is probably an optimal number of advisors who sit on a board, but this will depend on their expertise, crossover of expertise, the size of the company they are advising, and the personality of those who sit on the board.
If you are considering working with a board, it’s probably worth looking for one with fewer than 10 members.
What’s another name for an advisory board?
You might hear people refer to a board as a planning board, consultant board, board of advisors, or a consultative body. However, they all refer to the same thing.
You might have seen advisory shares being discussed on Shark Tank. In this context, they are often offered in addition to actual shares and equity in the company. As we’ve discussed above, this can sometimes help with issues such as conflict of interest, if the ‘Shark’ has other closely aligned businesses that they own stock in.
What are stock options?
A stock option is very different from actually owning stock or shares in a company. If you have an option you don’t actually own any part of the related company. Stock options give you, the investor, the right to buy or sell a specified amount of stock at a specified and re-defined price which holds no matter what the stock price or valuation of that company does.
Another critical differentiation between an option and actual shares in a company is that the investor has no obligation to buy or sell their stock options.
How does a stock option work?
A stock option works by giving an investor or advisor a contractual option to purchase stock in a specified company for a specified amount. this contract would also specify the time horizon of the deal. This period, known as the ‘exercise period’ is the period in which the option must be bought or sold within.
How do you cash out your stock option?
How you cash out your option will depend largely on your stock option agreement. Both the exercise period and the exercise price will be specified in your contract. To exercise your option might be as simple as paying the agreed price. However, if you then want to cash out those shares, and the company is not trading publically, you will need to find someone to buy those shares and have this sale authorized by the company.
Can an advisor stop providing advisory services?
Again, this would depend largely on the agreement you have in place. In some cases, there might be a specified time commitment from the advisor and duration over which this time would be delivered. However, in most cases, there would be no set deliverables on the side of the advisor.
This is where giving the advisor enough advisory shares to keep them engaged is a good idea. If the advisor knows that by continuing to do a few hours each week to help drive the company forward that their share options will have increased in value by $500k that year, they are very likely to do it – and continue doing it. However, if they only have a 1% share option, for example, the motivation to continue adding value would be significantly diminished.