Advisory shares are equity shares offered to a business advisor for their expertise and advice. They can be given to startup consultants as a payment instead of cash.
Business mentors and general business consultants are usually offered advisory shares. It ensures the business is well-run and allows the advisers to share in the company’s profit if things go well.
Advisory shares are a type of stock arrangement that allows startups and business experts to benefit from each other’s expertise. Rather than giving up capital, startups can attract advisers and encourage them to stay the course by providing them equity benefits linked to a predetermined vesting plan.
Distributing advisor shares as part of a company is laden with ambiguity. Hence, founders must exercise caution when distributing shares to advisors. Read on to find out how startups in the US can distribute advisory shares wisely.
What are Advisory Shares?
Advisory shares are stock options given to company advisors for financial compensation. In vesting and taxation, they differ from full-time employee stock options and ordinary stock. Advisory shares provide advisors with a non-cash stock option in exchange for their advice without needing the startup to give up any funds.
Types of Advisory Shares
Two types of advisory shares are commonly given out:
Restricted stock agreement: Advisors are compensated with restricted stock in exchange for their advice and experience. The advisor might have a certain number of shares they can sell on the open market at any time.
However, the advisor must pledge not to sell their shares for more than the agreed price. Also, there is a restriction on the number of shares they can sell during that time.
Non-qualified stock option: Non-qualified stock options allow employees to buy a specified number of shares in their company at a fixed price for a specified time.
Types of Advisors in Startups
Business advisors are individuals who provide strategic advice to businesses. They are typical business people who have succeeded and can offer the company competent advice. There are two types of business advisors:
1. The name advisor
This advisor has had previous business success or worked with and for large corporations. As a result, the company gains credibility and power due to its name and experience. In addition, this type of advisor gives the organization more stability and security.
2. The practical adviser
This type of advisor is usually a business coach or entrepreneur who has launched multiple businesses and worked several jobs throughout their career.
They have a diverse range of experience in different sectors, enabling them to gain a deeper understanding of various aspects and areas of a business, which benefits both the advisor and the entrepreneur when they collaborate to start a company.
Choosing Advisors Wisely
When choosing advisors for your startup, concentrate your efforts and select those people who are indeed an asset to your startup. Choose advisors who will genuinely assist your startup and are dedicated to the company’s success.
Ensure to keep an eye out for people who are more interested in only making quick money, trying to make a living by asking for a substantial amount of advisory shares, and who may be over-promising the amount of guidance, advice, or assistance to your business.
Once you have chosen your advisors, document your agreements with your lawyer and the advisors and a vesting plan.
Another option involves founders distributing shares to people who “lend” their names to their startup but do not contribute. Founders, in most cases, believe attaching a name will result in sales or help raise funds.
However, this is rarely the case. Therefore, rather than providing non-contributors advisory shares, you should sell the shares and hire people who are committed to the company’s success.
How to Distribute Shares to Advisors?
The number of advisory shares will vary greatly depending on the situation. Individual advisers receive between 0.25 and 1% of a company’s total equity, while the advisory board receives roughly 5%. The advisor’s background and level of participation will also decide whether the individual receives shares.
The overall amount received by an advisor, on the other hand, is determined by how much they are expected to provide. Therefore, younger, riskier startups may need to increase their percentages, whereas more experienced start-ups can require lower percentages.
If you have a long-term advisor who will be regularly involved and committed to your firm, you may choose to give them 25 basis points, or 0.25 percent of the company’s equity. Giving advisers 25 or 50 basis points is OK if they are genuinely dedicated to the company’s success.
You could give an advisor as much as 100 basis points, or 1%, of the company’s equity if they are an exceptional mentor having an extensive network along with the potential to raise capital (funding). However, you should vest that money over four years to ensure they continue working with your startup.
The amount of equity given to advisors varies a lot. Advisory shares are given based on an advisor’s expertise and role. You could also determine how long the advisor and the company plan to collaborate.
You may wish to offer up to 1% of advisory shares to a genuinely excellent mentor who you’ve known for a long time and who is a true asset. Still, you’ll probably only have one person like that on your capitalization table. Nevertheless, good, high-quality consultants can benefit your firm, and an equity agreement could start a fruitful association.
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