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December 14, 2021 | 9-minute read (1723 words)
Advisers can offer the knowledge and expertise required to get a burgeoning company off the ground. Yet young companies may find themselves unable to pay the cash rate a qualified adviser would expect.
To get around this problem, entrepreneurs often choose to offer equity in their company in the form of advisory shares. Naturally, you need to speak to a startup stock adviser before going down this route, but it can be a great way of launching your startup.
A grant advisor stock is no more than a type of stock option. Stock options and startups go hand-in-hand, but even major corporations offer them to reward their management teams and low-level employees.
A stock option is a contract between two parties. The standard stock option agreement gives the buyer the right to buy and sell the underlying stocks of a company at a predetermined price within a specific period.
In most cases, startups will offer the stock call option exclusively. Some industries, such as investment banking, provide both types of stock to suit various trading strategies. It’s not uncommon for traders of every type of stock option to execute plans, like the covered call.
An advisory share is a type of stock option given to company advisers rather than employees, typically in lieu of cash compensation.
Company CEOs are free to reward advisers with any class of stock and with any terms and conditions under a stock option agreement. It all depends on how you want to reward your advisers for the work they do.
Regular shares, sometimes known as just shares (stock units), signify ownership of a portion of a company. In other words, you own a portion of a company when you buy shares. Shareholders often receive dividends if the company performs well and succeeds.
Shareholders also have the right to vote on certain company matters and to be elected to serve on the board of directors. Because you and the company are separate legal entities, your personal assets are safe if the firm goes bankrupt.
Advisory shares are not the same as regular shares. In a nutshell, advisory shares are nothing more than financial incentives in the form of stock options. For example, as the sole owner of a company (often a startup), you may want advice from someone more experienced but also to keep your business secrets safe. To incentivize the adviser to focus on the firm's long-term success, rather than giving shares up front, you award options with a vesting time.
Startups are the most common issuers of advisory board shares. Shares can be issued even if the company is still nothing but a vague idea. Alternatively, the company may already be in the late-stage capital phase.
If a company is already active and doing business, issuing shares to advisers can be a red flag for investors. After all, the primary purpose of an adviser is to support companies that have yet to generate the capital necessary to pay their advisers properly.
Advisers are typically granted options to purchase shares rather than being given actual shares. This prevents the company from incurring a potential tax obligation if the advisory shares granted are worth a significant amount.
Advisory shares are different from many other forms of equity because they do not entitle the shareholder to voting power, the right to sell or trade shares or to receive dividends. In most cases, advisory shares do not entitle the shareholder to any powers at all. Because of this, advisory shares carry no risk to the shareholders and are considered just another form of compensation.
While stock options are often used as an incentive for advisers to invest in a business’ long term success, company managers and executives are more likely to receive shares instead of options.
The vesting schedule for advisory shares is usually one to two years with no cliff, which refers to a period without stock vestments. That means the advisor’s advisory shares will vest monthly over 12 to 24 months.
The amount of equity represented by a share in your company can vary widely. Entrepreneurs typically use the 5% to 10% range, but there are no regulatory limits on how much you can offer.
Individual advisers usually receive anywhere from 0.25% to 1% of the company as an incentive to continue providing technical insights and strategic direction. However, the actual amount is determined by the adviser's contribution to the company's growth.
Advisers' equity may vary significantly depending on their experience, influence and role. It is also contingent on how long the company and advisor plan to be in business together.
Tax rules vary for incentive stock options (ISOs) and nonqualified stock options (NSOs). ISOs are reserved for employees, allowing them to buy stock options at a discounted price. Employees with the right to purchase the stock options must wait until the shares become fully vested before they can begin exercising their options. ISOs may not require payment of ordinary income tax when exercised. You may pay the lower capital gains tax if you exercise them in a certain amount of time and hold them for a certain amount of time.
NSOs are meant to incentivize directors, consultants, partners, advisors and others not on the company’s payroll. The IRS taxes NSOs as regular income when shareholders want to exercise the stock option. You pay regular income tax on the difference between the fair market value at grant date and the fair market value at the time you exercise your options.
Is it a good idea to offer advisor shares?
Like anything, everything depends on your specific situation. There are advantages and drawbacks to offering advisory shares in your startup.
Let’s dive into the pros and cons of issuing this share class.
First, advisor shares make it simpler to attract reputable advisors with the experience necessary to launch your business. Without fresh capital to pay, this share class may be your only option available.
You also have the advantage of encouraging your advisor to spend more time working with your company. Shares are a powerful incentive, especially if your advisors have already bought into your idea.
Finally, you have the advantage of confidentiality. Bringing on share-owning advisors enables you to ask them to sign non-disclosure agreements. It may seem like a relatively minor benefit, but a code of silence is vital when your advisors see your product development and marketing schemes.
Advisors tend to be impartial, but this could become a problem if they own shares within your business. It may well compromise their impartiality, as they now have skin in the game.
Another issue is that although giving away fractional parts of your company may not seem like a big deal, it can cause problems later if your company takes off. Remember, stock options involve giving away some level of ownership.
Speak to a stock advisor before giving away any equity within your company. You have complete control regarding how your advisory board stock works and how much equity each advisor can hold.
If you’re struggling to manage your startup during its embryonic stages, get help from the experts at Early Growth. We specialize in startup accounting services. Discover how we can help you manage your FinOps and PeopleOps today.
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