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What Are Advisory Shares? (Plus Pros & Cons)

Posted by Early Growth

December 14, 2021    |     5-minute read (847 words)

Advisors 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 advisor 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 advisor before going down this route, but it can be a great way of launching your startup.

What are Different Types of Stock Options?

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.

You have two types of stock options:

  • Stock Call Option - Grants the purchaser the right to buy stock without an obligation. Stock call options increase in value when the underlying value of each share rises.
  • Stock Put Option - A stock put option allows the buyer to short their stock. Put options increase in value when the underlying value of each share decreases.
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.

What are Advisory Shares?

A common stock option type is the advisory share. This class of advisory shares gives equity to business advisors who have provided insights and expertise to a company instead of a direct cash payment.

In many cases, a name or price advisor will be a company founder or a high-ranking executive if they take these shares.

Advisor shares are types of stock options vested over a one to two-year period. There’s typically no cliff and provide 100% single-trigger acceleration.

Company CEOs are free to reward advisors with any class of stock with any terms and conditions under a stock option agreement. It all depends on how you want to reward your advisors for the excellent work they do.

Who Issues Advisory Shares?

Startups are the most common issuers of advisory board stock. These 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 advisors can be a significant red flag for investors. After all, the primary purpose of an advisor share is to support companies that have yet to generate the capital necessary to pay their advisors properly.

The amount of equity represented by a share in your company can vary widely. Entrepreneurs typically use the 5-10% range, but there are no regulatory limits on how much you can offer.

Individual advisors usually receive anywhere from 0.25% to 1% of the company as an incentive to continue providing technical insights and strategic direction. It all depends on how you want to reward your advisors.

What are the Pros & Cons of Advisory Shares?

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 delve into the pros and cons of issuing this share class.

Pros

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.

Cons

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.

Conclusion

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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