Farwah Jafri | April 15 2024
Ever wondered “What are advisory shares and why do I need to learn all about them?” The answer lies in the question. An advisory share is just like any other type of share except, well, that it is offered in exchange for advice!
Advisory shares are often great news for companies, especially startups that are struggling to get off the ground. In the earliest stages of the business, you need all the help you can get. This is where advisory shares come in.
They allow you to work with someone who knows what they are doing, absorb the wisdom they accumulated over the years, and achieve financial growth at top speed. You don’t even need to make mistakes or wait for half a decade before you begin to realize what went wrong and how to fix it.
Great question. Why would an advisor offer a startup free advice? Well, with advisory shares, you aren’t really getting the advice for free. You get an external advisor in exchange for shares in the form of common stock options.
They affect dilution in an entirely different way, which is why if you are thinking of providing your potential advisors with these shares, you’re in the perfect place. We discuss this and much more below.
What are advisory shares really? Why doesn’t everyone use them. Why do people use them in the first place?
Advisory shares aren’t limited to a particular category. The term encapsulates multiple ways in which startups compensate advisors or advisory groups. This compensation replaces the generic cash or credit payment in return for their services.
Advisors may choose to provide advice to companies they strongly believe in. This could translate as a belief in their eventual profitability or in the cause said companies support.
Startups are almost always on the lookout for advisors. They need this advice usually in the pre-seed or seed stage. In these stages, it is hard to procure the cash or credit needed to fund a full-time advisor. Thus, they lean on equity i.e. a share that allows them partial ownership in the company.
With this equity, the advisor doesn’t just secure the company’s future but also their own. A share in the company they are advising can translate to significant revenue in the future. It is also good news for the company as the advisor’s income is dependent on whether the firm makes money, so they would work extra hard to ensure that it does get to that level of growth.
Moreover, companies can also access multiple different kinds of advisory shares. An advisory share can be restricted when it comes to ownership which means that these shares do not need to have a negative effect on your investors if you don’t want to mess with their stake in the company. In fact, advisory shares typically do not allow the advisory shareholder to vote.
There are two different types of advisory shares you can opt for;
Restricted stock awards, also known as a restricted stock agreement (RSA) would typically include shares of common ordinary stock that would be granted to an advisor and paid for by cash or through services. These shares are also limited by vesting requirements.
RSA’s would typically be issued by startups at the initial phases as it is great incentive for advisors to receive the shareholder title up front in exchange for their “advice.” For an advisor, this is a great option as the market value would be pretty low and they can even give the shares away.
These are also commonly known and used by startups. Non-qualified stock options are usually the ones advisors get, which allows them to purchase shares at predetermined prices (also known as the strike price) within a particular vesting period.
As non-qualified stock options, these stocks do not meet the standard requirements of the IRS, which means they can escape the complicated preferential tax treatment that incentive stock options normally go through. It’s a win win for all!
Now that you have found your answer to “What are advisory shares,” let’s take a closer look at how they work. For an advisory share agreement, you would need to record the details of the agreement just like all other equity-related transactions.
If you want to get into an advisory share contract, you must start by listing down the details. This includes the number of shares, the value, vesting schedules, advisory share type, and so on. Once the agreement is signed, it becomes binding for both parties.
Although it is a legal process, you can find quite a lot of advisory share agreement formats available online. However, you would definitely need to hire a lawyer at some point. Make sure you carefully and accurately list down the roles of the advisor, the share type and ownership or voting structure if any, vesting schedule, and other important information.
Don’t forget that non-disclosure agreement! Remember that advisors are a unique part of the business process which means that they have access to important company information. Ensure you create the right kind of legal agreements to ensure confidentiality and prevent conflicts of interest.
So, what is a vesting schedule. In simple terms, a vesting schedule is recognized by the time advisors must wait before they can convert what they have received into a share in the company. This time frame assures the company that the advisor would do everything in their power to ensure optimal financial performance for them.
Here are some of the vesting schedules one can abide by;
This is where you predetermine the task that you would need the advisor to complete which would eventually give them the right to the stock or vesting option.
Vesting by time involves binding the advisor to a specific time frame before they can claim their rights. If the advisor is limited to four months, for example, their stock will vest only when the four months are over.
This involves both systems whereby the advisor would need to complete a milestone and a specified time period for the stock to vest.
It is important to share essential information with your advisor to be able to reap the full benefits. According to Forbes, “The more you share with your advisor, the better they’ll be able to do their job and help you optimize your financial life.”
It also lists 14 essential pieces of information you should divulge, such as your goals, values, challenges, experience, risk tolerance, income, expenses, assets, liabilities, insurance, and more!
Often, certain types of advisory shares can create issues for the company. Here are some you might expect;
Before you get your advisor, make sure you read up on advisory shares, understand the documents you would need to draft, and get in touch with an accountant who can help you figure out the potential dilution as well as the pros and cons of all the different types of stock options.
Before you choose your advisor, list down your needs. Figure out whether you need help to find your customers, investors, or need to solve any other problem. Remember, there is a different advisor out there for various issues your company may be facing.
Once you have figured it out internally, start to reach out to people you think may be the perfect fit your company and industry. It may take some digging before you come up with someone suitable enough to fit with your setup.
For most startups, trusted financial advisors can be the difference between staying afloat and sinking even before the initial stages. Startups typically need a lot of advice during the seed stage, but they may not be able to afford a full time CFO.
This is where Monily comes in. Need someone to vet an advisor you are looking at, decide the type of advisory shares you need to provide your advisor, or just need advice for your startup? We are here to guide you every step of the way.
We have helped multiple startups grow and rise to success. We can help you too! Be it tax related issues or generating capital for your startup, we can guide you every step of the way. Contact us today and take the first step to financial success.
If you are looking for advice on establishing a successful business empire, don’t forget to follow our social media handles and stay up to date on our posts as we help you build your finances in the 21st century.
Read more: Interim CFO Services For Proactive Business Choices
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.
