What Are Advisory Shares? A Comprehensive Guide

Advisory shares are a type of equity granted to advisors of a company, particularly in early-stage startups. These shares serve as compensation for the advisors’ time, knowledge, and network, all of which are extremely valuable to a young company trying to establish itself in a competitive market.

In the realm of startup companies and early-stage businesses, there’s an abundance of specialized language that can be daunting, especially for those new to the world of entrepreneurship or investing. “Advisory shares” is a term that frequently arises in conversations, but what exactly do they entail, and why are they significant? Let’s delve into this concept to gain a better understanding.

Understanding Advisory Shares

Advisory shares are a term that frequently arises in conversations, but what exactly do they entail, and why are they significant? Let’s delve into this concept to gain a better understanding.

While regular employees may receive a salary and stock options as part of their compensation package, advisors are usually not full-time employees. Instead, they provide guidance and strategic advice on a part-time or as-needed basis. In exchange for their input, they receive a small percentage of ownership in the company in the form of advisory shares.

Why do companies offer advisory shares?

Startups often face financial constraints, but having experienced advisors on board can significantly impact their growth through expertise, connections, and credibility. Offering advisory shares allows startups to attract top-notch professionals to join their advisory board without a substantial initial cash outlay.

Advisory shares ensure that advisors’ interests are aligned with the company’s success. These shares are typically vested over a period, usually 1-2 years, which incentivizes advisors to actively contribute to the company’s growth and success as the value of their shares grows along with the company’s success.

How do advisory shares work?

Advisory shares are typically granted with a vesting schedule, meaning that the advisor earns their shares gradually over time. For instance, if an advisor is given 1% of the company’s equity, they might receive 0.5% after the first year and the remaining 0.5% after the second year. This setup ensures that the advisor stays dedicated to the company for an extended period of time.

The specific terms of advisory shares, including the vesting schedule, are typically detailed in an agreement between the company and the advisor. This agreement will also outline any conditions that may lead to the forfeiture of shares, for example, if the advisor fails to meet their obligations.

What are the benefits of advisory shares?

Access to Expertise: Advisory shares enable startups to draw in and keep high-caliber talent who can offer valuable perspectives and direction without requiring cash compensation.

Alignment of Interests: As advisors directly benefit from the company’s success, they are more motivated to make meaningful contributions to its growth.

Cost-effective: For cash-strapped startups, offering equity instead of cash allows them to conserve their resources while still compensating their advisors.

Networking Opportunities: Advisors frequently come with a network of contacts that can help the startup by creating opportunities, connecting with potential clients, and attracting investors.

Potential Drawbacks

Remember to keep in mind that although advisory shares have several advantages, they also come with certain potential drawbacks.

Dilution of Ownership: Please bear in mind that providing equity to advisors results in a reduction of ownership for the founders and current shareholders. While this may not be a major concern in the initial stages, it’s important to be mindful of it as the company continues to expand.

Advisor commitment: If advisors are not properly motivated or involved, they may not provide the expected level of value, resulting in wasted equity.

Complexity in Agreements: Drafting and negotiating advisory share agreements can be complex and may require legal assistance to protect both parties.

What is meant by advisory shares?

Please remember the following information about advisor shares: 

Advisor shares are equity shares or stock options given to advisors in exchange for their guidance, expertise, and advisory services. They form part of the compensation package, aiming to attract and retain experienced advisors. These advisors provide valuable strategic input and mentorship to the company’s leadership team.

Here’s a breakdown of advisor shares:

• Equity Stake: Advisors receive a percentage of the company’s equity, allowing them to own a portion of the company. This equity can be in the form of shares or stock options exercisable later.
• Vesting Schedule: The shares are often subject to a vesting schedule, meaning the advisor earns their shares over a specific period. For example, shares may be granted in quarterly increments over two- or four years.
• Non-Employee Role: Unlike full-time employees or executives, advisors typically have a mentor or consultant role. Their involvement can vary based on the company’s needs.
• Incentive: Advisor shares serve as an incentive for advisors to contribute to the company’s success. When the company performs well, the value of the shares increases, providing a financial benefit to the advisor.
• Negotiation: The amount and terms of advisor shares are usually negotiated based on the advisor’s experience, the company’s stage, and the expected level of involvement.

In summary, advisor shares are a way to compensate and motivate individuals who contribute valuable expertise to the company without being employees.

What is the difference between equity shares and advisory shares?

The main difference between equity shares and advisor shares lies in their purpose, recipients, and how they are typically granted. Here’s a breakdown:

1. Equity Shares:

• General Definition: Equity shares, also known as common shares or common stock, represent ownership in a company. Shareholders who hold equity shares have a claim on the company’s assets and earnings and often have voting rights in company decisions.
• Recipients: Equity shares can be issued to a wide range of people, including founders, employees, investors, and the public (in the case of publicly traded companies).
• Purpose: The primary purpose of equity shares is to raise capital for the company. When a company issues equity shares, it sells ownership stakes in exchange for money that can be used for business operations, expansion, or other purposes.
• Vesting and Terms: Equity shares can be granted outright or subject to a vesting schedule, especially in the case of employee stock options. The terms are usually more standardized and tied to the company’s growth and success.
• Rights: Equity shareholders often have voting rights, meaning they can influence major corporate decisions. They also have the right to receive dividends if the company decides to distribute profits and have a claim on assets if the company is liquidated.

2. Advisor Shares:

• General Definition: Advisor shares are a specific type of equity that is granted to advisors as part of their compensation for providing strategic guidance and expertise to a company.
• Recipients: Advisor shares are specifically granted to individuals serving as advisors to the company. These individuals are not employees or full-time members but are brought in for their specialized knowledge or experience.
• Purpose: The purpose of advisor shares is to incentivize advisors to contribute their expertise and help guide the company toward success. Since advisors are not salaried employees, these shares are a form of compensation that aligns their interests with the company’s growth.
• Vesting and Terms: Advisor shares are almost always subject to a vesting schedule, often over a shorter period than employee equity shares. The terms are typically negotiated individually, based on the advisor’s expected level of involvement and the value they bring to the company.
• Rights: While advisor shares are a form of equity, the rights associated with them (such as voting rights or dividend eligibility) can vary. In some cases, advisor shares may have fewer rights compared to those granted to employees or investors.

What is the difference between ownership and advisory shares?

The terms “ownership shares” and “advisory shares” are often used in the context of equity in a company, but they refer to different concepts. Here’s how they differ:

1. Ownership shares:

• General Definition: Ownership shares, also known as equity shares or common shares, represent a stake in the ownership of a company. When someone holds ownership shares, they own a portion of the company and have rights associated with that ownership.
• Recipients: These shares can be granted to a variety of stakeholders, including founders, employees, investors, and sometimes the public (in the case of a publicly traded company).
• Purpose: The primary purpose of ownership shares is to allocate ownership in the company. They are often used to raise capital (in the case of investors), compensate employees (through stock options), or retain control (in the case of founders).
• Vesting and Terms: Ownership shares can be issued outright or subject to a vesting schedule, especially for employees and founders. The terms are often standardized and include rights such as voting, dividends, and claims on the company’s assets.
• Rights: Holders of ownership shares typically have full rights, including voting on important company matters, receiving dividends, and claiming a share of the company’s assets in case of liquidation.

2. Advisory Shares:

• General Definition: Advisory shares are a specific type of equity granted to advisors in exchange for their expertise and guidance for the company. They are a form of compensation for advisory services rather than a direct purchase or allocation of ownership.
• Recipients: These shares are specifically issued to advisors who are not full-time employees but are brought in to provide strategic advice, mentorship, or other specialized knowledge.
• Purpose: The purpose of advisory shares is to incentivize advisors to contribute to the company’s success. Since advisors are not typically compensated with a salary, advisory shares align their interests with the company’s growth.
• Vesting and Terms: Advisory shares often come with a vesting schedule, but the terms are usually more customized based on the advisor’s role and expected contribution. The vesting period may be shorter compared to that of traditional ownership shares.
• Rights: While advisory shares do confer ownership, they may come with fewer rights compared to traditional ownership shares. For example, they might have limited or no voting rights, and the holders’ influence on company decisions may be minimal.

Summary

• Ownership Shares are a broad category representing full ownership in a company, with all the associated rights and responsibilities. They are typically issued to a wide range of stakeholders, including founders, employees, and investors.
• Advisory shares are a specific subset of equity given to advisors as compensation for their guidance and expertise. While they represent ownership, the rights associated with them may be more limited, and they are tailored to the advisory role rather than full participation in company management.

How do advisory shares work in Shark Tank?

In Shark Tank, advisory shares are sometimes discussed as part of the negotiation between the entrepreneurs and the investors (the “Sharks”). Here’s how advisory shares work in the context of Shark Tank:

1. What Are Advisory Shares on Shark Tank?

• Compensation for Expertise: Advisory shares offer a way for the Sharks to receive compensation for their time, expertise, and connections, without necessarily injecting additional capital beyond their initial investment. These shares ensure that the Sharks’ interests are in sync with the success of the company, as their value grows in tandem with the company’s performance.
• Equity Stake: Upon receiving advisory shares, a Shark is allocated a stake in the company, akin to regular equity shares. Nevertheless, these shares are linked to the shark’s function as an advisor rather than solely as a financial investor.

2. How Advisory Shares Are Used in Negotiations:

• Negotiation Tool: During the negotiations, a shark might offer to take on an advisory role in exchange for a percentage of the company, either in addition to or instead of their usual equity investment. For example, a shark might say, “I’ll give you $100,000 for 10% of the company, plus 5% in advisory shares.”
• Incentive for Sharks: Offering advisory shares can be an incentive for the Sharks to be more involved in the company’s operations, leveraging their experience, network, and reputation to help the company grow.
• Value Proposition: Entrepreneurs on the show might offer advisory shares as a way to reduce the amount of equity they need to give up for the capital investment. For example, instead of offering 20% equity for $100,000, they might offer 15% plus 5% in advisory shares, retaining more control while still securing the shark’s involvement.

3. Vesting and Conditions:

• Vesting Period: Similar to other equity forms, advisory shares may be subject to a vesting schedule. This implies that the stakeholders would receive their advisory shares gradually over time, guaranteeing their continued engagement with the company for a specified period.
• Performance Conditions: Advisory shares are often linked to particular performance goals or circumstances. For example, a shark might only be entitled to their advisory shares if they contribute to the company reaching specific sales targets or establishing a crucial partnership.

4. Examples from Shark Tank:

• Active involvement: Sharks such as Mark Cuban or Kevin O’Leary may request advisory shares if they believe that their expertise can significantly influence the company’s direction. These shares are given because the entrepreneurs recognize the value of having the Sharks’ guidance beyond just financial investment.
• Leveraging Expertise: For companies in industries where a Shark has significant experience (e.g., technology for Mark Cuban, branding for Daymond John), advisory shares are a way for the entrepreneurs to benefit from the Shark’s specific expertise and industry connections.

Who are the advisors?

Advisors are seasoned professionals, industry experts, or accomplished entrepreneurs who offer guidance, expertise, and strategic advice to companies or organizations, usually in a non-executive capacity. They provide their knowledge and insights to help a company overcome challenges, expand, and thrive.

What are the different types of advisors?

Industry Experts:

Definition: These are experts with extensive expertise in a particular industry. They grasp the market, competition, and trends, and can offer valuable insights to assist the company in making well-informed decisions.

Example: An advisor with decades of experience in the tech industry might help a startup navigate the complexities of product development and market entry.

Successful Entrepreneurs:

Definition: These advisors have built and scaled businesses themselves. They bring firsthand experience in overcoming the challenges of starting and growing a company.

Example: A serial entrepreneur who has successfully exited multiple startups might advise a new company on growth strategies and scaling operations.

Former Executives:

Definition: These are individuals who have held high-level positions in major corporations. They bring leadership experience and an understanding of corporate governance, management, and strategy.

Example: A former CEO of a large corporation might advise a startup on leadership, organizational structure, and strategic planning.

Investors:

Definition: Some advisors are experienced investors who understand the financial landscape and can provide guidance on fundraising, valuation, and investor relations.

Example: A venture capitalist with a track record of successful investments might advise a startup on how to pitch to investors and manage funding rounds.

Technical Experts:

Definition: These advisors have specialized technical knowledge in areas such as software development, engineering, or data science. They help companies with product development and innovation.

Example: A renowned software architect might advise a tech startup on building scalable and secure software platforms.

Mentors:

Definition: Mentors are advisors who take a more personal and developmental approach, often working closely with the founders to help them grow as leaders and entrepreneurs.

Example: A mentor might work with a young entrepreneur, providing advice on leadership, decision-making, and personal development.

Board Advisors:

Definition: These advisors sit on a company’s advisory board, providing strategic guidance but without the formal responsibilities of a board of directors. They might meet regularly to discuss the company’s progress and challenges.

Example: A seasoned business leader who sits on an advisory board might provide ongoing advice on company strategy, partnerships, and market expansion.

Role and Contribution of Advisors:

• Strategic guidance: Advisors help companies make high-level decisions, offering a perspective that might not be available internally.

• Networking: They often provide access to their professional networks, which can lead to new business opportunities, partnerships, and funding.

• Problem-Solving: Advisors help companies navigate challenges by offering solutions based on their experience and knowledge.

• Mentorship: Beyond business advice, advisors often mentor the company’s leadership, helping them develop as individuals and as leaders.

• Credibility: Having well-known advisors can enhance the credibility and reputation of a company, making it more attractive to investors, customers, and partners.

What are the different types of advisory shares?

Advisory shares take various forms, each serving distinct purposes and offering unique features. Typically, these shares are granted to advisors as part of their compensation for providing strategic guidance and expertise. Below is a summary of the different types of advisory shares.

1. Common Shares

Definition: Common shares represent a standard equity stake in a company, giving the advisor ownership and, typically, voting rights.

Features: voting rights in shareholder meetings. Eligibility to receive dividends (if distributed).Entitlement to a portion of assets in case of liquidation after preferred shareholders.

Usage: These are less commonly used for advisors since they come with full shareholder rights, which may not be necessary for the advisory role.

2. Preferred Shares

Definition: Preferred shares come with certain privileges over common shares, such as priority in dividends and claims on assets, but typically lack voting rights.

Features: Priority over common shares in receiving dividends. Priority in the distribution of assets during liquidation.

Often, there are no voting rights.

• Usage: Preferred shares might be issued to advisors when the company wants to offer financial benefits without granting voting power.

3. Stock Options

Definition: Stock options give advisors the right to purchase a set number of company shares at a predetermined price (the “strike price”) within a specified period.

Features: Advisors can buy shares at the strike price, potentially benefiting from the increase in the company’s value. Often tied to a vesting schedule. There is no immediate ownership until the options are exercised.

Usage: Stock options are commonly granted to advisors, providing them with the potential for financial gain without an immediate cash outlay.

4. Restricted Stock Units (RSUs)

Definition: RSUs are shares granted to advisors that are subject to certain restrictions, usually a vesting schedule. Advisors do not own the shares until the vesting conditions are met.

Features: Shares are awarded after vesting conditions (e.g., time or performance milestones) are fulfilled. Typically, RSUs do not include voting rights until they are fully vested.

Usage: RSUs are used to incentivize advisors to stay involved with the company over some time.

5. Phantom Shares

Definition: Phantom shares are a type of compensation that mirrors the value of actual shares but does not represent actual equity ownership. Instead, advisors receive cash or stock equivalent to the value of a set number of shares at a future date.

Features: Advisors benefit from the company’s growth without owning actual shares. Often paid out in cash or stock at a future date, based on the company’s performance.

There is no dilution of actual company equity.

Usage: Phantom shares are often used when the company wants to reward advisors without diluting equity or granting voting rights.

6. Warrants

Definition: Warrants are akin to stock options, allowing advisors the privilege to buy shares at a predetermined price within a specific timeframe. Nevertheless, warrants are generally dispensed directly by the company and may entail distinct conditions.

Features: Similar to stock options but often with different terms regarding the price and expiration date. Can be customized based on the advisor’s role and the company’s needs.

Usage: Warrants may be granted to advisors as a way to incentivize long-term involvement with the company.

How Advisory Shares Differ from Regular Shares

Advisory shares and regular shares are both types of equity in a company, but they serve different purposes and are structured differently. Here’s a comparison:

1. Purpose

• Advisory shares: Issued specifically to compensate advisors for their expertise, guidance, and contributions to the company. They are typically given to individuals who are not employees or full-time executives but who provide valuable strategic advice.
• Regular shares: issued to founders, employees, investors, and sometimes the public to represent ownership in the company. Regular shares can be used for raising capital, compensating employees, and providing ownership stakes.

2. Vesting and Conditions

• Advisory shares: usually subject to a vesting schedule tied to the advisor’s continued involvement with the company. The vesting terms are often more flexible and tailored to the advisor’s specific contributions.
• Regular Shares: For employees and founders, regular shares may also be subject to vesting, but this is typically tied to employment duration or performance milestones. Shares issued to investors are usually fully vested at the time of purchase.

3. Rights and Privileges

• Advisory shares: often come with limited rights compared to regular shares. For example, they might not include voting rights, or they might have restricted transferability. The focus is on aligning the advisor’s incentives with the company’s success rather than providing full shareholder privileges.
• Regular Shares: Shares generally come with full rights, including voting privileges, entitlement to dividends, and a claim on assets if the company undergoes liquidation. Typically, investors and founders possess shares with the most extensive set of rights.

4. Dilution

• Advisory Shares: Since they are often a smaller percentage of the company’s total equity, the dilution impact of issuing advisory shares is typically minimal. However, companies might take steps to limit dilution through anti-dilution provisions.
• Regular Shares: These can be more susceptible to dilution, especially when new shares are issued during funding rounds. Investors and founders often negotiate anti-dilution rights to protect their equity stakes.

5. Transferability

• Advisory Shares: May be subject to restrictions on transferability, meaning the advisor cannot sell or transfer the shares without company approval.
• Regular Shares: While employee shares might have some restrictions (especially in private companies), investor shares and public shares are generally more freely transferable.

Restricted Stock Awards (RSAs) vs. Stock Options

Restricted Stock Awards (RSAs) and Stock Options are both forms of equity compensation, but they function differently in terms of ownership, taxation, and risk. Here’s a comparison:

1. Ownership

• Restricted Stock Awards (RSAs): With RSAs, the recipient is granted actual shares of the company’s stock, but with certain restrictions, typically a vesting period. The recipient is considered an owner of the shares from the time they are granted, even if they do not fully vest until later.
• Stock Options: Stock options give the recipient the right to purchase shares at a predetermined price (the “strike price”) after a certain period or once certain conditions are met. The recipient does not own the shares until they exercise the options.

2. Vesting

• Restricted Stock Awards (RSAs): RSAs usually have a vesting schedule that must be completed before the recipient gains full ownership rights. Until the shares vest, they are subject to forfeiture if the recipient leaves the company.
• Stock Options: Stock options also typically vest over time or based on performance milestones. Once vested, the recipient can choose to exercise the options and purchase the shares at the strike price.

3. Taxation

• Restricted Stock Awards (RSAs): The value of RSAs is typically taxed as ordinary income when they vest. If the recipient files an 83(b) election within 30 days of the grant, they can choose to be taxed on the value of the shares at the time of the award, potentially reducing the tax burden if the shares appreciate later.
• Stock Options: Taxation for stock options depends on the type:
  • Incentive Stock Options (ISOs): No taxes are due at the time of grant or vesting. Taxes are paid when the options are exercised and/or when the shares are sold, potentially at capital gains rates.
  • Non-Qualified Stock Options (NSOs): Taxed as ordinary income when the options are exercised, based on the difference between the strike price and the market value at the time of exercise.

4. Risk and Reward

• Restricted Stock Awards (RSAs): Since RSAs are actual shares, recipients have ownership and voting rights from the outset, but they also face the risk of forfeiture if the shares do not vest. The potential reward is more certain since the shares are granted at their current value.
• Stock Options: Stock options are riskier because the recipient must pay to exercise the options, and the market value of the shares might fall below the strike price, making the options worthless. However, the reward can be substantial if the company’s stock appreciates significantly above the strike price.

5. Cash Outlay

• Restricted Stock Awards (RSAs): Recipients do not need to pay to receive RSAs; they are granted outright, subject to vesting conditions.
• Stock Options: Recipients must pay the strike price to exercise stock options and purchase the shares. This can require a significant cash outlay, especially if the strike price is high.

Conclusion

Equity in exchange for advice is a valuable resource for startups aiming to benefit from the knowledge and connections of experienced professionals without hefty upfront costs. By tying advisors’ incentives to the company’s prosperity, equity arrangements can stimulate development and originality. However, it’s crucial for companies to thoughtfully contemplate the terms of these agreements and ensure that they engage advisors who are genuinely dedicated to their vision.

In conclusion, offering equity for guidance is a strategic approach for startups to attract the right expertise at the right moment, aiding them in navigating the demanding landscape of early-stage growth and achieving success at scale.