Advisors to a company may be offered advisory shares, a form of stock option. Advisors to a startup may receive them instead of monetary payment. Options to purchase shares rather than actual shares are more common forms of payment given to advisors. Advisory shares are a useful tool for maintaining the privacy and avoiding conflicts of interest. However, they can be quite expensive for a startup. Stock options are a common method of payment for advisory services.
Advisors who are compensated with advisory shares tend to be successful entrepreneurs who have served as company founders or executives in the past. In return for financial investment, they offer their expertise and network to a fledgling business.
In contrast to attorneys and accountants, these experts offer a unique perspective. It is expected that those experts will be compensated monetarily for their work. There is little chance that advisors who are eligible for advisory shares will be asked to provide tax or contract advice to companies in exchange for receiving those shares. Instead, they will be counted on for strategic input and introductions to relevant people in the industry.
Mechanism of Advisory Shares
Commonly, rather than giving advisors actual shares of stock, companies will give them options to purchase shares. If the company grants advisory shares of significant value, this can help them avoid a large tax bill. Advisors are often offered stock options as a way of rewarding their commitment to the long-term growth of their employer. On the other hand, executives and managers may be given stock instead of options.
Shares of stock usually become fully vested after two years. This keeps the advisors invested in the company’s long-term success while delaying the ownership transfer.
Who Issues Advisory Shares?
Generally speaking, startups are the most common issuers of advisory shares. At that moment, the company might exist only as a concept. Alternatively, the issuer could be well past the seed capital stage and well into the growth phase of the business.
Another pioneer and incredible Advisory Board Member joining DATALAND! Can’t wait to share what we are building with our mind and soul! pic.twitter.com/QPRxahtTxJ
— Refik Anadol (@refikanadol) July 19, 2022
The amount of stock awarded to consultants can vary widely. Advisory shares are given to advisors based on their level of expertise and their specific role. The length of time an advisor and a company plan to work together may also play a role.
Financial advisors may receive up to 5% of the company’s equity. Equity compensation is sometimes used by startups to attract and retain expert advice. One percent of the company’s equity is possible for each advisor. The exact sum may be determined by the advisor’s contribution to the development of the business. In this case, an advisor who only attends monthly meetings to offer advice might be paid a lower rate of 0.25%. An advisor could earn 1% of the client’s annual revenue if the person they referred turned out to be a significant customer.
Companies that have been around for a while typically pay their advisors a smaller slice of equity. A company in its formative stages might offer an advisor 0.25 percent of the company in exchange for regular meetings. A company in the expansion phase could reduce that to 0.15 percent for the same advisor if they started paying them after the company was profitable.
By offering advisory shares, startups can encourage experienced people to guide their development. Before giving up equity in exchange for advice, entrepreneurs should do their research. Inexpensive advice in the early stages of a company’s development can end up costing a lot later on. It’s simple to give away one percent of nothing, but much more difficult to part with one percent of a market value in the billions.
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