The world of startups is quite complex – there are a lot of terms that a founder needs to know. Think of dilution, anti-dilution, tag-along rights and so on. One such term you may encounter is “advisory shares”. Thanks to Shark Tank, advisory shares are becoming more popular than ever before.
But what are advisory shares? Imagine this – you need deep tech expertise to build your product. Hiring a full-time CTO is not an option, because of the pay package it comes with.
Moreover, you may not need someone as senior as a CTO full time in early stages. All you need is an advisor who can guide your team, and provide critical inputs to bring the product to shape.
Enter the world of advisory shares. Simply put, advisory shares are a form of equity compensation given to early stage advisors. These advisors contribute to the start-up by providing advise, and other contributions.
When used right, advisory shares can be a very important strategic tool for startups. They can attract top talent and expertise without affecting the company’s cash flow. This is particularly useful when you are strapped with limited financial resources.
However, like any other shares, advisory shares leads to equity dilution, and comes with a host of other challenges. Therefore, as a founder it is crucial to understand advisory shares meaning, and its implications.
Advisory Shares Definition
Advisory shares are a form of equity compensation granted to advisors of a company. Unlike regular stock options, they do not usually require monetary investment from the advisor. They serve as a reward for the advisor’s expertise, time, and contributions that help the startup succeed.
The concept of advisory shares is particularly appealing for early-stage startups. In early stages of a startup, cash is a limited resource. At the same time, you would also need early traction to help you acheive milestones and plan for further fundraises.
Offering advisory shares to experts in the early stages, is a win-win for both the start-up and the advisor. For the start-up, cash can be conserved. For the advisor – they will win in the long-term as the company’s value increases. This also puts some skin in the game, because the advisors are incentivized to contribute to the start-up’s growth. The typical percentage allocated to advisory shares varies (depending on their contribution).
In most cases, companies would have agreements with the experts providing for cash compensation and advisory shares. Normally advisory shares come with differential voting rights, and restrictions.
Key Characteristics of Advisory Shares
Advisory shares come with unique traits that distinguish them from standard equity:
a. Vesting Period: Unlike normal ESOPs, advisory shares could have different vesting periods. This is to make sure that the advisors are aligned with the long-term vision of the startup. I usually recommend my clients to make it a milestone-based vesting rather than a time-based vesting. This way, the advisor and the startup are clear as to what milestones are to be achieved.
b. Restrictions: In most cases, advisory shares do not have the restrictions that a normal equity share would have. They don’t have to invest financially, and certain restrictions on transfer may not apply to such shares.
Benefits of Offering Advisory Shares
Offering advisory shares provides startups with a unique edge in a competitive environment. One significant advantage is attracting high-caliber advisors without straining the company’s finances. Startups often operate on tight budgets, and advisory shares present a cost-effective way to acquire expertise.
Advisors granted shares generally have a vested interest in the startup’s success. This alignment of interests can lead to more dedicated involvement and better advice. Advisors may bring valuable networks and opportunities to the startup. Their influence can open doors to collaborations, partnerships, and potential investors, which are crucial during the growth phase.
Moreover, advisory shares can facilitate the filling of knowledge gaps within the startup team. Founders might lack expertise in areas like finance, marketing, or legal matters. Advisors with the right skills can bridge these gaps, providing guidance that accelerates strategic planning and execution.
Advisory shares also serve as a incentive for advisors. Knowing their compensation is tied to the company’s performance can drive them to contribute innovative solutions and strategic insights. This proactive contribution often benefits the startup in substantial ways, leading to sustained growth and development.
Finally, offering advisory shares can improve the startup’s credibility in the eyes of investors and partners. Having reputable industry figures as advisors signals confidence in the startup’s potential. This can be a decisive factor in securing investment and forming partnerships.
Equity Compensation and Advisory Shares
Equity compensation is a powerful tool for startups aiming to attract and retain top talent without significant cash expenditures. It involves granting ownership interests in the company as a form of compensation. Advisory shares are a unique form of equity compensation tailored specifically for advisors. They provide a way for startups to leverage the insights and networks of experienced professionals.
By issuing advisory shares, startups can conserve cash while still rewarding advisors for their valuable contributions. This approach allows startups to tap into expertise that might be otherwise unaffordable. Offering equity as compensation aligns the overall interests of advisors with that of the company.
Furthermore, equity compensation via advisory shares can help startups build a diverse advisory board. A range of advisors with different expertise and perspectives can enhance the company’s strategic direction. This diversity of thought is vital for startups looking to innovate and disrupt traditional markets.
Structuring Equity Compensation Packages
Structuring equity compensation packages is a nuanced process that requires careful planning. For advisory shares, startups must first determine the total amount of equity available for advisors. This calculation helps avoid excessive dilution of existing shareholders’ equity.
Once the equity pool is defined, startups should establish clear metrics for allocating shares. Factors like the advisor’s experience, reputation, and potential impact on the company should guide this process. It’s crucial to negotiate terms that are fair, beneficial, and sustainable for both parties.
Incorporating vesting schedules into the equity compensation package can align long-term interests. Vesting schedules ensure advisors remain engaged over a specified period, while cliffs protect the company from premature equity relinquishment. Additionally, startups should draft comprehensive advisory agreements, clearly outlining responsibilities and expectations tied to the shares.
Finally, ongoing communication is key. Regular reviews of equity compensation arrangements can ensure they remain effective as the startup evolves. This proactive approach helps align advisory contributions with the company’s changing goals and strategies, ensuring both parties derive maximum value from the relationship.
Managing Equity Dilution
Managing equity dilution is crucial for startups issuing advisory shares as part of their compensation strategy. Dilution occurs when a company issues new shares, thereby reducing existing owners’ percentage of ownership. For founders, being proactive is essential to mitigate the effects of dilution while still attracting high-value advisors.
Startups need to weigh the benefits that advisors bring against the dilution cost. Advisors can offer critical insights, establish strategic partnerships, and provide access to valuable networks. This intangible value, while not immediately measurable, can significantly outweigh the fractional dilution caused by issuing advisory shares.
Clear communication with stakeholders is vital in managing dilution impacts. Founders should ensure transparency about dilution effects and how advisory shares contribute to long-term goals. Maintaining this clarity can foster trust among existing shareholders, helping them understand the strategic advantage of involving seasoned advisors.
Moreover, it’s beneficial for startups to maintain a detailed cap table. This table tracks all share allocations and helps in analyzing the impact of new share issues. By keeping it up-to-date, founders can make informed decisions regarding future equity grants. Additionally, considering various compensation structures can help balance the need for advisors with the goal of minimizing dilution effects.
Balancing Stakeholder Interests
Balancing stakeholder interests while distributing advisory shares demands careful negotiation and planning. Startups must consider the needs and concerns of various parties, including founders, investors, employees, and advisors. Striking the right balance ensures that all stakeholders remain committed to the company’s success.
For founders, safeguarding significant influence is vital. Preserving decision-making power while leveraging advisory expertise can help drive the company towards its strategic objectives. Communicating with investors about the necessity and value of advisory roles can reinforce support and maintain investor confidence.
Including employees in the conversation about equity distribution can also be beneficial. Employees should understand how advisory shares fit into the broader equity strategy and the company’s vision. Such transparency can boost morale and align the team around shared goals.
Advisors, in turn, seek compensation that reflects their contributions and expertise. A clear understanding of each advisor’s role and the potential value they bring can assist in fair share allocation. Regularly revisiting these terms allows adjustments as the company grows, ensuring continued alignment among all parties.
Best Practices for Startups
To effectively leverage advisory shares, startups should follow several best practices. These include setting clear criteria for advisor selection, structuring transparent agreements, and having well-defined valuation and vesting strategies.
Startups should first understand their unique needs and gaps. By identifying areas lacking in expertise, they can prioritize advisors who can fill these specific roles. This targeted approach ensures that each advisor adds maximum value.
Clear advisory agreements are also vital. Such contracts should outline roles, responsibilities, and expectations. Legal backing protects both the company and advisor, fostering a productive partnership.
Vesting schedules can align advisors’ contributions with the startup’s long-term success. Instead of granting shares upfront, consider time-based or milestone-based vesting. This strategy encourages continued involvement and aligns advisors’ interests with company growth.
Furthermore, keeping comprehensive records, such as cap tables, helps track equity distribution. Regularly update these to assess dilution impact and evaluate the balance of equity ownership over time.
Criteria for Selecting Advisors for Shares
Choosing the right advisors is crucial in maximizing the benefits of advisory shares. Start by assessing your startup’s needs and aligning them with advisor expertise.
Evaluate potential advisors based on their experience and track record in the relevant industry. Prioritize those with practical expertise and a history of successful advisory roles. They should offer strategic guidance and an extensive network that aligns with your goals.
Cultural fit is another essential criterion. Advisors should embody values and ethos that match your company’s culture. This alignment ensures seamless collaboration and a more productive relationship.
Additionally, consider advisors’ availability and willingness to engage actively. Ensure that they can dedicate the necessary time and resources. Their commitment can significantly impact their effectiveness in contributing to your startup’s success.
Conclusion
Advisory shares play a pivotal role for startups looking to leverage external expertise without straining financial resources. They enable companies to attract and retain advisors who can drive strategic growth. By carefully structuring advisory share agreements, founders can align advisor and company interests, ensuring all parties are committed to the startup’s success.
Navigating the legal and strategic aspects of advisory shares demands attention but offers substantial rewards. With proper planning and transparent communication, these shares can significantly enhance a startup’s growth trajectory. In the competitive startup landscape, they serve as a unique asset to foster innovation and progress.
Navigating advisory shares can be tricky. How much equity should you offer? What’s the right vesting schedule? These decisions can impact your startup’s future. If you want expert CFO guidance to structure equity the right way, let’s talk. Book a 1:1 call today.
