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What Are Advisory Shares
In business, advisory shares refer to a type of stock option granted by a company to its advisors.
In other words, instead of issuing options to its employees, a company chooses to compensate its advisors for their services by paying them in options rather than in cash.
Advisory shares are typically issued by startups that do not have the financial means to pay their advisors.
The advisory shares can be issued to any type of advisors such as business experts, company executives, or individuals having expertise in a specific domain.
Why Issue Advisory Shares
The main objective for issuing advisory shares is for a company to reward certain advisors for giving the company valuable advice, guidance, and expertise when it’s really needed by the organization.
Very often, advisory shares are issued by startups to other business professionals or senior executives who can provide valuable advice to the company during its crucial startup phase.
The advisors that get advisory shares are those that provide highly valuable and strategic advice to the company.
Although advisors such as lawyers and accountants may get advisory shares to the extent it does not put them in a conflict of interest, they will typically get paid for their services in cash.
Who Issues Advisory Shares
Any company can issue advisory shares to its strategic advisors.
However, in practice, advisory shares are commonly issued by startups as they are hungry for strategic advice and they do not have the cash flow to pay for all the services they need.
As a result, startups may allocate a percentage of their share capital to be issued to advisors who give them valuable advice, introduce them to strategic partners, gives them access to key business contacts, and so on.
As a company matures, it may not need as much advice as it used to and so it will not issue as many advisory shares.
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Who Gets Advisory Shares
Although it’s called advisory “shares”, in most cases, they are actually granted as stock options.
When a company wants to reward an advisor for crucial and strategic advice, it will issue advisory shares to the advisor to compensate him or her for the work.
Depending on the nature of the advice received by the company, the company may choose to compensate the advisor with more or less options.
The reason why options tend to be a better approach is that they vest over a period of time that could range between a year to three years.
By getting the stock options, the advisor will be incentivized to continue providing good and sound advice to the company allowing it to grow thereby ensuring that the options will be worth exercising in the future.
The more the value of the company goes up, the more the advisory shares become valuable to its beneficiary.
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Advisory Share Advantages
There are a few key advantages for companies to issue advisory shares.
The main advantage is that a company can attract highly qualified advisors at a very crucial stage in the company’s development.
This means that a company can obtain highly strategic advice from potentially a senior business executive, investor, or business professional.
Not only the advisory shares can be attractive and highly profitable for the advisors, but the company can also use equity to compensate them without tapping into its cash reserves.
Another important advantage is that by issuing advisory shares to key advisors, the company can include confidentiality terms to ensure that the advisor does not provide the same advice to a competitor.
The advisory shares will also help prevent potential conflict of interest between the advisor and the company.
Typically, the advisors may be in touch with many firms, companies, and organizations and so enforcing restrictive covenants may be difficult for them.
However, it’s still possible to contractually set certain parameters in place to minimize the risk that the advisor advises a competing organization.
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Advisory Share Disadvantages
Although advisory shares can bring significant benefits to an organization, they also come with important drawbacks.
The main disadvantage in issuing advisory shares to advisors is that a startup company may over-compensate them.
When a startup is in its development stage, issuing options to advisors may appear appealing as the company may not have the capital to otherwise compensate them.
However, as the company grows, the issued advisory shares can represent an important percentage of the company’s share capital.
The company founds may immediately benefit from the advice and later on regret having issued valuable equity stocks to them.
Another drawback of issuing advisory shares to issue options to an advisor who does not end up giving the strategic advice needed or does not put the company in touch with the key business contact.
In such a scenario, the company may have issued advisory shares without getting the benefit of the advice.
To reduce this risk, an advisory agreement can be put in place where the advisor must advise the company for a period of three to six months before the company issues any options to them.
This way, the company can “try” the advisor’s services before committing to any stock options.
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Advisory Shares FAQ
What is an advisory share?
An advisory share is a type of stock option that startups issue to their key advisors.
By issuing advisory shares, startups are able to obtain valuable advice from key experts without having to use up precious cash to pay them.
Who receives advisory shares?
Experts and key advisors are those who typically receive advisory shares.
In most cases, this does not include lawyers and accountants as they typically demand cash payment for their services.
Advisors tend to be business professionals, company executives, investors, or individuals with valuable contacts.
How much do advisors get in advisory shares?
It all depends on the company, who is the advisor, and the nature of the advice.
In general, advisory shares can range between 0.25% to 1% of the company’s shares.
The more the advisor is strategic and the more complex the nature of the advice, the more a company may compensate its advisors.
Startups looking to grant advisory shares may reserve up to 5% of their share capital to be issued in this context.
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Who issues advisory shares?
Although any company can issue advisory shares at any time, in most cases, it’s issued by startups early on in the company’s life.
Startups may need help with their product development, launch process, commercialization, and so on, and may find it worth paying someone highly experienced in these areas with advisory shares.
What is the difference between advisory shares and regular shares?
Advisory shares are stock options issued to company advisors whereas regular shares are standard stock units issued by a company to anyone.
The advisory shares are stock options issued to advisors in exchange for their advice.
The advisor can then exercise the options for regular shares in the company.
Takeaways
So there you have it folks!
What are advisory shares?
In a nutshell, “advisory shares” refers to stock options issued by companies to compensate certain experts to help them achieve certain goals.
Most of the time, advisory shares are issued by companies early in their development stage such as startups.
What’s interesting is that startups without the financial means can attract and compensate highly strategic experts at a very crucial point in time in their development.
Now that you know what are advisory shares, how they work, and their pros and cons, good luck with your research!
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