What are Advisory Shares?

Advisory shares is the term used to describe any form of equity compensation given to a startup’s advisors. Most often, advisory shares are stock options. While giving out advisory shares is a common practice in the startup world, there are several critical considerations founders should account for before handing out advisory shares.

In this article, we’ll dive into the world of advisory shares—covering why startups offer them, key considerations for founders, and a few helpful tips when structuring advisory shares agreements.

What are Advisory Shares?

An “advisory share” is a term of art used in the VC space; there is not a uniform legal or securities law definition applicable to an advisory share. Advisory shares are often understood to refer to equity compensation for advisors. Instead of draining precious capital, a young startup company may instead offer an adviser equity in the form of advisory shares. However, not all advisory shares are created equal. These shares often come in two forms, and the form they take influences how advisory shares work.

Form #1: Non-Qualified Stock Options (NSOs)

An advisory share can take the form of a “Non-Qualified Stock Option,” or NSO. Here, the advisory shares are presented as stock options, not actual shares in the company. However, like a typical option, a NSO will provide the advisor with the right (but not obligation) to purchase a predetermined amount of the startup’s common shares at the option’s exercise price. The exercise price will typically be the startup’s fair market value or 409A valuation at the time the advisor is brought on. Also note that common shares are not the same as preferred shares, which are reserved for investors.

Advisory shares given as NSOs may have a few key differences with employee stock options (e.g., an Incentive Stock Option [ISO]). As compared to an employee stock option with a typical 4 year or longer vesting schedule, an NSO granted to an advisor may vest in 1-2 years, with either no cliff or a cliff that is only a few months long. This is because most of the value advisors can provide a startup usually happens upfront. Finally, the tax implications for NSOs will be different than ISOs and other types of employee stock options.

Form #2: Restricted Stock Agreements (RSAs)

The second—though less common—form that advisory shares can take is restricted stock agreements (RSAs). As compared to an NSO, which is an option to purchase shares, a RSA represents a direct grant of shares in the company.

However, the RSAs are “restricted,” meaning the shares are subject to a vesting schedule and are non-transferable (though they typically become unrestricted in the case of a liquidity event). When the RSAs vest, the advisor will receive them at the startup’s fair market value. In practice, RSAs are typically granted in the early stages of the startup’s life when the fair market value of the startup is difficult to determine or negligible.

Why do Startups Grant Advisory Shares (and Who Gets Them)?

Startups grant advisory shares for many of the same reasons they offer employees stock options—incentive alignment and cash flow savings. By giving advisors direct skin in the game, they’ll ideally be more motivated to help the company succeed. At the same time, providing compensation in the form of equity allows startups to better manage their cash flows.

This leads to the natural follow-up question—who are these “advisors” and what can they offer to a startup that warrants such compensation?

Just like there is no legal definition of advisory shares, there is also no legal definition for what constitutes an advisor. Often, they’re just people who can offer valuable strategic insights and industry connections, much the same way actual investors do. For instance, they may have the network that can help the startup raise their next funding round or hire C-suite talent. An advisor could also be someone who has built and exited a successful company in the same space—and can share pitfalls to avoid on the path toward scalability.

In some cases, advisors can also be fund managers or General Partners (GPs) who operate and manage their own VC fund. It is not uncommon to find GPs who will both facilitate an investment into a startup, and then serve as an advisor to the same startup. In those instances, to avoid any conflict of interest, the GP will usually offset the value of the advisory shares against the management fee.

How Many Advisory Shares do Advisors Typically Receive?

Because there is no regulatory standard for advisory shares, the amount of shares a startup may grant an advisor can differ from startup-to-startup and advisor-to-advisor. That said, the industry standard is 0.25% to 1% of a startup’s total equity on a per-advisor basis. If a startup has an advisory board, it is typical for the startup to allocate 5% of its total equity to be split amongst that board.

Again, these are just guidelines—not hard and fast rules. For instance, the younger the startup, the more advisory shares (as a percentage of total equity) they would likely have to offer to incentivize key advisors (and vice versa).

Key Considerations for Founders When Issuing Advisory Shares

Like anything, advisory shares have both pros and cons. If you’re a founder, advisory shares enable you to:

• Gain access to strategic insights and connections that may be otherwise impossible to obtain. Without offering equity compensation, it could be extremely difficult to obtain access to advisors’ POV / resources.
• Help protect your companies’ confidentiality. This might seem counter-intuitive at first, but because advisor-startup relationships typically contain confidentiality and non-disclosure agreements, offering advisory shares as part of a formal agreement can actually help protect a company’s secrets. Remember that to offer advice, advisors will often need access to the inner workings of the company.

All these benefits are valuable. But founders should also consider that:

• You may inadvertently end up giving away more of your company than they realize. Sure, giving away 5% of your startup to the advisory board when it’s pre-Series A doesn’t sound like much. But think about what that would mean years down the line—how much could that equity be worth at Series E? Or if and when the company goes public?
• Most advisors are advising multiple companies—not just yours. You’re not the only startup your advisor is advising. Now, there’s nothing inherently wrong with this and it’s very common for advisors to be helping multiple businesses, but an advisor’s other existing relationships is something to clarify ahead of time to ensure there are no conflicts of interest.
• Things can get messy if expectations and commitments on both sides aren’t properly documented. Employees have job descriptions and KPIs to benchmark against. What about advisors? The last thing you want is for your advisors to become less and less available—which can happen if they’re unclear about what you expect from them.

Because of these considerations, it’s crucial that you as a founder use a proper advisory shares agreement when working with advisors. However, keep in mind that you would first need a valid equity incentive plan in place—and approval from your board of directors—before you can proceed with the advisory shares agreement.

Important Tips for Structuring Your Advisory Shares Agreement

An advisory shares agreement is just a document outlining the terms of your startup’s relationship with an advisor. While there is no standard format, you can find plenty of templates online. And if you’re a founder who came up through an accelerator program, there may already be an advisor-startup structure that you can just plug into.

Regardless of format, a properly structured advisory shares agreement should contain at least four things:

1. The specific role the advisor will play. The agreement should clearly lay out what kind of contributions the advisor is expected to make to your company. Is it strategic business advice? Is it to assist with fundraising or hiring? The clearer you can put it in writing, the better.
2. How the advisor and your startup will work together. This means detailing things like confidentiality and non-disclosure clauses, intellectual property protection, representations that there are no conflicts of interests, and termination notice periods. Regarding the final point, it is typical that both parties can terminate the agreement at their convenience with a notice period.
3. Time commitment required by the advisor. Advisors are busy people with other jobs and responsibilities. That’s why it’s best to agree upfront on what kind of time commitment you expect (for example, 2 hours a week or 10 hours per month). This helps avoid the so-called “advisor drift,” where the advisor slowly drifts away from your company.
4. The offered equity compensation and its associated terms. This includes the type of advisory shares, the amount granted, the strike price (if any), the vesting schedule, expiration dates (if any), and any other associated terms. These terms may include things like acceleration—meaning the advisory shares fully vest upon a liquidity event.

Advisory Shares Can Help Accelerate Your Startup’s Journey

There’s a reason most startups have advisors—they can add real value to a company and accelerate its path towards scalability. In exchange, founders will likely have to offer advisory shares, which is why understanding their ins-and-outs and how to structure the relationship is so important.

If you are undecided about issuing advisory shares, or need further assistance on structuring an advisory share agreement, it’s always best to seek counsel on the matter before granting away any portion of your company.