What Are Advisory Shares?

Advisory shares are a form of equity compensation awarded to individuals who provide strategic guidance, mentorship, or expertise to a company.

Unlike employee stock options or investor shares, advisory shares are not tied to employment contracts or financial contributions. Instead, they are a recognition of the value an advisor adds to the company through their knowledge, network, or specific expertise.

Advisory shares often include vesting schedules and cliffs. These conditions ensure that the advisor remains committed to the company over a defined period, aligning their incentives with the startup's long-term success.

Equity (regular shares) vs. advisory shares

Equity is a broad term that encompasses ownership in a company. Common shares, preferred shares and advisory shares are all forms of equity.

Each type of equity grants the holder a proportional stake in the company's profits and, in some cases, participation in decision-making processes and other rights.

1. Common shares

Common shares, typically issued to founders and employees through stock option grants, represent the most basic type of equity. These shares carry certain rights and responsibilities, though they are generally subordinate to preferred shares in terms of financial and control privileges.

2. Preferred shares

Preferred shares, typically issued to investors, offer ownership with added rights and privileges. These often include priority in receiving dividends or liquidation payouts over common stockholders. They may also include negotiated rights, such as anti-dilution protections or board representation.

3. Advisory shares

Advisory shares are typically a type of common stock but may come with specific restrictions or terms outlined in the advisor agreement.

These shares:

• Are subject to vesting schedules to ensure ongoing contribution from the advisor.
• May have non-voting status to limit their impact on company governance.

What are the types of advisory shares?

The two most common forms of advisory shares are Non-Qualified Stock Options (NSOs) and Restricted Stock Agreements (RSAs)

1. Stock options (NSOs)

Stock options give the holder the right to purchase company shares at a predetermined strike price.

There are two types of stock options: Non-Qualified Stock Options (NSOs) and Incentive Stock Options (ISOs).

Advisors are typically considered contractors or service providers and are hence issued NSOs. ISOs are only reserved for employees.

What is the difference between ISO and NSO?

1. ISOs offer favorable tax treatment

In the U.S., when you exercise NSOs, you'll pay ordinary income tax on the difference between the stock’s fair market value (FMV) at the time of exercise and the exercise price, since the IRS treats this difference as compensation.

However, with ISOs, there’s no ordinary income tax owed at exercise, provided employees hold the shares for at least one year after exercise and two years after the grant date. 

Post this, any gain is taxed as a long-term capital gain, which typically has a lower rate than ordinary income tax.

2. NSOs are flexible

Companies cannot grant more than $100,000 worth of exercisable ISOs to an employee in a given year. Additionally, the vesting and cliff periods of NSOs are also adjustable.

2. RSA (Restricted Stock Agreements)

RSAs involve directly granting shares to advisors, rather than offering them as options. 

These shares are ‘restricted,’ meaning they are subject to vesting schedules and non-transferable until the restrictions are lifted, which usually happens during a liquidity event such as an acquisition or IPO.

Why do startups grant advisory shares?

Companies use advisory shares to tap into external expertise and resources without straining their cash flow. 

By offering equity, advisors become invested in the company’s success, motivating them to contribute their knowledge, networks, and time to help the company reach its goals.

Typically, advisory shares vest over time, so advisors earn their equity in stages as they continue to engage with the company. Unlike investors, advisors don’t provide capital upfront; instead, they take on limited risk by offering their time and expertise in exchange.

Who gets advisory shares?

Companies grant advisory shares to individuals who offer valuable strategic guidance, insights, and industry connections to support their growth.

This may include:

1. Industry experts: For example, a startup developing a new medical device might grant advisory shares to a renowned healthcare professional or a medical technology expert to help them.

2. Serial entrepreneurs: People who have built and exited businesses are invaluable for their strategic insights. Companies often bring them on as advisors to leverage their experience.

3. Investors with strategic value: Angel investors or early-stage investors who take on a more hands-on role can be granted advisory shares.

Examples:

Ashton Kutcher joined Airbnb in 2011 as a strategic advisor after investing around $2.5 million.

Margot Schmorak, CEO of Hostfully tells SVB

“It has helped us move faster.”

“Our advisors act as an extension of our team — sometimes there are these hard decisions when you need to talk only to people you trust. Advisors are really great for that.”

She also adds that they can provide a “third-party” perspective.

How do advisory shares work

Advisory shares typically come with a vesting period, which means the advisor earns the shares gradually over time.

While employee stock options often have a vesting period of 4 years or more, NSOs granted to advisors tend to vest much faster, typically in 1-2 years, and may have a shorter or no cliff period. This is because the most valuable contributions from advisors usually happen early in the company's growth.

A  ‘Startup advisor agreement’ or a ‘The Founder/Advisor Standard Template (FAST)' is used to outline the terms of the arrangement between a company and its advisors.

The Startup Advisor Agreement is a customized contract that details an advisor's specific role, responsibilities, type of shares and percentage of total equity, and vesting terms.

It may also cover confidentiality, non-compete clauses, and intellectual property rights.

The Founder/Advisor Standard Agreement is a more general, standardized document used for multiple advisors. It outlines common terms such as type of share and percentage ownership, vesting schedules and more.

It was developed by the Founder Institute.‍

How much of the company's total equity should you give to advisors?

The amount of equity a startup should give to advisors can vary based on the stage of the company, the advisor's level of involvement, and the value they bring.

As a general guideline, advisory shares typically range from 0.25% to 1% of a startup’s total equity per advisor. If the startup has an advisory board, the total equity allocated to the board is usually around 5%.

Venture Hacks breaks down advisors into 'normal' and 'super advisors' to help decide who should receive higher advisory shares and who should receive less.

For a ‘normal’ advisor, who provides significant, but less hands-on support (e.g., introductions to key customers or investors), the equity grant is usually between 0.1% and 0.25%.

For ‘super advisors’ which are high-value individuals who go above and beyond the typical advisory role can receive 1 -2% of the startups total equity. They are deeply involved in the startup’s growth and success, leveraging their extensive networks, expertise, and influence to make a significant impact. 

As mentioned by Venture Hacks, YC is a great example of a super advisor.

While YC is an accelerator rather than a typical advisor, it acts like one by helping develop the company’s product, introducing them to investors, and building the company’s brand. 

Initially, YC used to take about 6% of a company’s equity in return for $15,000-$20,000, now they have restructured this deal as 7% for $125,000. 

We hope you found this blog-post helpful. If you need any help with figuring out how to manage your equity effectively, reach out to us here.