In the world of startups and new ventures, equity compensation is a tool often utilized to attract talent and incentivize contributors. Among the various equity vehicles available, one unique instrument that has gained traction is the advisory share, also known as advisor shares or advisor stock options. This article delves deep into advisory shares, offering insights and examples for investors.
What are Advisory Shares?
Advisory shares are a form of equity compensation given to advisors of a company in exchange for their guidance, expertise, connections, and other non-tangible assets. Unlike traditional employees who might receive salary and benefits, advisors often provide value through strategic advice, introductions to potential partners or investors, and mentorship. To recognize and incentivize this unique contribution, startups often reward advisors with advisory shares.
How Do They Differ From Regular Shares or Stock Options?
While advisory shares are still equity in the company, they differ from regular employee stock options in a few ways:
Vesting Period: Advisory shares typically have a shorter vesting period than employee stock options. A common vesting schedule for advisory shares is over two years with monthly vesting, versus the standard four-year vesting period with a one-year cliff for employees.
Amount: Since advisors often aren’t involved in the day-to-day operations of a company, the equity they receive is usually a smaller percentage compared to founding team members or key employees.
Role: Advisory shares recognize the strategic contribution of the advisor. Their role isn't operational but rather consultative.
Why Do Companies Offer Advisory Shares?
Startups, especially in their early stages, might not have the financial resources to pay for high-level expertise. By offering advisory shares, they can:
Attract industry veterans and experts.
Gain access to valuable networks.
Receive strategic input without incurring immediate financial cost.
Tech Startup Example: Imagine a new tech startup working on an innovative AI tool. While the founders have a solid technical background, they lack connections in the investment world. By offering advisory shares to a seasoned venture capitalist or a well-connected individual in the tech industry, they gain the benefit of introductions to potential investors, strategic advice on fundraising, and insights on market positioning.
Fashion Brand Example: A budding fashion brand might offer advisory shares to a recognized figure in the fashion world. In return, the brand receives the credibility of association with the advisor, potential introductions to influential figures in the industry, and guidance on trends and branding.
Points for Investors to Consider
Dilution: As with any equity compensation, offering advisory shares results in dilution for existing shareholders. However, if the advisor brings significant value to the table, the dilution can be justified by the overall increase in company value.
Advisor Engagement: It's crucial to ensure that advisors remain engaged and continue to provide value. A clear advisory agreement outlining expectations can mitigate potential misunderstandings.
Alignment of Interests: It's beneficial when advisors have a vested interest in the long-term success of the company, not just short-term gains. This alignment can be ensured by structuring the equity such that it rewards long-term commitment and contribution.
Transparency: Companies should be transparent with their investors about who their advisors are, what they bring to the table, and the terms of their advisory shares.
Advisory shares represent a strategic tool in the equity compensation toolkit for startups and emerging companies. They allow companies to harness high-level expertise and networks without immediate financial outlays. For investors, while they do represent dilution, the potential upside brought about by key advisors can often outweigh the costs. Like any investment decision, it's essential to weigh the benefits against potential downsides carefully.