What Are Advisory Shares in Investment?

What Are Advisory Shares in Investment?

If you’ve been wondering what are advisory shares, you’re not alone. Advisory shares refer to equity compensation granted to advisors who provide guidance, expertise, or industry connections to a company, often in place of cash payments. 

This form of compensation is commonly used by startups and early-stage companies that need advice but want to conserve their cash flow.

What Are Advisory Shares?

What are advisory shares? Simply put, they are a form of equity offered to external advisors in exchange for their professional advice. These shares typically come in the form of stock options or restricted stock, and they allow advisors to benefit from the company’s long-term success.

• Stock Options: Advisors are granted the right to buy shares at a set price in the future.
• Restricted Stock: These shares are given upfront but are subject to a vesting schedule, meaning they become fully owned by the advisor over time.

Why Do Companies Use Advisory Shares?

What are advisory shares used for? There are two primary reasons companies offer advisory shares:

1. Cash Flow Protection: Instead of paying high upfront fees, companies grant equity to attract valuable advice without straining their limited resources, especially in the early stages.
2. Incentive Alignment: By offering advisory shares, companies ensure that their advisors are motivated to contribute to the company’s growth, as their own success is tied to the company’s performance.

How Advisory Shares Help Traders

Understanding what are advisory shares can indirectly benefit traders, especially those who invest in or trade stocks of startups and companies that issue these shares. Here’s how knowing about advisory shares helps traders:

1. Insight Into Startup Valuation and Equity Distribution: If you’re trading stocks of early-stage companies or interested in venture capital, knowing about advisory shares helps you understand how equity is distributed. This can give you insight into a company’s valuation, the potential for future growth, and how much control founders and advisors have.
2. Predicting Company Performance: If an influential advisor is granted advisory shares, it could signal that the company is positioning itself for a major milestone, such as an acquisition, IPO, or new product launch. Traders may view this as a sign of positive growth, helping them make more informed investment decisions.
3. Identifying Potential Market-Moving Events: When a company grants advisory shares, it often signals important developments, such as strategic advice or new partnerships. Traders who track these movements can anticipate potential stock price changes and adjust their positions accordingly.
4. Understanding Dilution Risks: Knowledge of advisory shares allows traders to assess dilution risks. If a company grants a significant amount of equity to advisors, it could lead to dilution of existing shareholders’ stakes, which can negatively impact stock prices. Understanding this helps traders mitigate risks when investing in such companies.
5. Assessing Corporate Governance: When advisors are granted equity in the company, it can also provide insight into the company’s corporate governance. If advisors have significant equity, they may have more influence over strategic decisions, which could impact the company’s performance and stock movement.

How Much Equity Do Advisors Receive?

The equity granted to advisors can vary based on the company’s stage and the advisor’s role, but typical benchmarks include:

• Pre-seed Stage: Advisors may receive 0.25% to 1% of the company’s equity.
• Seed Stage: The equity granted generally ranges from 0.12% to 0.5%.
• Series A Stage: Advisors typically receive between 0.05% and 0.2% of the company’s equity.

Advisory Shares vs Employee Shares vs Investor Shares

It’s essential to distinguish advisory shares from employee shares and investor shares:

How Long Do Advisory Shares Take to Vest?

Typically, advisory shares have a two-year vesting schedule, with a three-month cliff to ensure that the advisor is contributing early on. Monthly vesting after the cliff is common for most advisory share grants.

Tax Implications and Other Considerations

The tax treatment of advisory shares depends on the type of equity granted. Stock options may trigger taxes when the options are exercised, while restricted stock is taxed when it vests. Companies should seek legal and tax advice to ensure they manage the tax implications effectively.

Advisory Shares and Mutual Fund Advisor-Class Shares

While discussing advisory shares, it’s important to clarify the distinction between advisory shares in startups and advisor-class shares in mutual funds. Advisor-class shares are a type of mutual fund share available to clients of financial advisors. They are not related to equity compensation in companies but rather represent an investment product offered through financial advisors.

What are advisory shares in the startup world? They are equity grants given to advisors to incentivize them to help a company grow, whereas advisor-class shares are used in financial markets and investment products.

Risks and Challenges with Advisory Shares

Though advisory shares offer several benefits, there are also risks:

• Over-granting Equity: Advisors should not be granted too much equity early on, especially when multiple advisors are involved, to avoid excessive dilution.
• Unclear Expectations: Without a well-defined role, advisors may not provide the expected value.
• Conflicts of Interest: Advisors who work with competitors or have conflicting agendas can create challenges.
• Paperwork Issues: Equity agreements should be formalized and tracked properly to avoid legal complications later.

Conclusion

In conclusion, what are advisory shares? They are a vital tool for startups to attract expertise without depleting their cash reserves. By granting advisory shares, companies can incentivize advisors to help drive the company’s success, while aligning their interests with the company’s growth.

For traders, understanding advisory shares can provide insight into a company’s growth potential, equity distribution, and potential risks, helping them make more informed investment decisions. These details can help traders navigate opportunities and risks in the ever-changing market landscape.