Founders of early-stage startups frequently consult with advisors. These advisors are typically successful entrepreneurs who enjoy giving back to the startup community. While their motivation for assisting may not be primarily commercial, advisors usually anticipate receiving a small equity grant. This equity grant may be the first non-founder equity issuance for some startups, which can (or should) raise questions about how to do it correctly and within industry norms.
The amount of equity that startups give to advisors varies depending on the advisor’s expertise, role in the company, and stage of the company. This article aims to deepen the reader’s understanding of advisor shares, equity compensation, how to issue advisor shares, how much equity to give to advisors, factors that affect advisor shares, and more.
Advisor shares and equity compensation
Advisor shares are equity granted to a business advisor in exchange for their expertise and advice. They can be given to startup consultants instead of monetary compensation. Business mentors and general business advisors are frequently given advisory shares. It ensures that the business is taken care of, and it allows the advisors to share in the company’s success if things go well.
What are advisor shares?
Advisor shares, also known as advisory stock, are stock that you assign as compensation to advisors in your startup. Giving an advisor stock gives them equity in your company.
Typically, startups pay their advisors with a salary, equity, or both. If an advisor receives shares or stock options, they should always have a vesting schedule. This means that if your advisor quits or is fired early, they will not receive all of their shares or options. The company has the right to buy back unvested shares with shares. Your advisor would only receive the options that have vested up to that point if you used options.
Vesting distinguishes advisor shares from investor shares; investors invest in your company and immediately receive their full allocation of shares.
How do advisor shares work?
Business advisors are given advisor shares, which they use to motivate and encourage both the company and its employees. The advisors can profit from the shares as well, but they and the company have agreed not to sell their shares within a certain time frame. Advisor shares typically have a monthly vesting period with no cliff. Advisors may also have the option to sell their stock before or after the agreed-upon expiration date.
Types of Advisors in startups
We have discovered that startup advisor roles typically fall into one of three categories:
- Tech advisor – These advisors assist your company by utilizing their extensive knowledge of the technology sector. They may implement technology best practices (Scrum, Agile, Lean, and so on), system architecture (SaaS, scaling, and blockchain), or even roll up their sleeves and code alongside your developers. These advisors frequently help shape the longer-term tech vision and roadmap in ways that would be too time-consuming for a CTO, whose focus can be entirely consumed by the daily tasks involved in delivering an amazing product.
- Board advisor – Typically, these advisors have experienced ex-founders or industry experts. You could solicit their feedback on the company’s strategic direction. They are typically appointed to your board of directors to help shape your strategy and influence decision-making.
- General advisor – These advisors are similar to Board Advisors, but they are not members of your board. This does not imply that they have less experience, but it does imply that they have less influence over your company’s strategic direction. An ex-Chief Marketing Officer from a different industry could be a valuable General Advisor for your startup.
If your advisor does not fit into any of these categories, they may be better classified as a startup mentor or coach.
How do advisors help grow a startup?
Advisors are valuable because they provide the right help at the right time for your startup. Their unique skills can help your company grow and achieve a variety of objectives.
- They provide skills that you do not have – A startup advisor is someone who possesses the necessary skills and knowledge. As a result, seeking startup advice compensates for your weakness. You can concentrate on your strengths with the assistance of an advisor.
- They safeguard vital connections – A startup advisor typically has connections that a new company can use. As a result, connecting with startup advisors provides invaluable assistance that can open doors to potential partners and hires.
- They meet the requirements of your startup – Startup advisors may visit multiple startups or spend countless hours analyzing issues and concerns every week. When they are with you, however, you gain access to their skills and talents. Furthermore, when they are with you, they will give you their full attention and address your concerns.
Why should startups issue shares to advisors?
Advisors are essential in a startup because they have the knowledge and experience to do what you are attempting to do. Their advice is frequently invaluable to the company, assisting it in reaching greater heights. There are no hard and fast rules to follow when issuing advisors shares in a startup, but the most basic percentage is 0.5 to 1. Among the various factors to consider are the advisor’s experience, knowledge, and time with the company.
Issue advisor shares in startups
Businesses should keep in mind that these shares can result in conflicts of interest. Furthermore, if the shares have a low value, they can pose a risk to the company. The following are some strategies that companies can use to avoid problems with these types of shares:
Equity offerings based on advisor roles and time commitments are critical for business owners to ensure that advisors are compensated appropriately for their time. The greater an advisor’s role and time commitment, the more equity they will receive.
Prepare company confidentiality and intellectual property agreements – Companies should also ensure that confidentiality agreements between the company and its advisors are in place. This way, the company can ensure that its advisors do not reveal confidential information about the business or serve as advisors without receiving an equity threshold.
Which compensation is best for advisors: Cash or Equity?
Often, how you decide to compensate an advisor – salary, equity, or both – will come down to the advisor’s preference. However, there are some notable differences in how different types of advisors are compensated:
General advisors are compensated almost entirely with equity (81%), whereas other advisor types receive a mix of cash and equity. Although tech advisors are the most likely to be compensated with both cash and equity, the figure is still less than one in five (18%). Board advisors are most likely to be paid in the form of advisor shares rather than a salary (36%).
Factors that affect advisor shares
Various factors affect advisor shares and the whole compensation functionality are discussed as follows:
- Advisor role – Companies typically give General Advisors less equity than Board or Technology Advisors, possibly because Board Advisors have a defined role as a director with corporate and legal obligations. And, on average, Tech Advisors work 43 days per year, which is more than the other advisor roles. It’s also possible that General Advisors are chosen solely to serve as figureheads for the pitch deck and website rather than truly ‘working’ for you.
- Startup valuation – The higher the valuation, the lower the percentage of equity an advisor should expect to receive for advisors who only receive equity as compensation. However, while the percentage given to advisors is lower on average for companies with higher valuations, the median (the midpoint) for both data sets is the same: 1%. Regardless of your valuation, it appears that the neat round number of 1% is a popular amount of equity to give advisors.
- Working hours/day – Advisors who only receive equity compensation, as well as advisors who work more than two days per month, receive significantly more equity than those who work fewer than two days per month. If your advisor works fewer than two days per month, they may be a figurehead, someone who looks impressive on your pitch deck or website but doesn’t contribute much time to your company. If your advisor works more than two days per month, this indicates a “real-time commitment” that should be compensated appropriately.
- Vesting – Vesting is common for advisor grants, but it is almost always shorter than for founders, employees, and other service providers. Vesting is typically done every month over 1-2 years. A cliff may or may not exist. For example, if you have a trusted advisor who has been assisting you for months before receiving equity, a cliff is probably unnecessary (and may not be well received if proposed). On the other hand, if you’re not sure whether an advisor will add real value, a cliff can serve as a probation period during which you can determine whether the advisor is a good fit before they vest.
- Exercise – Stock plans typically require that vested options be exercised within three months of the holder’s termination, or the option to buy will expire. This is a requirement for “incentive stock options,” which is why most plan default to them, but not for “non-qualified stock options,” which are what advisors will receive.
- Tax implications – When it comes to taxation, options and shares are treated differently. In general, if you are issued shares in exchange for services, you should expect to have an income tax liability, whereas options do not create a liability until they are exercised. Before entering into any advisor agreement, we recommend that you seek tax and accounting advice.
- Other provisions – The advisor should agree to appropriately assign to the company all intellectual property and other business, technical, and financial information obtained from the company or learned in connection with his or her services. At the very least, the advisor should be bound by confidentiality obligations. You may want to include a no-conflict provision and a requirement that the advisor follows certain company policies.
Finally, there is usually a right of termination for both parties, as well as automatic termination if the company has not requested that the advisor render any services for an extended period.
How many shares should you issue to startups?
There are various models for determining how much equity to offer. The Founders Institute provides a useful framework based on the company’s stage (idea, startup, or growth) and the various levels of engagement. However, this is only a guide.
|Advisor Performance Level
Why should you prepare an advisor agreement to issue shares?
A startup should present an advisor agreement for signature to the advisor, which details the nature of the advisor’s relationship with the company. These agreements are critical because they outline each party’s commitments and how they will be met.
Make sure the agreement states that the equity award is subject to the board of directors’ approval, how many shares will be purchased or how many shares the grantee will have the option to buy. Avoid ambiguity by being specific with your numbers.
How does the Fast agreement work to issue shares to advisors?
A FAST agreement is another option for compensating advisors. A Founder Advisor Standard Template (FAST) agreement is a contract that appoints someone to serve as an advisor. The advisor is not required to accept monetary compensation under this agreement. Instead, they will receive shares in the company in the future. This person is not an employee but rather an independent consultant.
The Founder Institute created the Founder / Advisor Standard Template (“FAST”) to assist aspiring entrepreneurs in startup launch programs. The Founder Institute made the FAST Agreement public in 2011, and we have been making incremental updates to Version 1 of the Agreement ever since. The Founder Institute released Version 2 on August 1st, 2017, which includes several enhancements to improve its functionality.
What does a fast agreement include?
A FAST agreement will outline the following:
- Services expected from the advisor
- Which shares they’ll receive and how they’ll receive, in compensation for the vesting schedule
- The expenses made by the advisor entitled to reimbursement
- Terms and period of termination
- Establish the advisor as an independent contractor and not an employee
- Non-disclosure terms
- Specification of no guarantee to rights
- Specification of company’s intellectual property rights over the advisor’s concepts and inventions under the contract
Get your valuation report to decide how much advisor shares to issue with Eqvista!
Financial advisers can profit from investing in advisor shares. However, before distributing such shares to their business advisers, enterprises should carefully consider the conditions. Contact the valuation experts of Eqvista for guidance on how to approach your advisers for possible equity conversion. It is easier to manage advisor shares in your business with our thorough business valuation report in hand.