Advisory shares, also called advisor shares, are stock alternatives given to company advisors. They are commonly given to a company’s advisors as a reward for chipping in to help with a company’s growth. A burgeoning company might want to offer shares rather than monetary compensation, especially during a company’s infancy, when it might not have much cash on hand.
In this article, we’ll walk you through how advisory shares work, the type of companies that issue advisory shares, the pros and cons of advisory shares, the tax treatment and vesting schedule. By the time you’re done reading, you’ll have a grasp of what you need to know about advisory shares.
How Advisory Shares Work
How do advisory shares work?
Startups commonly grant advisors options to buy shares rather than give them the actual shares themselves. (Company leaders, such as the founders, on the other hand, may directly receive shares instead of options.) A few common types of awards include stock options as well as restricted stock awards (RSAs) and restricted stock units (RSUs).
Stock options: Stock options give you the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date in the future. The two main types of options include incentive stock options (ISOs) and nonqualified stock options (NSOs). ISOs give an advisor the right to buy shares of company stock at a discounted price with possible tax breaks on the profit. They are usually taxed at the capital gains rate, not ordinary income tax rate. The other type commonly offered is a nonqualified stock option (NSO), a form of equity compensation which allows shareholders to purchase a company’s stock at a predetermined price, becoming profitable if the stock price rises above that level.
Restricted stock awards (RSAs): RSAs are often issued before the first round of financing when a company doesn’t have much money in the bank. RSAs allow shareholders to own company stock and become a shareholder with voting rights. However, RSAs also come with restrictions, such as that they must follow the vesting schedule (they must “earn” shares over time — more on that later). In other words, you can’t sell the stock until you’ve met the stated conditions.
Restricted stock units (RSUs): RSUs allow advisors to acquire shares of common stock. Shares are delivered as the advisors satisfy certain conditions, and everything is outlined in the RSU agreement.
Learn More: RSU vs Stock Options
How much of the company’s equity might advisors receive? They may receive between 0.25% and 1% of the company’s equity, but it varies widely, depending on the company’s growth and the advisor’s experience as well as the length of time the advisor and the company plan to work together.
Who Issues Advisory Shares?
Most companies that issue advisory shares are startups, or young companies in their early stages of development. The advisors on the receiving end of advisory shares are usually businesspeople who have before been company founders or on the leadership team at another company. Young companies bring them on board for their expertise and exchange them for profit potential in a young company that shows promise.
Advisory Shares: Pros & Cons
It’s important to consider the pros and cons as both a company owner and as an advisor. We’ll go over the pros and cons from both perspectives in this section.
First, the possible benefits of advisory shares:
Dangling carrot: Advisor shares make it easier for startups to attract advisors in order to launch your business. They offer a strong incentive for advisors to want to work with your business, especially if they are passionate about your business.
Confidentiality: Share-owning advisors must sign confidentiality agreements, which is beneficial when there is highly confidential information being shared about products and marketing.
Earnings: Advisors who join a company likely do so for one reason — to earn money. Advisory shares are one way to earn equity in exchange for any advice and guidance you provide to the company.
Now, the possible downsides of advisory shares:
Neutrality issues: If advisors own shares within your business, it could mean that they could have a hard time remaining impartial because they want your business to succeed. They need to remain steadfast in helping your business thrive.
Ownership changes: When you offer advisory shares, it means that you give away partial ownership of your company, which you may come to regret in the future.
Absence of cash: Advisory shares are much different than earning cold, hard cash. Therefore, it’s important to consider advisory shares vs equity before you make a decision as an advisor to take on this method of compensation.
Share dilution: Share dilution occurs when a company adds additional shares to the pool, which reduces the number of shares a shareholder owns.
Vesting schedule: As an advisor, you likely will not automatically receive advisory shares. You’re subject to vesting, which means you may need to wait a specified period of time before having the full rights to the benefits.
Do Advisory Shares Get Diluted?
Yes, it’s possible for advisory shares to become diluted. But what exactly does this mean?
In short, share dilution occurs when a company issues more stock, thereby reducing the ownership percentage of a shareholder. Companies commonly dilute shares because they may need more capital to keep the business going and issue new shares to investors in a funding round. They may also choose to increase the number of incoming investors, which can result in diluted shares.
Are Advisory Shares Taxable?
One of the most important questions for both businesses and advisors has to do with tax treatment. If shares are kept for a certain holding period, they will qualify for capital gains tax treatment instead of ordinary income and will be taxed at a lower rate.
Long-term capital gains occur when you hold an asset for more than one year. They are taxed at 0%, 15% or 20%. Short-term capital gains, on the other hand, are taxed at your ordinary income levels and go up to 37% in 2022, depending on your tax bracket.
Common Advisory Shares Vesting Schedule
Advisory shares are subject to vesting, which means that you don’t receive the shares right away — you “earn” the shares over time. Why do companies often require a vesting schedule?
Simple: Vesting doesn’t offer immediate ownership, which encourages advisors to stick around with the company longer in order to be completely vested. It may potentially cost the company less money in the long run. Stocks typically vest within a year or two.
There are two types of vesting schedules: fixed-term and time-based vesting schedules. Fixed-term vesting offers advisors shares that expire after a certain amount of time, while time-based shares vest in increments over time. For example, let’s say an advisor has shares that vest on a 10% basis per year. In this case, 10% will vest after one year and an additional 10% will vest after two years.
Another example of a vesting schedule might be two years with no cliff, which means that an advisor’s shares vest in monthly increments over the course of 24 months. Cliffs are periods without stock vestments. These typically occur in one year and are usually a prerequisite of employee stock options, not part of the advisory shares vesting schedule.
Startups should do ample research before offering advisory shares because they run the risk of overcompensating advisors with stock options. These fractions of equity might seem small in the early innings of the business, but they may experience tremendous growth in the future.
As an advisor in a company advisory role, it’s also a good idea to consider how you might need to view advisory shares. Understand your stock options thoroughly, their potential, what they are worth and how they fit into your existing portfolio. Advisory shares aren’t guaranteed because the company itself may not succeed.
Want to manage your money in a better way? Personal Capital allows you to see all your financial accounts in one place in order to help you make decisions that meet your future needs.
You may also consider asking a financial advisor for more information about how to position your company with stock options.
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Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.
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