Advisor Equity: What Is It and Who Gets Them?

Amid a flurry of capital infusion into Indian start-ups, a wave of fast-growing companies, including Simplilearn, Arya,  Zoomcar, Bizongo, and Wakefit, are bringing in seasoned advisors from India and abroad to assist scale up to the next level of growth.

According to Reet Bambhani of EMA Partners, demand for such advisors in the startup ecosystem has increased three to four times since pre-Covid levels.

Most startups have plenty of cash in hand, and they are looking for experienced hands. As a result, almost every startup company is now attempting to enlist the help of advisors, whether as non-fiduciary advisory board members, consultants, or even board members.

In a start-up, an advisor or advisory board may assist the early-stage company in traveling the uncharted territories. Because these start-ups may not have the financial resources to pay cash (unless well-funded), start-ups often compensate advisors by granting them a portion of the company’s ownership or advisor equity.

What is Advisor Equity? All you Need to Know

Advisor equity is a stock option offered to corporate advisors instead of employees for their guidance. It may be given to startup company advisors in lieu of cash.

Rather than granting actual shares, advisors are given options to buy them. Advisory shares can help keep information confidential while also avoiding conflicts of interest. They may, however, be costly for a startup company.

To whom is advisor equity issued?

New enterprises and start-ups always search for experienced advisors who can help them make money. Advisors, who receive advisory equity, are often experienced business people with previous stints in C-suits or senior executives and company founders. In return for shares in a startup company, these advisors exchange their insights and contacts.

Advisors’ suggestions might range from business relationships to the company’s target demographic. The entrepreneurs always cherish the advice given, no matter how modest it is. Advisor equity usually results in a company’s capitalization.

Generally, startup advisors expect to be paid for their services. Therefore, they usually never ask for monetary compensation. This is advantageous since most startups do not have enough funds to divert from marketing or operations.

Instead, the advisors want a share of the company’s ownership (equity). The incentive to the advisor is that if the business succeeds, the value of the advisor’s ownership position will skyrocket.

Who issues advisor equity? How many shares are they given?

The majority of advisor share issuers are start-ups. At the time of issuance, the company may have been little more than a concept. However, the issuer might also potentially be in the later stages of seed capital or even later when it is an active, growing business.

The amount of equity allocated to advisors differs. Advisor equity is given based on an advisor’s role and expertise. It might also be determined by how long the advisor and the company plan to collaborate.

Advisors might be given up to 5% of the company’s total equity. In addition, a new company may form an advisory board and offer equity to board members as an incentive.

Individual advisors might receive anything from 0.25% to 1% of the company’s equity. The exact amount will be determined based on the advisor’s contribution to the company’s growth.

For example, an advisor who provides insight at monthly meetings could only be paid 0.25%. For more specific contributions, for instance, if an advisor refers to a prospect who becomes a large client, the advisor may receive 1%.

The more mature the company is, the smaller the equity advisors will receive. For example, a startup may offer 0.25% of its stock to an advisor who attends monthly meetings. For the same advisor, a company that is a past startup and in the growth stage might reduce that to 0.15%.

How do advisor shares work?

Rather than being given actual equity, advisors are generally given options to purchase them. If the company issues advisor equity worth a substantial amount, it helps prevent a potential tax liability.

Stock options are usually given to incentivize advisors to engage in the company’s long-term growth. On the other hand, company leaders and managers may be given shares rather than options.

Within a year or two, stock options normally vest. This permits the company to postpone handing ownership to advisors while keeping them focused on its long-term success.

Pros and Cons of Advisor Equity

Many startup companies use advisory equity. This is because they can recruit expert advisors at a pivotal stage in its growth. Startups do, however, have certain potential disadvantages.

As a pro, advisory equity can aid in protecting the confidentiality of a company. For example, advisors see the product development and marketing strategies companies desire to keep secret. Hence, for this purpose, advisors may be requested to sign non-disclosure and confidentiality agreements (NDAs).

Meanwhile, advisors may work for different companies. Hence, companies that offer advisory equity may not prevent their advisors from working for competitors. They can, however, find out if advisors have any pre-existing arrangements that may hinder their capacity to provide unbiased advice.

Companies contemplating using advisory equity should take their time before issuing equity in return for advice. Even experienced executives may not make excellent advisors. It’s good to do some research before investing your money or equity.

A three-month trial term is required in some advisory equity agreements. The agreement can be canceled at this period without any options being transferred to the advisor.

Bottom Line

Startup companies might use advisor equity to entice experienced specialists to assist them on their growth journey. But, it must be noted, that advisor equity isn’t suitable for all businesses or advisers. They can, however, allow entrepreneurs to have access to key relationships and information without having to forego cash.

Entrepreneurs who are prepared to give up equity in return for guidance should first do their homework. Cheap advice in the early phases of a company’s development might quickly become extremely expensive as the company grows. It’s easy to give up 1% of nothing; however, it’s far more challenging to give up 1% of a multibillion-dollar market capitalization.

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