Cake Equity | Advisory Shares: What Startup Founders Need to Know

Advisory Shares: The essential things startup founders need to know

November 24th, 2022   —   Alex Kazovsky

icon clock5 minutes read

cake blog post illustration
Became an equity superhero with Cake

Share this post

Advisory shares are a type of equity compensation given to company advisors in lieu of (or on top of) a professional fee. Similar to employee equity, issuing advisory shares to those key inception-phase advisors are common practice for early-stage startups.

Finding subject matter experts who are willing to help a company succeed is extremely valuable; particularly for pre-seed to series A+ startups. Cashflow may be tight, but absorbing and executing on the wisdom and insights of seasoned advisors is invaluable. Our recommendation? Reward them with a slice of cake!

The good news is, many experienced company advisors prefer equity compensation over cash. Not only are they familiar with the startup capital situation, they also know the potential financial gains of getting in on the captable of your company its early stages.

With that said, we tackle in this article:

advisory shares explained

Beginning your startup journey can be daunting and is, arguably, one of the most challenging yet rewarding experiences you'll ever embark on. With so many moving parts to take into account like developing an MVP, raising capital, product awareness and iterations, hiring the right people - the list goes on and on, getting entrepreneur's block (as we like to call it) is all too common. But you don't have to go it alone! Reaching out to existing networks and finding someone who can help you get that much needed inspiration and traction to start turning that flywheel doesn't have to be difficult (or expensive).

What is a startup advisor

One of the first realizations you’ll have as a startup founder is there is almost no way you can build your startup alone. If you want your startup to succeed, you need to surround yourself with the right people and the right angels (and demons for a contrarian view) on your shoulder. This is why, aside from your founding team, you should always be on the look out for strategic advisors.

Startup advisors are professionals with industry expertise, business knowledge, and vast networks that can help founders like you fast track you learning (and reduce mistakes) and make those key connects that you may otherwise struggle to make on your own. An Obi-Wan to your Luke, if you will - someone to show you the way of the (startup) force.

From former founders, to angel investors, or venture capitalists , startup advisors can come in many forms. Usually they have specialized skills in various fields such as HR, software development, sales, operations, or even marketing.

The point is, these advisors have been in your shoes and possess deep expertise in areas that could take you years to learn. So why not leverage it?! Finding the right advisors is pivotal to your success and knowing how to compensate them fairly is a skill in and of itself.

How are startup advisors compensated

The quick answer is, you can either pay them in cash, offer them equity, or a combination of the two.

It often boils down to the preference of the advisor but keeping cash-constraints top of mind, negotiating a compensation package and using advisory shares is both pragmatic and cost-effective.

As mentioned earlier, most startup advisors will accept equity as a valid form of compensation for their time. Some might even be interested in investing into your business! With that said, let's talk about advisory shares and how to use them as a compensation tool.

What are advisory shares

Advisory shares (or advisor shares) are a form of non-cash equity compensation given to advisors in exchange for their time and expertise, strategic insights, experience, and network.

Equity vs advisory shares

Equity grants, stock options, shares — all this terminology can get confusing, especially when its used interchangeably and mean different things depending on context, the country you're in and who you ask!

In general, equity is a share of ownership in a company. Advisory shares is just the name for equity given to advisors.

Regular shares vs advisory shares

Another important distinction to make is the difference between regular and advisory shares.

Regular shares or stock are a unit of ownership that you can acquire in either a publicly traded company (by trading on an exchange), or in private companies (issued to investors through private transactions or to team members). These usually come with voting rights, shareholder rights, and other protections.

Advisory shares, on the other hand, are given to part-time advisors and, depending on the class of shares on offer, typically don't include the right to vote. Advisory shares are also often subject to vesting schedules based on the period of time the advisory services are needed.

What are the types of advisory shares

There are two types of advisory shares:

Restricted stock awards

Restricted stock awards or a restricted stock agreement (RSA) are shares of common or ordinary stock that are granted to someone, paid for by cash or through the provision of services. Generally, these shares are also subject to vesting requirements.

RSAs are usually issued in the early stages of a company. It gives advisors the opportunity to be shareholders upfront (at the time the grant is accepted) and receive the shares in exchange for their services. The fair market value is very low at this point, which means a lower and more favourable tax outcome for the advisor. Assuming you use a standard agreement, they're also practically free to give away ie. you won't be burning cash (win-win).

Stock options

Unlike RSAs, stock options are the right to acquire stock at predetermined strike price.

If you're familiar with employee stock options, you've probably heard of non-qualified stock options (NSO) and incentive stock options (ISO). Advisory shares are almost always categorised as NSOs due to the contractor / service provider relationship that advisors have with a company.

The amount of equity granted to advisors may vary considerably depending on their experience, influence, and role. It also depends on how long the advisor and the company plan to work together.

How do advisory shares work

Just like any equity-related transaction, you will need the details of the agreement in writing.

Startup advisor agreement

When you and your advisors finally agree on the details (amount of shares or options, their value, any vesting schedules etc.), an agreement is signed and becomes a binding contract between both parties.

There are many startup advisor agreement templates available out there that you can customise. Just remember that this is a legal document and you want to make sure that it serves its purpose of mitigating the right legal risks and issues. The important, and not-so-boilerplate provisions that you should check for are:

  • Roles responsibilities and expectations ie. a clear scope;
  • Type of shares and percentage of the company's total equity;
  • Vesting schedules and/or length of service;
  • the conversion mechanism (if using options);
  • Confidentiality; and
  • Intellectual property agreements and non-disclosures of other proprietary information.

It's important to note that during their time as advisors, they will likely have access to sensitive information such as financial documents, marketing plans, product development roadmaps or growth strategies. Well written advisor agreements are a way to protect company confidentiality and prevent conflicts of interest. You may also like to consider a side deed of confidentiality... but that's a bit OTT in this day and age IMO.

The Founder/Advisor Standard Agreement template

The Founder/Advisor Standard Agreement, or “FAST”, was developed by the Founder Institute to make the advisory agreement process more efficient for startup founders.

FAST agreement template

With the FAST agreement, founders and advisors can agree on how to work together, what to accomplish, and the right amount of equity compensation in a short and simple 5-pager. It really doesn't need to be much longer than that! or take much time (pun intended).

The template is free to download from the Founder Institute website.

Advisory shares vesting schedule

The vesting period is the time individual advisors must wait to exercise their right to convert the option into a share or stock in the company. Placing time or performance based vesting ensures that the recipients are both financially and strategically incentivised through a commitment to the overall performance of the company, creating alignment between the two parties.

There are three types of vesting schedules:

  • Time-based vesting. An advisor will have to stay with your company for a specified time to claim rights to their stock or option. For example, a four-year vesting  schedule with a one year cliff means that:
    • All stock will vest after four years of service by the advisor.
    • The advisor must work for at least one year for any stock to vest.
    • The remaining stock will vest increasingly on a monthly or quarterly basis.
  • Milestone-based vesting. This type of vesting is not time-based, but rather based on completing a task that adds value to your company, which triggers the stock or option to vest.
  • Hybrid vesting. This type is a mixture of time- and milestone-based vesting. The advisor will have to stay for a specific amount of time at your company and complete certain tasks in order for the stock or option to vest.

How much of the company's total equity should you give to advisors?

Typically, advisors can expect to receive anywhere between 0.25% to 5% - but the exact percentage ultimately depends on how much the advisor contributes to the company's growth, their expertise, and how much you're willing to give away!

An advisor sitting in monthly meetings to give advice during pre-funding stages might be given .25% to .5% equity, whereas an advisor with a huge network of contacts that could become future customers might have a bigger piece of the cake.

When the first seed funding takes place, an advisor's stock might be diluted to .5%. At this point the advisor no longer attends monthly meetings anymore and might just be on-call. When another round of financing happens, an advisor's stock is further diluted to .25%, and so on.

These percentages will continue to reduce throughout the company’s lifetime. Now .25% might not look like much, but depending on the valuation of a business - that thin slice of cake might be worth a ton!

How to manage advisory shares

Cake Equity takes the guesswork out of advisory share management.

With Cake, you can manage your advisory shares and equity stock options in one easy-to-read dashboard. You can also issue shares and manage contracts in a few clicks.

Giving and managing your advisory shares with a single cloud-based solution has never been simpler. Sign up today and make advisory share management seamless and efficient for both yourself and your advisors.

This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.

Related articles