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 stock options, issuing advisory shares to those key inception-phase advisors are common practice for early-stage startups.
Advisory shares are a type of equity instrument that are used to provide advice and consultation to the company. These shares do not confer voting rights, and the holder is not entitled to receive any dividends or other distribution of profits. In India, advisory shares are becoming increasingly popular, particularly among start-ups and early-stage companies
Provisions of Advisory Shares in India
There are no specific provisions regarding advisory shares in the Companies Act, 2013 or under SEBI guidelines in India. Advisory shares can be issued by a company to a person who has expertise or experience in a specific area, and who is willing to provide advice and consultation to the company. The holder of advisory shares does not have any voting rights, and is not entitled to receive any dividends or other distribution of profits. The shares can be converted into equity shares at a later date, subject to the approval of the company’s board of directors and shareholders.However, companies in India can still issue shares to their employees or directors through various schemes, such as Employee Stock Option Plans (ESOPs) or Stock Appreciation Rights (SARs), which function similarly to advisory shares in providing equity-based compensation. These schemes are governed by their own specific regulations and guidelines.
ESOPs, for example, are regulated by the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, as well as the Companies Act, 2013. These guidelines specify the maximum number of shares that can be granted to employees and the lock-in periods for those shares. Similarly, SARs, which allow employees to receive the appreciation in the value of the company’s stock over a specified period, are regulated by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA) Regulations, 2017.
Types of Advisory Shares
Restricted Stock Units (RSUs)- An RSU is a form of common stock that a company promises to deliver to an employee at a future date, depending on various vesting and performance conditions. RSUs are not received until these restrictions are over or conditions are met. An employer will promise to give an employee stock under certain conditions, such as meeting particular work goals or being at the company for a particular amount of time.
Taxes on RSUs apply when the shares are delivered – at the time of vesting. They require you to pay ordinary income tax on their market value when the shares are delivered to you (usually as soon as they vest), even if you do not sell them at that time. This includes federal, state and local taxes. Sometimes companies allow employees to sell a portion of the vested shares in order to cover the amount in taxes.
Following that, the employee can choose between holding the rest of the shares to sell later, or selling them right away. Selling the shares of course means paying any capital gains taxes on any appreciation, or increase in value between the selling price and the fair market value when the person vested.
Stock Options- This type of compensation, which is granted to employees, contractors, consultants and investors, is a contract. It gives the recipient the right to buy, or exercise, a set number of shares of the company stock at a preset price, also known as the grant price.
This offer doesn’t last forever, though. You have a set amount of time to exercise your options before they expire. Your employer might also require that you exercise your options within a period of time after leaving the company.
The number of options that a company will grant its employees varies, depending on the company. It will also depend on the seniority and special skills of the employee. Investors and other stakeholders have to sign off before any employee can receive stock options.
How Advisory Shares Work
Advisors are usually granted options to buy shares rather than given the actual shares. That helps avoid a potential tax obligation if the company grants advisory shares worth a considerable amount.
Advisory shares are often used as incentives for advisors to invest in a company’s long-term success. Company executives and managers, on the other hand, may receive shares instead of options. Stock options will usually vest within a year or two. That allows the company to delay transferring ownership to advisors while keeping them focused on the company’s long-term success.
Importance of Advisory Shares in India
Advisory shares can be an effective way for start-ups and early-stage companies to attract experienced professionals who can provide valuable advice and guidance. In many cases, these professionals may not be able to invest large amounts of capital in the company, but they may be willing to provide their expertise in exchange for equity. Advisory shares can also be used to incentivize key employees and consultants. By offering these shares, the company can align the interests of these individuals with those of the company, and encourage them to work towards the long-term success of the business. Another important advantage of advisory shares is that they can help the company conserve cash. By issuing equity instead of cash payments to advisors and consultants, the company can reduce its cash outflows and conserve capital for other purposes. However, it is important for companies to be careful when issuing advisory shares. These shares do not confer voting rights, which means that the holder does not have any say in the management of the company. Therefore, it is important for the company to ensure that the holder of the advisory shares is truly providing valuable advice and guidance, and that their interests are aligned with those of the company.
Who Issues Advisory Shares?
Most companies that issue advisory shares are startups. The company may be little more than an idea at the time. The issuer also may be in the later seed capital stage or even later when it is an active, growing concern. Equity given to advisors can vary considerably. An advisor’s expertise and role can determine if they receive advisory shares. It could also depend on how long the advisor and company expect to work together.
Up to 5% of the company’s total equity could be given to advisors. Sometimes a young company will form an advisory board and allocate equity as an incentive for board members. Individual advisors may get anywhere from 0.25% to 1% of the company’s equity. The exact figure may depend on how much the advisor contributes to the company’s growth.
For instance, an advisor who offers insight at monthly meetings might receive a smaller amount of 0.25%. An advisor who introduces a prospect that becomes a sizable customer could get 1% for this more concrete contribution.
The more mature the company is, the smaller the percentage of equity advisors can expect to receive. For instance, a company in the idea stage might give 0.25% of equity to an advisor who attends monthly meetings. A company that is a past startup and is in the growth stage could cut that to 0.15% for the same advisor.
Advisory Shares: Pros and Cons
Many startup businesses use advisory shares. They can attract experienced advisors during a crucial stage in a company’s development. However, they do have some potential drawbacks. Advisory shares can help protect a company’s confidentiality. Advisors are likely to see product development and marketing plans that businesses want to keep secret. For this reason, advisors may be asked to sign confidentiality and non-disclosure agreements.
Meanwhile, advisors may be working with a number of companies. Companies that issue advisory shares may not be able to restrict advisors from working with rival firms. They can find out in advance if advisors have pre-existing arrangements that could affect their ability to give impartial advice.
Young companies must also take care not to over-compensate advisors with advisory shares. Founders may find it easy to give away fractional percentages of equity in a young company with few assets. Those slices could get much larger as the company grows. This is one reason the equity given to individual advisors shrinks as the company ages.
Experts suggest companies considering using advisory shares take their time before offering equity in exchange for advice. Even experienced business leaders may not make good advisors. It is best to do some research before parting with equity. Some advisory share agreements call for a three-month trial period. During this time the deal can be terminated without any options being transferred to the advisor.
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