Advisor Stock Options: Everything You Need to Know
Advisor stock options are stocks offered to the advisors of a company when shares are issued during the early options of the formation stage.4 min read
Updated July 10, 2020:
Advisor stock options are those stocks being offered to the advisors of your company when you issue shares. When determining how much to pay your advisor, you’ll want to think about the type of work he does for the company.
As a business owner, you should understand that stock options are usually given out during the early options of the formation stage. Therefore, it is generally done during the late stage of the financing round to better identify who has which shares, and how much leverage you will give to all executives and managers, including your advisor. But when issuing stock, you want to refrain from issuing actual shares to your advisor. While you will issue such shares to the company’s executives and managers, you should be issuing only stock options to your advisor.
Changing Valuation Will Effect Stock Options
Since the company’s valuation is always changing, it is important for business owners to identify the appropriate stock options for their advisors while taking into account the fact that the business will change in value over time. When you initially form your business, you might want to give stock to your advisor. However, if you do so, you are taking a big risk. For example, let’s assume that you form a business that is worth $50 million and you give your advisor 10% of the stock. You are essentially giving him equity of $5 million in the company. This can cause a very significant tax consequence. This is why stock isn’t usually given to a company’s advisor. Rather, options are given for such stock.
Stock Options During Financing Stages
During the development stage of financing, the following equity percentages are given:
- Key stakeholders and C-Suite executives are given approximately 8 to 10% equity
- The advisor might be given 0.25 to 1% equity (actual equity and not stock options)
It will be up to the CEO to determine the equity percentages throughout the financing stages. However, when the company is ready to launch, the percentage given to the key stakeholders and executives now drops to between 6 to 10%. At this point, additional managers and employees might be given equity as follows:
- Directors and Vice Presidents of the company might be given between 2 to 6% equity
- Employees might be given 2 to 4% equity
Thereafter, the early seed round of financing will take place. During this stage, the executives equity is now diluted to between 3 and 8%. The directors and VPs are diluted to approximately 1 to 3%. Managers are given 1 to 2%, and employees are diluted to 0.5 to 1%. At this point in the financing stage, the advisor’s stock is diluted to 0.25%.
Next is the acceleration A round, one of the last financing stages before the company offers its final shares of equity. During this round, the executives are further diluted in equity at a rate of between 2 to 6%. Directors and VPs now have 0.5 to 1% equity. Managers are down at 0.25 to 0.75% equity, and employees have 0.1 to 0.5% equity.
These percentages will continue to reduce throughout the company’s lifetime. While it might seem like 0.5% isn’t much, it might be a lot of money depending on the valuation of the business.
Some companies offer vesting periods for advisors rather than equity or stock options. This means that the advisor will be given stock with a particular vesting or maturity date. However, the options might vest on a yearly or even a monthly basis. For example, a company might choose to give its advisor a certain amount of stock options at a specific rate that vests on a monthly basis. The percentage might be between .25 and .75%, depending on how high of a percentage the company wants to give to its advisor.
The business will need to identify whether it wants to offer a diluted stock or one that isn’t diluted but rather an outstanding share. The diluted stock will provide less benefits than an outstanding share. Regardless, if the company provides a vesting period for the advisor, it must be careful to have an appropriate vesting period and not one that is too long. Longer vesting periods might be problematic in that companies over time will rely much less on the advisor, especially after the company is fully formed and operating business as usual. This means that the company will have to terminate the advisor in order to stop the vesting period.
If you need help learning more about advisor stock options, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.