What Is the Difference Between Advisory Shares and Equity?

Understanding the different forms of ownership and compensation is important for startups and growing businesses. General company equity and advisory shares are two common concepts that often cause confusion. While both involve a stake in a company, they serve distinct purposes and come with different rights, responsibilities, and implications for the recipient.

Understanding Company Equity

Company equity represents an ownership stake in a business. For founders, employees, and investors, equity signifies a direct claim on a portion of the company’s assets and future earnings. Holding equity means you are an owner, and your financial success is tied to the company’s performance.

Common stock is the most prevalent form of equity, granting holders voting rights on significant company decisions, such as electing the board of directors. These shares also offer the potential for capital appreciation as the company grows and succeeds. In a company’s liquidation, common stockholders have a residual claim on assets, receiving a payout only after creditors and preferred stockholders have been satisfied.

Some companies also issue preferred stock, which typically provides priority in dividend payments and liquidation proceeds but often carries no voting rights. Preferred stock is frequently issued to investors, offering them a more stable income and security compared to common stock. Founders and employees typically receive common stock, often subject to a vesting schedule. The tax treatment of restricted stock, common for employee equity, generally involves taxation as ordinary income upon vesting, unless a Section 83(b) election is made within 30 days of the grant date.

Understanding Advisory Shares

Advisory shares are a specific type of equity compensation granted to individuals who provide strategic advice, mentorship, or specialized expertise to a company. These individuals are not full-time employees or founders but offer valuable guidance to help companies navigate challenges and achieve growth. Companies use advisory shares to incentivize external experts and align their interests with the company’s long-term success without requiring significant cash outlays.

Advisory shares are a small percentage of the company’s equity, ranging from 0.1% to 1% of total shares. These shares are subject to a vesting schedule, ensuring the advisor remains committed to the company. Vesting periods for advisory shares are shorter than those for employees, ranging from one to two years, potentially with a shorter cliff or no cliff. This vesting ensures the advisor’s continued engagement and contributions.

Advisory shares mean advisors are taxed on the fair market value of the shares at vesting, with this value treated as ordinary income. Advisors can elect to file a Section 83(b) election within 30 days of receiving the grant. This election allows them to pay taxes on the value of the shares at the grant date, potentially reducing their overall tax liability if the company’s value appreciates significantly. Advisory shares aim to provide advisors with ownership and a financial reward tied to the company’s performance.

Core Differences and Implications

The distinctions between general company equity and advisory shares lie in their fundamental purpose, the rights they confer, and their tax treatment. These differences have significant implications for recipients and the company.

Company equity, particularly common stock, represents a fundamental ownership stake for founders, employees, and investors. Advisory shares, conversely, serve as performance-based compensation for specific services rendered by external experts. The primary goal of equity is to build and grow the company by attracting capital and talent, while advisory shares are designed to secure specialized guidance and mentorship.

Regarding voting rights, common equity holders possess these rights, allowing them to influence major company decisions and elect board members. Advisory shares, however, come with limited or no voting rights, as their purpose is to reward expertise rather than grant decision-making power in corporate governance. This distinction highlights that equity holders are active participants in governance, whereas advisors are compensated for their insights.

Vesting schedules also differ between the two. Founder and employee equity vests over a four-year period with a one-year cliff, ensuring long-term commitment. Advisory shares have shorter vesting periods, such as one to two years, sometimes with a shorter cliff or none, reflecting the more defined term of advisory engagements. Both types of shares, when restricted, become taxable upon vesting unless a Section 83(b) election is made. Filing this election within 30 days of the grant allows the recipient to be taxed on the fair market value at the grant date, potentially converting future appreciation into capital gains, which are taxed at a lower rate than ordinary income.

Recipient profiles also vary. Core employees, founders, and primary investors receive general company equity as a foundational element of their relationship with the business. Advisory shares are specifically earmarked for external experts and mentors who provide strategic input without being integrated into the company’s full-time operational structure. Common equity and advisory shares, being forms of common stock, do not possess liquidation preferences. In a liquidation event, holders of these shares receive proceeds only after preferred shareholders and creditors have been paid, distinguishing them from preferred stock held by investors.