What Are Advisory Shares and How Do They Differ From Common Stock?

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Jan. 31 2022, Published 11:25 a.m. ET

Companies issue different types of shares. On a broader level, the shares include common stock and preferential stock. Within the common stock, companies have differential categories, mainly based on voting rights. A lot of tech companies keep different classes of common shares. The basic premise is to grant higher voting rights to the founders since many of them aren't willing to let go of their decision-making powers.

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Companies also issue ESOPs to employees in order to retain talented employees and align their interests with the company. Advisory shares are gaining traction amid the startup mania. What are advisory shares and how are they different from common shares and ESOPs?

What are advisory shares and who issues them?

Advisory shares are also known as "advisor shares." They're stock options that are issued to a company’s advisors. Theoretically, any company can issue advisory shares but they're usually issued by startup companies.

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Advisory shares are issued to experts that advise the company. It's important to make a distinction between advisors and other experts like accountants and attorneys. While they also offer advice to a company, they're generally paid a fee.

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As for advisors, they advise a company on the strategic level, including aspects like market and product development, growth strategies, and business transformation.

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What's the difference between advisor shares and ESOPs?

Advisor shares and ESOPs are both stock options. However, the difference is that while ESOPs are given to employees or senior business executives, advisor shares are given to outside consultants.

Also, while advisory shares are mainly issued by startup companies, most of the companies, big or small, issue ESOPs. Big tech companies are at the forefront when it comes to ESOPs. Most of the compensation that senior executives in these companies earn is in the form of ESOPs.

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Tesla is a case in point here since CEO Elon Musk doesn't take any fixed income or bonus. All of Musk's compensation is variable in the form of stock options. Over the last few years, Musk has unlocked billions of dollars worth of stock options amid the astronomical rise in Tesla’s stock price.

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What are the pros and cons of advisory shares?

Advisory shares have their pros and cons. A lot of startup companies are bootstrapped and might not be in a position to pay expert advisors in cash. Through advisor shares, these companies can gain access to industry experts' expertise, which they might not be able to do otherwise. Second, and as is the case with ESOPs, rewarding the advisors with a stake in the company aligns their interests with the company.

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There's also a flip side to advisor shares since they're dilutive in nature. If the business becomes successful, the advisor would end up earning a fairly large sum versus the usual fee. Simply put, the advisor would end up being “over-compensated” if the startup becomes a blockbuster success.

Drawing a corollary with Tesla, Musk became the highest-paid CEO in the U.S. in 2020. But then, the stock rose 740 percent in 2020, and in 2021, its market cap surpassed $1 trillion. Not many Tesla investors would complain about Musk being over-compensated since other stockholders also made a lot of wealth amid the rise in Tesla stock.

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