I was watching shark tank the other day and the owner offered “Advisory shares” vs regular shares. I tried googling it and it still didn’t make any sense.
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An “advisor” is someone hired by a company to give advice about how to run its business. Usually an advisor is a businessperson that, from the company’s point of view, has valuable experience and connections.
Usually, a company pays people to do their jobs with money. But a company can pay with shares of itself, instead. “Advisory shares” are just shares the company pays to someone to be an advisor.
Now say Bob starts BobCo in January and sells 10% of the company to Uncle Jeb for $100,000 to get started. Then in March Bob goes on Shark Tank, and after some haggling, Bob and Mark Cuban shake hands: Mark will invest $200,000 for 25% of Bob’s company.
*There’s a big problem with this*. The problem is that later investors will look at this and say “Okay, so in January Uncle Jeb paid $100,000 for 10% of the company, so extrapolating, the whole company’s worth $1 million at that point in time. But in March Mark Cuban bought 25% for $200,000 — so the whole company is worth $0.8 million in March. Why should I put my money into a company that’s on a downward trend?”
The term for this situation is a *down round* — the value of the company went down on a later round of investment. It’s.. not exactly a red flag, it’s more of a yellow flag, but it can scare investors off.
Advisory shares usually come up on Shark Tank in the context of avoiding a down round. So instead of the deal being “Mark Cuban buys 25% for $200,000,” the deal instead becomes “Mark Cuban buys 20% for $200,000, and then BobCo hires Mark Cuban to be an advisor and pays him with shares equal to 5% of the company.” That way Mark Cuban gets the same rate as Uncle Jeb (10% per $100,000 invested), and the company’s valuation math doesn’t change (10% for $100,000 = 100% for $1 million, 20% for $200,000 = 100% for $1 million).
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