Exploring Equity Options for Advisors in Startups

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Exploring Equity Options for Advisors in Startups

January 23, 2024

In the dynamic world of startups, securing experienced advisors can be crucial for success. Offering equity as compensation can be an attractive proposition for both advisors and founders. However, navigating the complexities of equity transfers requires a strategic approach. Let’s explore three options for giving advisor equity and the considerations associated with each.

Option 1: Transfer from Promoter

Transferring equity from promoters to advisors can be a viable option, but two critical factors demand careful consideration. Firstly, the tax implications must be thoroughly examined. It’s advisable to assess the tax impact on both the promoter and the advisor to avoid unforeseen challenges.

Secondly, while transferring equity from promoters, it’s essential to evaluate the book value of the company. This transfer is ideally best initiated by the company itself rather than individual promoters. If promoters initiate the transfer, a potential problem arises in readjusting the overall promoter holding. Strategizing a seamless adjustment is vital for maintaining transparency and equity in ownership.

Option 2: Phantom Stock

Phantom stock provides a creative alternative for compensating advisors based on the company’s performance. The process involves earmarking shares for advisors, and payment is made upon a liquidity event, reflecting the fair value of the shares at that time.

Before opting for phantom stock, startups should be aware of potential challenges. GST leakage, tax rates specific to advisory services, and distinguishing between capital gains and normal income tax are critical considerations. Understanding these factors ensures a smooth and mutually beneficial arrangement for both the startup and the advisor.

Option 3: Direct Issue from Company

Directly issuing equity from the company to advisors might seem straightforward but involves complexities related to company laws and tax regulations. Companies Act may restrict issuance below fair value under private placement, and tax laws may impose penalties for issuing below face value.

Navigating these legal and tax hurdles demands meticulous planning and adherence to regulations. Startups should seek professional guidance to ensure compliance while implementing this option.

In conclusion, startups seeking to compensate advisors with equity have multiple options, each with its unique considerations. It’s crucial for founders to assess the specific needs of their startup, the advisor’s role, and the long-term impact on equity structure. While these options provide a starting point, engaging with legal and financial experts is advisable to tailor the approach to the startup’s unique circumstances.

Author: Prashant Kumar Jain, Managing Partner

Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at info@samistilegal.in

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