As outside general counsel to dozens of startups in the technology, life sciences, medical device, clean energy and innovation economy, we are often asked about the utility and purpose of advisory boards.
Setting up an advisory board can be a great way for a startup company to capture the knowledge, seasoned experience, network and expertise of top leaders in your industry, market and field. Advisory boards are one of the most common ways for companies to bring in external experts for advice and introductions, without the complexity and responsibility that comes along with naming someone to the board of directors or hiring an executive as an employee or consultant.
This post will examine the ins and outs of advisory boards so that you are able to determine whether or not creating an advisory board is right for your startup.
What are the basics of an Advisory Board?
Advisory boards are informal bodies created by a company with the main purpose of providing non-binding strategic advice to its leadership. Advisory boards serve many functions, such as: coaching a newly hired CEO, helping companies acquire new levels of expertise, and making industry-appropriate introductions that increase sales. Advisory boards can also be tailored to a particular subject matter, such as an advisory board for energy or environmental issues, or an advisory board for medical fields. One of the most central tenets of an advisory board is that it remain informal. No member of an advisory board will be able to make any central business decisions for the company. Further, the advisory board not be held to the standard of a “fiduciary” to the company.
It is important to note the differences between an advisory board member and a member of the board of directors or an observer to the board. A board director has a fiduciary duty of loyalty and care to the company, and can be legally responsible for failure to comply with such duties. A board observer is not a fiduciary, and has rights that are usually contractual in nature to monitor the company, usually obtained in connection with a significantly sized equity or debt investment. An advisory board member has neither fiduciary duties or the right to observe. An advisory board member is available to the leadership team to provide strategic advice on specified matters when called upon.
What benefits do advisory boards bring to a company?
Through advisory boards, companies are able to create an independent environment where the top minds in a field can collaborate, develop compelling strategies, and test the company’s ideas. This provides several benefits to the company, such as increasing a company’s market presence and reputation, as well as fostering an environment where company decisions are more likely to result in customer satisfaction. Finally, an advisory board allows for a company to have a diverse array of thought, as opposed to the potential groupthink and uniform thinking that can occur in a board room.
What’s the best time to create an advisory board?
There is no “right” time to create an advisory board, and so the best times occur as and when you get connected to the leading minds in your industry or field. Thought leaders and industry players are always in high demand, and so finding a way to incentivize them to collaborate with your company through the creation of a body that has stature and provides equity compensation vesting over a one- to three-year period with single trigger change of control acceleration protection can help lock-in their commitment. If the advisory board is formed while times are good for a company, it could ensure that the company has greater agility to handle tough times when they come. It is of course much tougher to bring on senior leadership to an advisory board if a company has already started facing adversity and downward pressure.
There are also several key moments during a company’s life that they should consider creating an advisory board, such as when the company: wants to build a partnership, is moving in a new creative direction, needs to raise capital, or is simply experiencing rapid growth.
Who is best suited to serve on an advisory board?
When deciding who to put on an advisory board, the thought process should remain the same as with any major decision. You only want the very top talent and best people. An advisory board should not be created just for show. It should be composed only of the very top minds in a particular industry. The number of advisory board members is also important. Having too many can be cumbersome and difficult to harvest value.
What are the steps to creating an effective advisory board?
By their very nature, advisory boards should be tailored to the specific circumstances that a company finds itself, and should be flexible, evolving with the needs of the company. This means that creating tends to be straightforward, and can be informal. Some companies form advisory boards through a resolution of the board of directors, while others do so informally at the CEO’s discretion (equity compensation, if any, however, must be approved by the board or a designated committee thereof). There are additional steps that a company can take, such as setting goals for the advisory board, and adopting a charter to define the procedures, if any.
The agreements by which advisory board members agree to serve on a company’s advisory board function like a consulting agreement. That being said, the most important parts of these agreements are the confidentiality and invention assignment sections. Compensation is also an important aspect of bringing on a member to an advisory board. Generally speaking, a compensation package for an advisory board member consists of a fixed number of options of between 0.25 percent to 1 percent of a company’s fully diluted capitalization, depending on the level of engagement required and stage of growth. As with all equity grants, they should be priced with a strike-price at the company’s then prevailing fair market value per share of common stock, preferably established by a third party valuation firm and benefiting from a safe-harbor under Section 409A of the Internal Revenue Code). Usually, the company will also agree to cover all costs associated with traveling to and attending advisory board meetings, and other company business that the advisory may be asked to handle. It is also standard practice for a company to set a term for the advisory board members. which usually lasts anywhere from one to three years.
If everything is done correctly and carefully, creating an advisory board allows a company to utilize the knowledge of industry leading minds without the hassle or trouble that comes with appointing a new director bringing on an executive officer.
For many companies and advisors, that is a value-added opportunity for both.
Louis Lehot is the founder of L2 Counsel. Mr. Lehot is a corporate, securities and M&A lawyer, and he helps his clients, whether they be public or private companies, financial sponsors, venture capitalists, investors or investment banks, in forming, financing, governing, buying and selling companies. He is formerly the co-managing partner of DLA Piper’s Silicon Valley office and co-chair of its leading venture capital and emerging growth company team.
Ethan Floyd is a consulting attorney at L2 Counsel, and represents a wide range of entrepreneurs and their investors. A graduate of University of California, Berkeley, School of Law, Ethan served as the Editor-in-Chief of the Berkeley Journal of African-American Law and Policy, and is also published in the Harvard Journal of African American Public Policy.
L2 Counsel, P.C. is an elite boutique law firm based in Silicon Valley designed to serve entrepreneurs, innovative companies and investors with sound legal strategies and solutions.