Advisors are among the most important people you can bring on board when starting a new business. They’re most often people who have “been there, done that”, meaning they likely have experience in a similar industry to your business, or they may have created their own startup and successfully sold it (or watched it fail). As a result, they can help steer you in the right direction and provide meaningful feedback to help you chart a course to successful growth. Because advisors are such an important aspect of the startup ecosystem, it’s a good idea to put measures in place which formalizes their relationship with your company.
Do you Need an Advisory Board?
Do you have a single advisor or an entire group of advisors? The short answer is that you should have as many as would be helpful and practical. To start, you may have just one, but as your business grows and becomes more viable and influential, people will naturally be more interested in participating as advisors. By contracts, very early stage companies are sometimes fortunate to have even one. An advisor isn’t necessarily a shareholder or active participant in the management of the company, but an advisor position is still a role which requires time and effort. As a result, advisors can only offer so much of their time, especially if they act as advisors to multiple companies. If you have a single advisor, the relationship can be very simple – he or she will be on-call to provide advice at critical decision points throughout the business life cycle, and will hopefully also be someone who can make important introductions to expand your network, bring a product to market, or secure financing. If you find yourself with multiple advisors, it may be smart to create an advisory board. An advisory board looks much like a board of directors, except that its responsibilities and scope of influence look much different. An advisory board may recommend certain actions to the board of directors or senior management, but the company is not legally obligated to heed that advice. Similar to a board of directors, an advisory board should meet at regular intervals and structure its advice in such a way that recommendations are clear and attainable, should they be adopted by the company leadership.
Compensation and Onboarding Documents
Many advisors offer their expertise and guidance to companies and founders free of charge, typically in a very informal capacity. This is especially common with very early-stage founders who are not yet sure if their company will survive the near future. There will come a point, however, where advisors will want to be compensated for the valuable advice they provide. Since startups will want to use any available cash for developing an minimum viable product or paying critical employees, this is frequently done using equity compensation. Advisors can receive shares of restricted stock or, if the company has received a valuation to comply with the requirements of 409A, through stock options. Because advisors aren’t considered employees, they are eligible only for non-qualified stock options (and not incentive stock options).
Whether you have one advisor or an 8-member advisory board, you will need to follow certain procedures to make sure they are properly onboarded to the company. All advisors should be provided an offer letter, which outlines their expected role and their compensation award, among other things. Next, each advisor should sign an advisor agreement with the company. Advisor agreements are written somewhat similarly to employee agreements, in that they address certain critical aspects of the advisor’s behavior toward the company – specifically, that of non-disclosure and treatment of confidential information of the company, which an advisor may access at some point in their time with the company. Lastly, each advisor receiving equity compensation should receive an equity award, which is a detailed agreement stating the number and type of equity the advisor will receive. Keep in mind that each award of equity by the company needs to comply with the company’s equity incentive plan, and the award issuance will need to be approved by the plan administrator, which is usually the board of directors.
We encourage all founders to think about who could serve as advisors to the company. Such positions are invaluable, as advisors can help founders avoiding common but costly mistakes, and also seize opportunities which might otherwise pass them by. In selecting an advisor, be sure to ask about their experience with other startups and be sure to talk early about what they expect for compensation. And, as always, reach out to an attorney to help answer questions as they come up.
Bob Baker is a founding partner of Peak Corporate Counsel. He has worked with numerous founders on a variety of issues specific to startups. When he’s not advising innovators, he can be found at networking events, playing rugby, or hiking with his kids.
This article is for informational purposes only, and may not be considered legal advice.