Boards and Advisory Roles

16 minutes, 8 links

Boards and Advisory Roles

As an angel investor, you may be asked or choose to negotiate a board seat or advisory position with a company you invest in. We’ve mentioned boards a few times throughout this book, so let’s dig in to the details.

Board of Directors

In a corporation, the board of directors (or BOD) controls the company. It is typically made up of one or more founders, investors from each round, and one or more advisors. The board’s authority is expansive: it can fire the CEO and the other officers of the company; approve all equity issuances, including all stock option grants to employees and all equity financing rounds (including convertible note rounds); approve leases and other significant financial commitments; approve or deny the sale of the company or decide to shut the company down. On the board of directors, each director has one vote.

If you are on the board of directors, you are said to have a board seat. Sometimes, angel investors might want to have a board seat so that they can more closely monitor their investment. At other times, a company might want to give you a board seat for reasons of reputation or risk management.

In an early-stage company, the board of directors should be small. It is often made up initially of just the founders or a subset of the executive founders if there are more than three. Sometimes the founders will have added an industry veteran to the board to provide credibility and advice. The CEO is always a member of the board. Typically, the lead for each round of investment or their representative is added to the board, allowing them a small measure of control as well as visibility into the progress of the company. As the board grows, the founder board members, other than the CEO, may be replaced with representatives of the new investors.

Board representation is typically negotiated as part of each investment round. Because the board of directors is so powerful, you should expect entrepreneurs to be careful about adding members.

The Delaware corporations code expression of this power is pretty typical. It says: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.”

importantDirectors of for-profit corporations—that is, members of the board of directors—have two primary fiduciary duties: a duty of care and a duty of loyalty. A duty of care means your conduct will be held to a certain standard. And the duty of loyalty means you have to be careful with how you handle conflicts of interest. Becoming a member of the board of directors of a company is not a matter to be taken lightly.

caution You should always approach the decision of negotiating or accepting a board seat with caution—with great power comes great responsibility. Directors are fiduciaries to all of the shareholders and it is never a risk-free role.

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In addition, a board seat will not give you control unless you can build a coalition with other board members to form a majority in the event that things are going sideways or the CEO is being problematic.

Being a board member also takes time. There are regular board meetings to attend and prepare for, and members may be called on ad hoc to help address strategic issues. In addition to the formal duties and responsibilities of the board, board members may be called upon to help with fundraising, sourcing and hiring key employees, business development, and sales leads.

important If you accept a board seat, know that by accepting it you are accepting potential personal liabilities. We’ll explain that below. In contrast, a board observer does not have these fiduciary duties.

A board observer has the right to attend board meetings, they can participate in board discussions, and so can frequently influence board decisions as if they are a voting member of the board. A board observer has no vote in board decisions, and so they get access to all the information, but without the fiduciary duties and risk of liability. Board observer status for a member of a group of investors would normally be negotiated as part of the term sheet under observer rights. This might be appropriate, for example, for a large investor in a round who is not the lead investor.

If you are taking a board seat, we suggest getting a copy of the American Bar Association’s Corporate Director’s Guidebook, a very good guide to the duties of a director.

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Do Directors Sign Agreements?

Because a director’s duties arise by operation of law (the law fills in the blanks on what these duties are, rather than the duties being laid out in a contract), it is not necessary for a director to sign a confidentiality and IP assignment agreement. If you are only a director, you do not need to sign any agreement with the company save maybe an agreement on how they are going to pay you (such as stock option plan agreements, and you might also prefer an indemnification agreement). Of course, if you are also providing services as an executive officer, or as a consultant, then you should expect to sign an agreement with confidentiality, IP assignment, and potentially non-compete and non-solicitation provisions as well (if such provisions are enforceable in your jurisdiction).

important In general, if you agree to serve as a director of a company, you will want to enter into an indemnification agreement with the company. These agreements can be very important, as there is risk of personal liability as a board member.

An indemnification agreement is a contract between a company and a director or officer in which the company agrees to indemnify, defend, and hold harmless a director or officer if the director or officer is sued as a result of being a director or officer of the company.

You can find a sample indemnification agreement at NVCA.

Personal Liability As A Board Member

danger You risk personal liability as a board member, meaning that you can be sued personally in certain circumstances. Personal liability of a board member can arise in a number of different ways, including but not limited to:

  • A breach of fiduciary duty.

  • The company fails to pay wages due to employees, and the employees sue. Under some state laws, directors can be personally liable for willful nonpayment of wages, failure to pay tax withholdings, and similar items. In some states, the damages for these claims, which can be recovered personally from directors and officers in certain cases, include treble damages and attorneys’ fees. These numbers can add up fast.

  • The company fails, and creditors of the company sue, contending that once the company was insolvent you didn’t do anything to protect them, and in fact made things worse. Under most state laws, once a company becomes insolvent, then the directors’ duties shift from the stockholders to the corporation’s creditors.

  • The company otherwise engages in transactions that give rise to a shareholder lawsuit (for example, the company sells securities, while investors lose their money and sue).

important There are several ways to protect yourself if you become a board member.

  • Make sure that the company has directors and officers liability insurance, often referred to as D&O insurance.

  • Enter into an indemnification agreement with the company.

  • Make sure the company has competent legal counsel and is using that counsel in appropriate circumstances.

  • Make sure that the company is following good accounting practices, such as using a third party for payroll tax accounting, and has a good finance person on the team who can generate financial statements.

  • If you accept a board seat, you will want to review the company’s financial performance and condition as a part of your regular board meetings.

Keeping Minutes (It’s Not Hard)

If you are on the board, take care to make sure someone attending the meetings “takes minutes”—that is, documents what happens in the meeting. Minutes do not have to be long. In fact, they can and should be short.

At a minimum, minutes need to capture the following:

  • When the meeting started.

  • Who was present and if a quorum was reached.

  • If not all of the directors were present, who could not attend, and did they receive notice of the meeting.

  • Who acted as chair of the meeting, and who acted as secretary.

  • Topics discussed, such as:

    • the company’s financial position and financial trends;

    • a discussion of sales or other business matters;

    • the performance of management.*

  • When the meeting adjourned.

If the board will approve stock options at the meeting, additional detail will be required. You can find template board minutes in the appendix.

The Board of Advisors

Sometimes companies establish advisory boards to advise the senior management of the company (sometimes just the CEO) on strategic matters. Serving as a member of an advisory board for a company can be a great way to get to know the company in depth and keep track of what is happening. It will also help you develop a deeper relationship with the CEO and gain insight into the disruption of an industry. If you have useful domain expertise and the time to be an advisor, you may be able to increase the likelihood of success of your investment through your advice.

Being an active advisor can take time, and like BOD members, you will likely be asked to help with introductions to potential customers and sources of future funding, as well as recruiting of key employees, in addition to any domain-specific advice you may be able to offer.

confusion Advisory boards are not governing boards. That means that advisory board members do not have fiduciary duties. Nor are companies bound to observe the recommendations of an advisory board.

The advisor responsibilities and compensation are codified in the advisor agreement (advisory agreement or advisory board agreement). Advisor agreements will typically lay out the duration of the agreement, the amount of equity vested over the course of the agreement, and the vesting schedule.

As an advisor, despite not having fiduciary duties, you still might like to ask that your advisory board agreement include an indemnification obligation on the part of the company, in which the company agrees to indemnify you if you are sued as a result of your involvement with the company. If you would like to review an example advisory board agreement, the Founder Institute makes one publicly available.

Advisor Compensation

You will likely get an equity kicker to your investment in the form of common stock or common options. Cash compensation for advisors is not typical, except perhaps for reimbursement of some minor expenses.

The amount of equity may depend on how impactful you think you can be, the stage of the company, and your ability to negotiate. The low end of the range might be 0.15% vesting over four years, while the high end might be 1% or more and might vest in only two years. You can find suggested equity ranges for advisors at differing stages of development on the Founder Institute FAST agreement. Typical vesting schedules are either monthly or quarterly and can include cliffs similar to employee vesting agreements.

Equity compensation for advisors is almost always in the form of non-qualified stock options (NSOs or NQSOs) on common stock, similar to employee compensation. The advisory agreement will state that the board of directors will issue a stock option grant to the advisor, and ideally it should be clear as to the time frame in which the stock option grant will be executed. In a timely manner, if not coincident with the agreement, the board of directors should issue the stock option grant. That grant will state the number of options and the strike price of those options. The strike price should be the fair market value at the time of the option grant. It should also state that the stock will be subject to the stock incentive or stock option plan.

confusionIf you receive an option you will want to make sure it gives you more than 90 days to exercise the option once you stop performing services. Companies can extend option exercise periods to as long as ten years from the date of the grant of the option.

Tax Consequences for Advisors

danger If you are receiving equity compensation as an advisor, it is advisable to be aware of the tax consequences:

  • If you receive stock, you usually have to pay tax on the value of the shares you receive when you receive them. If the shares are fully vested upon receipt, they are taxable upon receipt at their fair market value. For tax purposes, you are treated as if you received cash equal to the fair market value of the shares, and that you then used the cash to purchase the stock. If the shares are subject to vesting, you would typically want to file an 83(b) election so that you could pay tax on the value of the shares at the time of receipt instead of in the future, when the value of the shares might be even higher and the tax consequences even more severe.

  • If you receive a stock option, as long as the stock option has an exercise price equal to the fair market value of the shares of stock underlying the option, you will not owe tax on the receipt of an option.

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