Innovation@work: Three Things to Know About Forming an Advisory Board for Your Small Business

By: Kristin Mendoza

More and more startups and small businesses are formalizing informal strategic relationships with their business advisors into advisory boards. An advisory board is, as the name suggests, advisory in nature. Individuals agreeing to serve on an advisory board provide knowledge, tactical advice and introductions to key industry players, all of which can be incredibly helpful to a startup founder. Advisory boards do not serve in the fiduciary role that a board of directors does nor do they provide direct oversight of the management and operation of a business.

However, even without the formality of fiduciary duty and oversight, the insights and depth of experience that can be tapped from an advisory board can bring a lot of value to startup founders. If you are a founder or business owner considering forming an advisory board, you will want to be aware of these three key things:

1. Setting Expectations Is Important

Even if your startup plan is to take an informal approach to having an advisory board, with occasional one-on-one check ins in lieu of formal meetings, you should be clear about the goals and objectives of the advisory board. For example, if the advisory board is intended to serve a strategic role in product development (which is a common use of advisory boards in biotech companies), then you will want to select industry experts in research and development, marketing and distribution and perhaps regulatory approval. If the guidance sought from the advisory board is more general in nature, you may want to recruit advisors with a broad cross-section of expertise, including finance professionals, other startup founders, industry experts, etc., so that you get the benefit of a diverse set of viewpoints.

Once the goals and objectives of the advisory board are set, consider using an advisory board agreement with each advisor to set expectations and have a clear understanding of the relationship. In addition to avoiding misunderstandings about the advisor’s role, written agreements with advisors will help the startup protect its interests in its confidential information and intellectual property rights, and will provide clear mechanisms for continuing or terminating the relationship later on.

Topics to cover in an advisory board agreement include:

• The term, or how long the startup is looking to engage the advisor
• Duties of the advisor, including expectations about attendance at advisory board meetings
• Compensation (see below)
• Indemnification (see below)
• Confidentiality of information shared with the advisor
• Assignment of any rights to developments, inventions or work product created by the advisor within the scope of his or her engagement as an advisor or that arises from the advisor’s use or access to the startup’s proprietary information

2. Having a Compensation Strategy Will Be Helpful

Companies can take different approaches to compensating advisors. Some advisors may be engaged on purely a voluntary basis. Others may receive reasonable expense reimbursements for travel to meetings or other expenses incurred in serving as an advisor. Some advisors may expect to receive either cash or equity compensation. For startups, compensating reasonable expenses or providing equity compensation are the most typical for attracting and retaining advisors who themselves may be very busy and may want some modest incentive for devoting time to your business.

In using equity to compensate an advisory board member, grants are commonly between 0.25% to 1% and vest over the term of the service arrangement. Laying out the terms of the equity grant, vesting schedule and forfeiture or repurchase rights of unvested equity in a written and signed agreement is critically important. In addition to that, equity grants must be made in compliance with federal and state securities laws. For those reasons, speaking with an attorney prior to initiating an equity compensation program for advisors is advisable.

3. Offering Indemnification Protection Will Be Important to Your Advisors

From the advisor’s perspective, having protection against liability exposure involving the company is key to agreeing to serve on an advisory board. No professional wants to get drawn into litigation simply for serving as an advisor to a company, especially if doing so in a volunteer capacity. This is especially true in the case of startups where advisory board members might have greater net worth than the startup and might be viewed as “deep pockets” in a litigation context. While state law governing the operation of corporations and limited liability companies might provide adequate indemnification of officers and directors, rights to statutory indemnification of advisors may not be as clear or robust.

For that reason, advisors will likely request contractual indemnity protection, either through a standalone agreement or as part of the advisory board agreement, that will require the company to indemnify the advisor in the event of a lawsuit. In addition to that, they may also inquire about coverage under the business’ directors and officers policy. If you carry that type of coverage, you should inquire with your insurance agent about the extension of coverage to advisory board members.

While there is no ideal size for an advisory board, you’ll want to assemble a group that is large enough to provide different perspectives but small enough for you to manage actively and efficiently. Signing up advisors to an advisory board that you infrequently use wastes everyone’s time. Taking the time to set the objectives of the advisory board, communicate expectations clearly, and properly incentivize your advisors will position your business to develop a strong advisory board that will provide benefits to your business for years to come.

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