Almost every entrepreneur comes across the term “advisory board” in the very early stages of developing its startup. But what does this term really mean?
An advisory board usually consists of a number of external advisors who provide counsel and strategic guidance to a startup’s leadership and management. An advisory board offers valuable perspectives and insights on the startup’s key decisions, market, and potential strategies. The advisory board can even help the startup to gain access to new networks and connections.
An advisory board is not a mandatory body operated under law, nor one of a company’s corporate organs. Rather, it is a group of knowledgeable advisors providing guidance, which operates separately from a company’s official board of directors.
Who Should Be on an Advisory Board?
Advisory board members are individuals who possess a wealth of experience and knowledge in a specific field. They are thus able to enrich the management’s point of view and provide input. These are usually well-known individuals in the industry in which the startup operates, and the startup’s association with them could have a significant impact to the startup. Nevertheless, in our experience, for an advisory board member’s appointment to add real value to the startup, it is essential that the advisory member commit to the startup’s success and provide actual assistance. They should not not just function as a “big name” on the deck.
What Should the Agreement Contain?
Formalizing a startup’s relationship with any of its advisory board members usually occurs by way of an advisory board agreement. This agreement outlines the parties’ expectations, responsibilities, and compensation. Advisory board agreements may change depending on the nature of the business and the specific needs of the startup. However, they typically address several key components:
1. Services
The advisory board agreement should outline the advisory board member’s duties and responsibilities. Usually, these include the following:
- Providing strategic advice regarding the startup’s business, products, and ongoing operations.
- Sharing industry insights.
- Participating in meetings with the startup’s management or board.
Nevertheless, due to the nature of this unique relationship, it is important that the agreement allow flexibility, in order to accommodate changes in the industry and provide the advisory board member with the liberty to provide his/her guidance and knowledge without feeling restrained.
2. Consideration
The consideration given to advisory board members may vary from agreement to agreement. It can include cash payments, equity grants, or a combination of both. In Israel, equity-based compensation (by way of granting options) is a common practice. It is particularly common in startups with limited cash resources. Equity-based compensation aligns the interests of advisory board members with those of the startup and incentivizes them to contribute to the startup’s long-term success.
The number of options granted usually shifts from 0.1% to 1%, depending on the advisor’s scope of contribution to the startup, his/her position in the industry, the startup’s stage, and the parties’ negotiation. In addition, it is standard for the options to be subject to vesting throughout a period of a few years (usually between 12 to 36 months), on a monthly or quarterly basis. Such structure contributes to the advisory board member’s desire to keep his/her position.
An Israeli startup can grant such options only in accordance with Section 3(i) of the Israeli Tax Ordinance (advisory board members in Israel are not entitled to the tax benefits under Section 102 of the Israeli Tax Ordinance as employees and “regular” board of directors’ members). Therefore, there are certain nuances an advisory board agreement should be sure to address with regards to the grant of options (such can be described in a whole other article).
Furthermore, advisory board members are often entitled to reimbursement for out-of-pocket expenses. Thus, it is expected that the agreement will include this component. However, it is also important to ensure the startup has the power to review and monitor such expenses.
3. Confidentiality and assignment of inventions
Given the sensitive nature of the information involved in the relationship with advisory board members, confidentiality and intellectual property provisions are essential. Confidentiality clauses typically require advisory board members to maintain the confidentiality of the startup’s proprietary information, refrain from disclosing it to third parties, and use it only with respect to engagement with the startup. In addition, as potential knowledge, ideas, or other intellectual property may be developed as part of the engagement, it is crucial for the startup to protect its intellectual property and to ensure all inventions and developments are and remain under the startup’s ownership.
Nevertheless, unique issues may arise with regards to this subject, that require adjusting the advisory member’s intellectual property undertaking. For example, advisory members often engage with additional third parties and do not provide services exclusively to a specific startup. Therefore, the advisory board member will want to protect the intellectual property of such third parties, or may even have an obligation to do so.
In particular, many advisory board members engage with research facilities, universities, colleges, etc., as they operate in the academic field in their day-to-day. In such event, a startup should first make sure to obligate the advisory member not to use any facilities, equipment, resources, or personnel of such academic institutes when providing its services to the startup, in order to avoid future questions of IP ownership rights. Furthermore, in the event the advisory board member owns his/her own intellectual property, he/she will most likely request to exclude such intellectual property from the assignment of inventions obligation. In such case, it is recommended to define the advisor’s former existing intellectual property as much as possible, to avoid misunderstandings in the future.
4. Publication rights
In most cases, advisory board members are well-known figures, and the startup will want to publicize the relationship. Furthermore, investors often expect to see advisory members as part of the startup’s deck when it seeks to raise funds, as this may help signal the startup has real knowledge and support in the relevant field. Therefore, the advisory board agreement should include the advisory member’s consent to the startup using his name and biography as part of the startup’s marketing materials.
5. Governing law and dispute resolution
To ensure enforceability and provide clarity in case of disputes, advisory board agreements should include provisions specifying the governing law and the preferred (and better, exclusive) method of dispute resolution, such as arbitration or the relevant courts, and their agreed location.
Why Are Advisory Board Agreements Important?
Construction of the advisory board agreement is important. However, maintaining effective communication between a startup’s management and its advisory board members is key to a successful relationship. Startups should maintain open lines of communication with their advisory board members, keeping them informed of relevant developments and seeking their input on strategic matters. This will allow the advisory board members to better understand the startup’s needs and business, and will make them feel part of the startup’s journey.
Advisory boards can have vital part of a startup’s formation, mainly in its early stages. However, to prevent any “red flags” in future due diligence, it is pivotal to carefully craft advisory board agreements while also adhering to best practices.
***
Barnea Jaffa Lande’s High tech and startups practice is happy to answer questions about advisory board agreements and other matters.
Adv. Inbar Katzir is an associate in the firm’s Corporate Department.