Monday, March 08, 2010

Advisory Board Agreement Basics

Requests for advisory board agreements seem to be on the rise. Five years ago, I would have dissuaded clients from bothering with an advisory board, largely because advisors dilute founders' equity stakes and typically ended up as short term additions, often squeezed out when venture capital comes in.

But that was then. In the last two years, the number of VC-free start-ups has skyrocketed, and many will likely never add venture capital investors to grow their businesses. In the new start-up reality, the right technical and business advisors can fill gaps in product and business strategy, and even open doors.

What kind of agreement should there be between companies and their advisors? Obviously, I'd prefer it if you bought me a donut, or even sent me flowers and candy before I answer. A gal likes to be wooed before she provides favours. Let's start with a checklist of provisions I recommend advisory agreements contain:

1. Description of the Relationship:

You need to think of this agreement in a similar way to any consulting agreement, and set expectations as to deliverables. After all, your advisors likely are receiving an equity stake in your business; it should be clear how they are to earn those shares. At a minimum, there should be a generic statment that the advisor will agree to meet with the company on an intermittent basis and provide general advice and guidance/ or work on the Company's behalf in the advisor's areas of expertise. The amount of time involved should be specified, e.g. "up to X days per month." Some advisors provide specific deliverables as part of their role and you should be specific as to what these are.

2. Disclaimer of Employment:

The agreement should state that the advisor has no right to employment or continued engagement.

3. Payment for Services:

State clearly what the advisor is receiving (shares or options),their vesting schedule and strike price. In addition, specify whether any out-of-pocket expenses of the advisor will be reimbursed.

The vesting of options need not follow the traditional 3-4 year schedule of most option plans. Many early stage companies allow the options to vest upfront and while I understand the need to attract the right advisors from the get-go, it needs to be tempered with a need to ensure the advisors actually contribute to the business in the way you intend. My own view is that everyone performs better with a carrot dangling in front of them,and any vesting schedule - per meeting attended, over just one year - is better than none.

Do not forget to state that the options are non transferable and that the advisor will be expected to agree that a voting trustee will vote those shares, not the advisor. An advisor is receiving a stake in the value he has created in the business, but he is not receiving a say in how that business is run.

4. Confidentiality:

The law will not necessarily agree that advisors owe you or your company a duty of confidentiality. It is therefore critical that you have nondisclosure terms in place with your advisors.


5. Competitors:

Because advisors have other jobs and investments, it is difficult to get them to agree not to compete with yours or not to solicit your customers. A reasonable middle ground is to ask advisors to notify you if their other work might compromise your business, so that you may terminate the relationship (or at least, limit your disclosure to them while they are so engaged).


6. Ability to Perform Services:

This provision is a statement made by your advisor that the advisor is free to undertake the services required by the advisory agreement, and that there is no agreement that would prevent the advisor from giving the benefit of his/her services. You have no way of knowing whether the advisor is under an exclusive services agreement elsewhere, or whether he/she has a non compete or other covenant in place that would be breached by taking on this role with you. You want to protect your business from any claim that an employer or other party might make that you have interfered with their agreement or induced your advisor to breach his contract with that party.


6. Ownership of Work Product:

As would be the case with any consultant, you need to ensure that you own any written work, suggested product improvements or other contributions your advisor makes to the business.

7. Termination:

Do not be afraid to reserve a right to terminate the advisory arrangement at any time. 50% of marriages end in divorce, and business relationships are no different. Simply state that either party may terminate this arrangement at any time without further payment or penalty, and state what you intend will happen with the shares or options that have been granted (vesting typically ceases).

If you are already using an agreement, please take a look at the terms and consider whether you need to add any of the above rpovisions. If you have other suggestions for must have terms for an agreement, send a comment.

7 Comments:

Anonymous Greg Boutin said...

Hi Suzanne,

Great post as usual, and very timely, as I have several clients seeking to structure a board.

One question regarding taxation of the stock options / shares: as you mentioned, board members are not employees, so they will be taxed immediately upon receiving shares or options, based on the fair market value (in Canada at least, I think in the US it's only upon exercise - but feel free to enlighten me).

So how do you structure this so board members don't have to pay taxes for joining the start-up's board?

8:59 AM  
Blogger Rick said...

This is good stuff, Suzy. Though I especially liked Point 6. The second one. :^)

10:05 AM  
Anonymous Anonymous said...

An advisor might also reasonably request indemnification I would think. Is that something that you would object to?

10:45 PM  
Blogger J. B. Loewen said...

Useful post, Suzy, as always - your box of chocolates is in the mail...
I liked number 1. Setting expectations to timing of meetings and deliverables will preserve a relationship.
thanks for sharing

11:15 AM  
Anonymous Anonymous said...

Относительно давно посещаю ваш блог, но ни как не могу подписаться на RSS. Подскажите, в чем проблема? Заранее благодарна.

12:57 PM  
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10:56 AM  
Blogger Gexton said...

Requests for advisory board agreements seem to be on the rise. Five years ago, I would have dissuaded clients from bothering with an advisory board,
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7:44 AM  

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