Our company clients often come to us at an early stage in their growth process with some variation of the following question: “We were introduced to an amazing resource who can help our team grow the business in a material way. We’re considering putting the person on either our board of directors or a board of advisors. What should we consider?” The answer varies, but often the following issues should be carefully considered from the perspective of both the company and the possible advisor/director.
Both directors and advisors generally are brought in to a company to help founders or management grow the company’s business. They are typically present either because they have mandated playing such a role in connection with an investment or because the company thought it would be prudent to formally engage them in an ongoing role. At the early stages of a company’s history, neither advisors nor directors tend to receive cash payments for their services (above and beyond expense reimbursement). Instead, both advisors and directors are generally compensated with equity that vests over time so long as they remain in service to the company.
Points of Differentiation
The most important conceptual difference between a director and an advisor is that directors have fiduciary duties that are imposed on them by law, whereas advisors typically have only duties incurred through a contract that they sign with the company. Practically speaking, that means directors have much more responsibility to a company’s stockholders than advisors. Directors are charged by state law (for our companies, that is often Delaware given the preference investors have for that state’s well-developed body of corporate law) with duties of care and duties of loyalty. They must make decisions in a reasoned, informed manner with the best interests of the company and its stockholders at heart. Any failure to meet that standard incurs the possibility of litigation from frustrated, disgruntled or aggrieved stockholders.
An advisor, on the other hand, is typically bound only by duties set forth in the contract that he or she may enter into with a company at the time he or she is engaged. As a result, an advisor entering into such a relationship incurs fewer risks than a director and the gravity of an advisor’s relationship with the company is less than that of a director’s, given the seriousness of the fiduciary duties imposed on directors.
The consequences of placing someone on the board of directors should be carefully considered. The director will have regular insight into the company’s finances, operations and decision-making processes. That is often a huge help, because a person with a fresh perspective who is well-versed in helping businesses scale can be especially helpful, particularly to founders new to the process of building and growing a company. However, this situation is not without drawbacks. An outside member on the board can have the effect of slowing down a decision-making process. Such a person may ask helpful questions and force management, founders and other board members into more deliberative decision-making processes that in the long run could be beneficial but in the short run may impair a company’s ability to make quick decisions.
Additionally, joining a board may be a bigger time commitment than becoming an advisor. Potential board members may also have contractual provisions in existing employment, advisor or director agreements with other companies that could restrict them from joining a board of directors.
For those reasons, many companies often ask value-add external team members to first serve as advisors. Advisors can be engaged to meet as often or as infrequently as the advisor and the company prefer. Additionally, the information that an advisor stands to receive by virtue of his or her appointment is typically reduced to only the information that the company needs to provide in order for the advisor to perform his or her duties.
Depending on a company’s bylaws, its certificate or articles of incorporation (colloquially referred to as the “charter”), and any voting agreements or arrangements in place, and depending on the nature of the vacancy on the board of directors, new directors may be appointed by the existing board members or elected by a company’s stockholders. The process by which directors may be removed is also typically set forth in the company’s bylaws, its charter and any voting agreements or arrangements in place. Broadly speaking, board appointment and removal tends to be a rather formal process and can range in time from receiving a few quick consents (for a newly formed company or a company with a limited number of stockholders) to a multi-day or multi-week process (for a company with a more robust capitalization table and with stockholders that have voting rights).
The advisor appointment process, by contrast, tends to be faster. At Perkins Coie, we have a form advisor agreement that can be customized and then prepared and sent to clients and potential advisors in relatively short order. Advisors may take a close look at provisions regarding confidentiality and intellectual property obligations, but most of the language in a typical advisor agreement should not trigger the need for substantial review or comment from the advisor.
Consultation with counsel and with any existing advisors, directors or key stockholders is often the best course when determining whether a strategic value-add person should be evaluated for an advisor or director role. The issues outlined above should provide a helpful starting point for framing such conversations.
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