Boost your Start-Up with an Advisory Board - Points to consider

1            Introduction

Most start-ups are founded by first-time founders directly after graduation, with the founding team consisting, also in most cases, of not more than two members. Such founders are naturally not equipped for all of their business challenges. Founders thus often make mistakes, especially at the very beginning of their activities, e.g. in relation to developing and distributing their products, when and how to raise capital and developing or moving into new markets.

Having an advisory board with qualified and trusted members can help the start­-up to transform its potential into successes and to create the foundation for sustainable development. In addition, external know-how and trusted advisors strengthen the confidence of potential investors and other business partners into the start-up. Lastly, the establishment of an advisory board does not necessarily lead to changes in the ownership control of the start-up.

The global trend towards advisory boards for start-ups has found its way to the Austrian market and starts having an impact on the corporate and organizational structure of domestic start-ups.

In light of the foregoing, this article summarizes the main legal challenges in the establishment and maintenance of an advisory board in a start-up company.

2            Establishment

Most Austrian start-ups are limited liability companies (Gesellschaften mit beschränkter Haftung), a legal entity that generally has only two corporate bodies: the general assembly (Generalversammlung) and the managing directors (Geschäftsführung)[1]. The establishment of an advisory board as corporate body is generally not foreseen by law. Nevertheless, shareholders of any limited liability company may establish an advisory board. Such establishment may generally occur within or outside of the start-up's articles of association (Gesellschaftsvertrag).

2.1         Advisory boards established outside of articles of associations

An advisory board can be established outside of the company's corporate structure via an agreement between the shareholders of the company (typically as part of the "shareholders/syndicate agreement" entered into in relation to the start-up company). In addition, the shareholders and/or the start-up company may conclude separate consultancy agreements with the individual members of the advisory board that govern their role as advisors to the shareholder and/or start-up.

The competences of such advisory boards are typically limited to consultation services. However, the advisory board can still have a major impact on the start-up's daily business and may include the shareholders' and/or managing directors' obligation to inform the advisory board on specific matters or to consult the advisory board in the decision making process.

Such advisory boards are typically not disclosed to third parties, which is also the great benefit of this form of establishment.

The agreement on the establishment of the advisory board and the consultancy agreements for advisory board members require no specific legal form[2]. Typically, the shareholders agreement would cover (i) the appointment and removal of the members and (ii) the basic corporate governance for the advisory board. Details of the competences and rules of procedure of the advisory board are typically stipulated in separate by-laws. Consultancy agreements should cover the following key areas: (i) commitment to assume the role as advisory board member, (ii) description of the role / area of consultancy, (iii) maintenance of confidentiality, (iv) remuneration and (v) liability.

2.2         Advisory boards established within the articles of association

Pursuant to article 20 para 2 of the Austrian Limited Liability Companies Act (GmbHG), an advisory board may also be established as an additional corporate body within the articles of association. Such advisory boards may exercise extensive control and may also have instruction rights over the management of the start-up. Since articles of association of a GmbH are publicly available, the establishment of such advisory board would also become public (although members of the advisory board would not be registered with the commercial register (Firmenbuch)).

Advisory boards that are established within articles of association may qualify as a supervisory board pursuant to art 29 para 6 GmbHG if their competences compare to those of a supervisory board, with the consequence that mandatory provisions on the supervisory board[3] also apply to the advisory board. This should be considered when establishing an advisory board with broader competences.

The establishment of the advisory board as additional corporate body comes with a few corporate requirements: Any changes to the advisory board's composition or competences may require an amendment of the articles of association, if the amended criteria are also provided for in the articles of association. Further, advisory board members have to be appointed by shareholder resolutions (the articles of association may grant individual shareholders the right to appoint advisory board members of their choice, including themselves).

While there is generally no limit on the number of members of an advisory board members, supervisory board-like advisory boards must be composed of at least three members (Art. 30 GmbHG).

2.3         Corporate Governance

For practical and legal reasons, shareholders should carefully define the internal organization of the advisory board in separate by-laws (Geschäftsordnung). Such by-laws should specify (i) the advisory board's purpose, (ii) a code of conduct for its members, (iii) roles, term of office and representation of members (e.g. in case of illness), (iv) convocation of meetings, (v) internal decision-making and (vi) communication with managing directors and shareholders.

3            Scope

The advisory board is typically established to support and advise the managing directors and shareholders in particular in essential situations. In addition, the advisory board may be granted control, consent and instruction rights. However, certain shareholder rights may not be assigned to an advisory board, e.g. amending the articles of association or dismissing managing directors.

Advisory boards may also be consulted to solve dead-lock situations, e.g. in a situation where a start-up is established by two founders with equal shareholdings. For this purpose, the advisory board may either be granted with a casting vote or entrusted with the management of a conflict-solving procedure.

For founders, the biggest challenge is typically to equip their advisory board with the right mix between control competences and advisory. An advisory board with the wrong set up of competences may slow down the start-up's pace. Founders have to elicit the advisory board's expertise wisely, defining clear tasks and expectations, cherry picking their advisors' super powers.

4            Liability

The liability of individual advisory board members depends on the advisory board itself. Members of an advisory board established outside of the articles of association are primarily liable towards the company for violations of their contractual obligations. Further, advisory board members could be held liable by third parties due to their involvement in the company's business and access to materials, where relevant. The start-up company (or the appointing shareholder) therefore sometimes agrees to indemnify advisory board members for any claims or damages incurred by them in connection with their services.

Advisory boards established within the articles of association are liable out of their role as a corporate body pursuant to Art. 25, 27 and 33 GmbHG. As a corporate body, all members of the advisory board are jointly and severally liable. Further damage claims may arise out of subsidiary applicable general civil law principles.[4]

For the management of the start-up, the establishment of an advisory board may also affect their liability vis-à-vis the start-up company: a managing director's liability may be limited in case the articles of association have granted the advisory board with comprehensive instruction rights. In such case, the managing director cannot generally be held liable for business activities within the scope of the respective instruction. Still, the managing director can be held liable when the compensation is required by the company to satisfy third party claims.[5] This is mostly relevant in case of an insolvency of the company. In such case, the advisory board's consent does not relief the managing director from his liability.

4.1         Business Judgement Rule

Members of supervisory board-like advisory boards may also benefit from the recently enacted Business Judgement Rule.[6] The rule is a safe harbor for business decisions that meet the following criteria: (i) advisory board members must act without any conflicts of interest; (ii) decisions must be based on all information reasonably available; and (iii) advisory board members have, in their good faith view, acted for the benefit of the company. The Business Judgement Rule supports that start-ups actively involve advisory board members in the making of groundbreaking decisions and protects each member when doing so.

5            Remuneration

The remuneration of an advisory board member is not regulated by law and their activities are often misinterpreted as voluntary. Advisory board members are lending their profound knowledge and expertise to the start-up's business. Thus, start-ups often offer their advisory board members a reasonable fee in return. The fee can be either performance-orientated or a fixed lump sum for a defined scope of services. To properly incentivize the advisory board members, advisors are sometimes granted up to 0.5 % ownership of the company, ideally with a vesting period of three to four years.

Fees can be determined within the articles of association, just by a shareholders' resolution or by contract. Typically, remunerations are of confidential nature, so the latter two options are typically preferred.

Fees for plain advisory activities based on consultancy agreements are fully deductible for tax purposes as operating expenses and can therefore be utilized as loss carried forward. In contrast, only one-half of all fees for members of a supervisory board-like advisory board are deductible as operating expenses pursuant to art 12 para 1 no 7 of the Austrian Corporate Income Tax Act (KStG).

6            Conclusion

Start-up founders should surround themselves with a community of supporters that are providing them with direct and constructive input. An advisory board serves as the ideal framework to get such community to work. With the right selection of its members and a clear set of rules, an advisory board can make a huge and long-lasting impact on the start-up's business. Although there is a huge flexibility in defining the scope and other parameters for an advisory board, founders and other start-up shareholders should carefully consider the applicable legal regulations and consult their lawyer to avoid any legal pitfalls.

[1]      A supervisory board (Aufsichtsrat) must be established only if certain criteria are met; see Art. 29 et seqq. of the Austrian Limited Liability Companies Act.

[2] A written agreement is strongly advisable to avoid disputes.

[3] This includes, in particular, the employee participation in companies with a works council according to Art. 110 ArbVG.

[4] See Art. 1295 in connection with art 1299 and 1300 of the Austrian Civil Code (ABGB).

[5] See Art. 25 para 5 GmbHG.

[6] See Art. 25 para 1a GmbHG.