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13 March 2017
Most start-ups are founded by first-time founders directly after graduation, with the founding team typically consisting of no more than two members. Because of this, founders are often unequipped to deal with the business challenges that they will face. Founders thus often make mistakes, especially at the start (eg, 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 a start-up to transform its potential into successes and create a foundation for sustainable development. In addition, external know-how and trusted advisers strengthen the confidence of potential investors and other business partners. Finally, the establishment of an advisory board does not necessarily lead to changes in ownership control.
The global trend towards instituting advisory boards has found its way to the Austrian market and begun to affect the corporate and organisational structure of domestic start-ups.
In light of the foregoing, this update summarises the main legal challenges associated with the establishment and maintenance of an advisory board in a start-up company.
Most Austrian start-ups are limited liability companies, a legal entity that generally has only two corporate bodies: the general assembly and managing directors.(1) The establishment of an advisory board as a corporate body is generally not foreseen by law. Nevertheless, shareholders of a limited liability company may establish an advisory board. Advisory boards can be established under or outside the start-up's articles of association.
Advisory boards established outside articles of associations
An advisory board can be established outside the company's corporate structure via a shareholder agreement (typically as part of the shareholder or syndicate agreement entered into in relation to the start-up). In addition, the shareholders or the start-up may conclude separate consultancy agreements with the individual members of the advisory board in order to govern their role as advisers.
The competences of 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 requiring shareholders and managing directors to inform the advisory board of specific matters or to consult the advisory board in the decision-making process.
Typically, shareholder agreements are not disclosed to third parties, which is also a major advantage of this form of establishment.
Agreements on the establishment of an advisory board and consultancy agreements for advisory board members require no specific legal form.(2) Typically, the shareholder agreement covers:
Details of the advisory board's competences and rules of procedure are typically stipulated in separate bylaws. Consultancy agreements should cover the following key areas:
Advisory boards established under articles of association
Pursuant to Article 20(2) of the Limited Liability Companies Act, an advisory board may also be established as an additional corporate body within the articles of association. These advisory boards may exercise extensive control and may also have instruction rights over the management of the start-up. Since a limited liability company's articles of association are publicly available, the establishment of such advisory board will also become public (although members of the advisory board will not be registered on the Commercial Register).
Advisory boards that are established under the articles of association may qualify as a supervisory board pursuant to Article 29(6) of the Limited Liability Companies Act if their competences compare to those of a supervisory board, with the consequence that the mandatory provisions imposed on the supervisory board(3) will also apply to the advisory board. This should be considered when establishing an advisory board with broader competences.
Establishing an advisory board as an additional corporate body comes with several corporate requirements:
While there is generally no limit on the number of members that an advisory board must maintain, supervisory board-like advisory boards must be comprised of at least three members (Article 30 of the Limited Liability Companies Act).
For practical and legal reasons, shareholders should carefully set out the internal organisation of the advisory board in separate bylaws. These bylaws should specify:
An advisory board is typically established to support and advise the managing directors and shareholders, particularly 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 the advisory board (eg, amending the articles of association or dismissing managing directors).
Advisory boards may also be consulted to end deadlocks (eg, where a start-up is established by two founders with equal shareholdings). For this purpose, the advisory board may either be granted a casting vote or entrusted with the management of a conflict resolution procedure.
For founders, typically, the biggest challenge is equipping their advisory boards with the right control and advisory competences. An advisory board with inappropriate competences may slow the start-up's pace. Founders must elicit the advisory board's expertise wisely, defining clear tasks and expectations, and cherry-pick their advisers' powers.
The liability of individual advisory board members depends on the advisory board itself. Members of an advisory board not established under the articles of association are primarily liable towards the company for violations of their contractual obligations. Further, advisory board members may be held liable by third parties due to their involvement in the company's business and their access to materials, where relevant. Therefore, start-ups or appointing shareholders sometimes agree to indemnify advisory board members for claims or damages incurred by them in connection with their services.
Members of an advisory board established under the start-up's articles of association are liable based on their role as a corporate body, pursuant to Articles 25, 27 and 33 of the Limited Liability Companies Act. As a corporate body, all members of the advisory board are jointly and severally liable. Further damage claims may arise out of subsidiary general civil law principles.(4)
For a start-up's management, the establishment of an advisory board may also affect its liability with regard to the start-up. A managing director's liability may be limited where the articles of association have granted the advisory board comprehensive instruction rights. In this case, the managing director cannot generally be held liable for business activities within the scope of the respective instruction. That said, the managing director can be held liable when the company must provide compensation to satisfy third-party claims.(5) This is mostly relevant for insolvent companies as, in this case, the advisory board's consent does not relieve the managing director from his or her liability.
Business judgment rule
Members of supervisory board-like advisory boards may also benefit from the recently enacted business judgment rule.(6) The rule is a safe harbour for businesses that meet the following criteria:
The business judgment rule supports start-ups actively involving advisory board members in the making of ground-breaking decisions and protects members in this capacity.
Remuneration for advisory board members is not regulated by law and their activities are often misinterpreted as voluntary. Advisory board members lend their 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 performance-orientated or a fixed lump-sum for a defined scope of services. To incentivise the advisory board members properly, advisers 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 through a shareholders' resolution or by contract. Typically, remunerations are confidential, so the latter two options are preferred.
Fees for plain advisory activities based on consultancy agreements are fully deductible for tax purposes as operating expenses and can therefore be used as loss carried forward. In contrast, only half of all fees for members of a supervisory board-like advisory board are deductible as operating expenses, pursuant to Article 12(1)(7) of the Corporate Income Tax Act.
Start-up founders should surround themselves with a community of supporters that provide them with direct and constructive input. In this context, the establishment of an advisory board is an ideal solution. With the right selection of members and a clear set of rules, an advisory board can have a huge and long-lasting impact on the start-up's business. Although there is significant flexibility in defining the scope and parameters of 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.
For further information on this topic please contact Clemens Rainer or Sascha Smets at Schoenherr by telephone (+43 1 5343 70) or email (firstname.lastname@example.org or email@example.com). The Schoenherr website can be accessed at www.schoenherr.eu.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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