By Marc Ernaga, Partner –
Understanding Advisor Agreements
Over the past few months, I’ve reviewed several advisor agreements for early-stage startup advisors. It’s encouraging to see that these contracts have become more concise and standardized over time. At their core, advisor agreements have two main goals:
- Clearly define what the advisor is expected to do; and
- Outline how the advisor will be compensated (typically with equity).
Additionally, these agreements usually cover essential legal housekeeping, such as confidentiality and intellectual property (IP) ownership. However, one important aspect that is often left unaddressed is risk allocation between the parties. For a more detailed discussion of advisor agreements, including how to approach and negotiate them, you can read Advising Advisors: Understanding the Advisor Agreement for further insights.
The Advisor’s Role: Sharing Expertise for Equity
An advisor agreement is based on a straightforward exchange: an expert lends their experience and knowledge to help a startup or early-stage company. In return, the advisor typically receives a small equity stake. If the company grows and succeeds, the advisor may enjoy a potential payday at exit. If, on the other hand, the equity proves worthless, so be it — that’s a risk inherent in early-stage companies. But it’s critical that this relationship remains low-risk for the advisor; their only risk should be the time they invest and the potential value of their equity, nothing more.
Yet, many advisor agreements have a critical gap: they often do not address indemnification. And this could leave advisors unknowingly exposed to legal risks.
The Hidden Risk: Why Indemnification Matters in Advisor Agreements
What is Indemnification?
An indemnification clause is a legal provision that ensures that one party (in this case, the company) agrees to cover certain legal costs, liabilities or claims that may arise against the other party (here, the advisor). Advisors, as independent contractors, don’t automatically receive the same legal protections as employees, including indemnification, unless their agreement specifically provides for it.
This is where many advisor agreements fall short. While the risks advisors face are generally small, they are not zero—especially when advisors take on visible roles, like being listed on the company’s website or making introductions to investors, partners, or customers. Increased visibility means increased legal exposure. If the company faces legal disputes with third parties, such as investors or customers, advisors can be pulled into litigation. Without an indemnification clause, advisors may be forced to bear the legal costs and responsibility of defending themselves, even if they were not directly involved in the issue at hand.
Indemnification Clauses: Essential Protection for Advisors
Why Every Advisor Agreement Should Have an Indemnification Clause
To mitigate this risk, every advisor should require that their agreement includes a clear and comprehensive indemnification clause. This provision should protect the advisor from any claims, liabilities or legal costs arising from their role, except in cases of gross negligence or willful misconduct. In other words, as long as the advisor acts in good faith and isn’t recklessly careless, they should not be held personally liable for legal issues related to their advisory role.
It’s important to note that an indemnification clause benefits both parties. It reassures the advisor that they are protected from unnecessary legal risks, while also allowing the company to limit its liability in cases of intentional misconduct or gross negligence by the advisor. By incorporating this clause, both parties can maintain a mutually beneficial relationship without leaving the advisor exposed to unnecessary risk.
Negotiating Indemnification Clauses
In my experience, negotiating indemnification clauses into advisor agreements is typically straightforward. Given the limited involvement of most advisors—who usually only receive equity as compensation (which may or may not materialize into value)—it’s difficult for companies to justify refusing this protection. By including a simple indemnification clause, companies demonstrate good faith, recognizing the advisor’s contributions while acknowledging that the advisor should not bear legal risks tied to the company’s operations.
The Takeaway
Advisors to early-stage companies should take a proactive role in reviewing their agreements to ensure they include a proper indemnification clause. This simple provision can make a significant difference in protecting against potential legal exposure, allowing advisors to lend their expertise without facing undue risk.
Have Questions About Your Advisor Agreement?
Advisor agreements can seem straightforward, but overlooking key provisions like indemnification could expose you to unnecessary risk. If you’re an advisor looking to review or negotiate your agreement, or if you simply have questions about protecting yourself legally, don’t hesitate to reach out.
For a deeper look at advisor agreements and their components, check out Advising Advisors: Understanding the Advisor Agreement.
Reach Out to Marc Ernaga
- Email: marc.ernaga@momentuslegal.com
- Phone: 650.391.5367
- LinkedIn: @MarcErnaga
Originally published on October 3, 2024, updated on October 21, 2024.
