Board Seat

What is a board seat?

Board seat (German Sitz im Beirat oder Aufsichtsrat) refers to membership with voting rights in a body that advises and oversees a company's management. In German, one speaks of a Beiratssitz or Beiratsmandat. In German funding rounds, it usually means an investor's right to send a member to the advisory board of a GmbH (German limited liability company). An advisory board (Beirat) is a voluntarily established circle of experts and shareholder representatives that accompanies the management without running the business itself.

The term originates in US corporate law. There, the body in which this seat exists is the supreme governing body, which appoints and removes the company's management. The GmbH has no such body: the management runs the company, and the shareholders' meeting appoints and oversees it. An advisory board with its own decision-making powers exists only if the articles of association establish it, and it has only the powers that they assign to it. Which rights a board seat confers therefore follows from the articles of association, the shareholders' agreement and the term sheet that prepares both.

Advisory board and supervisory board in a GmbH

Voluntary advisory board

Many growth companies in the legal form of a GmbH establish a voluntary advisory board after a funding round. Its role resembles that of a parents' council in relation to a school's management: it advises, is informed and takes part in certain decisions, but does not run the school itself. The articles of association determine size, composition, term of office and responsibilities; rules of procedure (the written procedural rules of the body) govern how it works. Usual tasks are advising the management, overseeing it on the basis of regular reports and consenting to transactions from a catalogue, such as the budget, larger investments, employment contracts at the executive level or equity participation programmes.

Under Section 46 no. 5 of the German Limited Liability Companies Act (GmbH-Gesetz, GmbHG), the appointment and removal of managing directors lie with the shareholders' meeting. The articles of association can transfer this responsibility to the advisory board; without such a provision, it remains with the shareholders. If the advisory board is to decide with effect for the company, for example by granting consents or appointing managing directors (corporate powers), it must be anchored in the articles of association. A body that rests only on the shareholders' agreement can advise but cannot decide bindingly for the company.

Optional and co-determined supervisory board

If the articles of association expressly establish a supervisory board (Aufsichtsrat), it is called an optional, that is, voluntary, supervisory board. Under Section 52 GmbHG, numerous provisions of the German Stock Corporation Act (Aktiengesetz, AktG) apply to it accordingly, including the rules on duty of care and responsibility, unless the articles of association provide otherwise. A supervisory board becomes mandatory only under co-determination law. With, as a rule, more than 500 employees, one third of the seats must be filled with employee representatives under the German One-Third Participation Act (Drittelbeteiligungsgesetz). With more than 2,000 employees, the German Co-Determination Act (Mitbestimmungsgesetz, MitbestG) requires parity composition, that is, half shareholder representatives and half employee representatives. This supervisory board also appoints the management (Section 31 MitbestG); the one-third-participation board does not. If a company grows beyond one of these thresholds, the existing advisory board structure has to be reorganised.

Right to nominate, number of seats and negotiation

Investor seats are usually designed as a nomination right: a particular investor or group of investors names a member and can remove and replace that member at any time. The right is often tied to a minimum shareholding, so that it lapses after heavy dilution or a partial sale. If the nomination right is in the articles of association, it is as a rule a special right (Sonderrecht), that is, a right that personally belongs to a particular shareholder. It then cannot be taken away from that shareholder without consent.

After a Series A, the first larger round with venture capital funds, advisory boards with three members are common. These include a representative of the lead investor (the investor who leads the round), a representative of the founders and an independent member whom both sides select jointly. With further rounds, the body often grows to five seats, and the majority shifts to the investors. An odd number of members avoids deadlocks; with an even number, the chair's vote usually decides.

Besides the number of seats, what is negotiated above all is the selection procedure for the independent member, the chair and the catalogue of transactions requiring consent (protective provisions). It is also often contested whether advisory board resolutions need the consent of a particular investor representative. This last point links the board seat with the investors' veto rights and often weighs more heavily than the majority on the body.

Duties, liability and conflicts of interest on the advisory board

An advisory board member owes loyalty to the interest of the company, not to the interest of whoever sent them. For an optional supervisory board, Section 52 GmbHG refers to the duties of care under stock corporation law. For an advisory board with oversight tasks, a comparable standard is predominantly assumed, unless the articles of association provide otherwise. If a member culpably breaches their duties, they may be liable to the company for damages. How far this liability extends depends on the tasks that the articles of association assign to the advisory board. The company therefore often takes out D&O insurance that includes the advisory board. This is a financial loss liability insurance for the members of management and supervisory bodies (corporate officers).

For an investor's representative, this creates a structural conflict of interest: they decide on the advisory board for the company and at the same time report to their fund. The articles of association, rules of procedure or shareholders' agreement should therefore regulate to what extent the member may pass information to the nominating investor and how conflicts of interest are to be handled. Typical conflicts are funding rounds in which the member's own fund participates, contracts with the investor and fund holdings in competitors. Common solutions are abstention, exclusion from individual discussions and separate documents.

Remuneration follows the role. Investor representatives generally receive no separate remuneration, because their work is part of looking after the investment. Independent members often receive a fixed annual fee.

Board seats in due diligence and company sales

In the due diligence of a follow-on round or a company sale, the articles of association, the rules of procedure and the minutes of advisory board meetings (board meeting) are requested. The review checks whether transactions requiring consent were actually approved, nominations were properly made and adviser agreements with advisory board members were disclosed. In a sale, the investors' nomination rights regularly end at closing. The acquirer then fills the body anew or dissolves it.

Practical example: board seat after Series A and Series B

A GmbH that develops software for logistics companies completes a Series A of EUR 8 million. The lead investor then holds 18% of the shares and demands a seat on the advisory board. The following is agreed:

• an advisory board with three members: a representative of the lead investor, a member named by the founders and an independent member with industry experience, whom the founders and the lead investor select jointly,
• a nomination right for the lead investor for as long as it holds at least 10% of the shares,
• advisory board consent to the annual budget, to investments above EUR 250,000 and to employment contracts with annual remuneration above EUR 150,000,
• appointment and removal of the management remain with the shareholders' meeting,
• the lead investor's representative may pass reports to his fund, as far as the fund is bound to confidentiality, and abstains in discussions on rounds in which his fund participates.

The Series B dilutes all existing shareholders by 20%. The first investor then holds 18% × 0.8 = 14.4% and keeps its nomination right. The new lead investor also receives a seat, and the advisory board is enlarged to five members: two investor representatives, two founder representatives and one independent member. Because the first investor has in the meantime also taken a stake in a competitor, its representative receives documents on pricing and product planning only in redacted form and does not take part in discussions about this competitor.

Three rules thus decide the influence of the first investor: the threshold for the nomination right, the catalogue of transactions requiring consent and the rule on conflicts of interest. If it falls below 10% in later rounds, its seat ends without the articles of association having to be amended again.

Distinction: board seat, observer seat and management

• Observer seat: a right to attend without a vote, often for co-investors or smaller existing investors. It complements board seats where the body is to remain small.
• Management: runs the company and represents it externally. An advisory board member oversees and advises but cannot represent the company.
• Consent reservations: can be exercised in the shareholders' meeting or on the advisory board. The board seat is one of the places where investors exercise such rights.

Common mistakes

• Adopting US ideas. Unlike under US law, an advisory board can appoint and remove the management only if the articles of association transfer this responsibility to it.
• Advisory board established only by contract. If the body is to grant consents with effect for the company, it belongs in the articles of association. A provision solely in the shareholders' agreement does not support this.
• Even number of members without a casting vote. With two votes against two, no resolution is reached, and transactions requiring consent stall.
• Passing on information left unregulated. Without a rule, the nominated member stands between confidentiality towards the company and the duty to report to their fund.
• Nomination right without a threshold. Without a minimum shareholding, an investor keeps its seat even when, after several rounds, it holds only a small stake.
• Independent member determined unilaterally. If one side selects the independent member alone, the composition loses its balancing function.

Frequently asked questions

Must a GmbH have an advisory board?

No. The advisory board is voluntary. An advisory board with its own decision-making powers arises only through the articles of association; a purely advisory circle can also be established by contract. A GmbH needs a supervisory board only under co-determination law, as a rule from more than 500 employees.

What is the difference between a board seat and an observer seat?

The voting right. With a board seat, the holder is a member of the body: they vote, bear the duties of an advisory board member and are liable accordingly. An observer attends the meetings and receives the documents but does not take part in decisions and bears no corporate-officer duties.

Can the advisory board of a GmbH remove the management?

Only if the articles of association transfer this power to it. Otherwise the shareholders' meeting decides, and the advisory board can at most give a recommendation.

To whom is a member nominated by an investor obliged?

To the company. The member may take account of the interests of their fund to the extent that they coincide with those of the company. In the event of a conflict, the company's interest takes precedence, and the conflict must be disclosed.

Are advisory board members personally liable?

In principle yes, if they culpably breach their duties towards the company and the company thereby suffers a loss. For a voluntary advisory board, the articles of association can, according to the prevailing view, limit liability, for example to intent and gross negligence. D&O insurance absorbs part of the remaining risk; intentional breaches of duty are generally not covered.

Does an investor with a small stake also receive a board seat?

As a rule, no. Seats usually go to the lead investor of a round and to large existing investors. Smaller investors are often accommodated with observer status or extended information rights.

The Roemer Capital view

We negotiate the composition of the advisory board as part of the overall structure of a round and not as a side issue. For the future governance of the company, the catalogue of responsibilities and the consent requirements often matter more than the number of seats. Before the term sheet is signed, we therefore calculate how the body develops over the planned rounds and at what shareholding nomination rights end.

For new investors, an advisory board with clear responsibilities, regulated conflicts of interest and an independent member that both sides support is a sign of orderly governance. The provisions in the articles of association are drafted by the company's law firm; we contribute the commercial view and the coordination with the investors.