Are you an accidental director? What startup advisors and board observers need to know
Startup governance often involves board observers, advisory boards and active investors. These arrangements can blur the line between advising a board and acting as a director.
To avoid personal liability as a director under the Companies Act 1993, that distinction matters. A person who is not formally appointed may still be treated at law as a director if they act like one, or if they have too much influence over board decision-making.
For those caught unexpectedly in this position, the consequences can be significant. Directors’ duties are personal, meaning liability may ultimately fall on the individual rather than the company. If the company becomes insolvent, courts may order directors to pay back company debts from their own pocket.
While formally appointed directors are usually aware of these risks — and may benefit from D&O insurance (directors and officers insurance) and indemnities — those who become directors in substance rather than title may not have considered these implications.
When someone becomes a “deemed director”
Whether someone is a deemed director depends on the specific circumstances. Courts generally look to the substance of a person’s role rather than their formal title.
Red flags may include:
• a pattern of the board following the person’s directions
• participation in board decision-making on the same footing as directors
• exercising authority typically reserved for directors
In startup environments, where formal governance is often still developing, these lines are at higher risk of blurring.
Board observers
It is common for an investor in a venture-backed startup to appoint a board observer who attends board meetings and receives board papers but does not vote. This allows the investor visibility over the company without formally assuming the responsibilities of a director.
However, in practice, the distinction between observer and director can become blurred. The risk of an observer being deemed a director is higher where:
• the observer participates extensively in board decision making
• the board routinely follows the observer’s advice
• board records do not clearly distinguish observers from directors
• the investor holds extensive approval or control rights in the company’s governance documents (e.g. a shareholders’ agreement)
To reduce this risk:
• observers should make sure their non-voting role is clearly different from directors both in practice and as recorded in any board papers
• investor control rights should be exercised through shareholder processes where possible, rather than through participation in board decision-making
Advisory boards
We have observed that early-stage companies often establish an advisory board rather than a formal board of directors. This allows founders to access experience and industry connections without adding governance complexity.
The risk arises where the advisory board begins to function like the actual board of directors.
Board advisors may be exposed where they:
• participate in governance decisions rather than just providing advice
• approve or sign documents on behalf of the company
• are treated internally or externally as members of “the board”
Courts will not lightly treat advisors as directors. However, where advisors move beyond advice into control or decision-making, the functional distinction between roles can disappear.
As with observers, clear role definitions and disciplined governance practices can help avoid this blurring of boundaries.
Incoming and outgoing directors
Governance boundaries can also become blurred around director appointments and resignations.
For example, investor nominees sometimes attend and participate in board meetings before their appointment becomes effective (we have frequently seen this in connection with closing an investment round). At this stage the investor nominee may not yet benefit from D&O insurance or indemnities, but may nevertheless influence board decisions.
Similarly, directors who resign but continue to act as advisors, consultants or observers should ensure their continuing role is clearly limited. Continuing to perform governance functions after resignation may create uncertainty about where responsibility lies. Once a director steps down, they should stop holding themselves out as a director and ensure public records — including the Companies Office register and professional profiles — are updated promptly.
The practical takeaway
Observer roles, advisory boards and investor control rights are all common features of startup governance. None of these arrangements are inherently problematic and can provide value without burdening the company with overly complex governance arrangements.
However, advisors and board observers should take care to clearly define their roles as distinct from formally appointed directors as the best protection against unintended director liability.