Boards (Part I) With Don Alexander and Barry Buzogany, GeneCoda.
Boards are a major player in the governance of most firms. In this series, we will be discussing the functions of the two major types of boards: corporate and advisory boards, including the legal and practical differences between them, as well as the pros and cons of each. We’ll cover:
- Why you should consider a board of directors or advisory board (Part 1).
- The right time to form a board.
- How to form a board and the criteria for selecting board member
- How to compensate members of a Board of Directors or Advisory Board.
The legal differences between a corporate board versus an advisory board are established by state and federal laws. State laws can vary in this regard. The practical differences between the two can also vary depending on the type of organization they are being created in. So, for example, these differences can depend on whether the company is public or private, or if it is a start-up versus an established company. In general terms then, what are the differences between an advisory board and a board of directors?
One major difference between a corporate board of directors and an advisory board is governing law. When a company or organization is formed and incorporated, it is required by the laws of the state of incorporation to have a board of directors. This is not true of an advisory board. The creation of an advisory board is purely discretionary on the part of the CEO or corporate board. There is no state law or other requirement that one should be formed.
Another difference between these two boards is in how they’re governed. When one incorporates a company, state law requires that the company file articles of incorporation and create a set of bylaws that speak to the formation of a board of directors, the number of board members, how often it meets, and more.
By contrast, an advisory board is a much less formal, structured organization in terms of governance requirements. The number of its members, their requirements, and more are left entirely up to the discretion of the CEO. An incorporated company’s board of directors reports to the company’s shareholders and is legally accountable to those shareholders. An advisory board is accountable only to the CEO that formed it. We should also note that virtually all US states allow for the founder of a company or its CEO to be the sole member of the company’s board of directors initially. Today, we’re focusing on companies where there is a fully formed board, i.e., that includes outside directors.
In order to have a full understanding and appreciation of the company’s business model and its operations, it may be advisable that board members are given access to the senior management team as well as other key employees of the company. Whether they get this access or not can vary depending on the opinion of the chairman of the board (in an incorporated company) or the CEO.
For example, in a given board meeting, the CEO might ask the CFO to give the a financial report to the board, or the Chief Scientific Officer might give a report or an update on clinical trials rather than the CEO. Promoting interaction between senior management and the board lets the board members better understand and appreciate what goes on in the company at the management level, in addition to giving senior managers access to the board.
In comparison, by the very nature of his/her duties, an advisory board member(s) should be able to interact with select senior team and staff, as the CEO may desire. Note that a company can have both a statutory board and an advisory board, so if a company that has both wants to form an advisory board, that would come through the authority given to it to do so by the statutory board.
Statutory board members in an incorporated company have a fiduciary duty to that company. That means there is a legal duty and the potential for legal liability on the part of each of the board members who serve; legal liability being defined over many decades of case law as a fiduciary duty, meaning that there is a legal duty of care and a duty of loyalty that the board has to the shareholders of that company.
A duty of care means that board members must make well informed decisions on behalf of the company and its shareholders. The duty of loyalty speaks to the fact that an individual shouldn’t be making some improper economic or other benefit from his/her place on a board, and that his/her loyalty is, again, to the shareholders and to the company.
For members of an advisory board, there’s no legal liability because they have no vote and do not make decisions on behalf of the company. The two agreements that the CEO are advised to enter into with each of his board of advisors are.
- A CDA, a confidentiality agreement
- A non-compete
Both of those documents could be folded into an advisory board agreement, and the advantage of that is that in it, the CEO can set forth the nature and scope of the advisor’s duties so it’s clear what’s expected of that advisor and vice versa. Signing these three documents would give the advisor a contractual duty to the company, but not a fiduciary obligation.
Often, board members on a statutory board company insist on D&O (Directors and Officers) liability coverage. The primary reason for this is that board directors and officers have the potential of personal liability to the shareholders, the company and to third parties. Advisory board members on the other hand do not have this same risk or legal exposure because they do not have the authority to vote or to make decisions that are binding on the company.
Authority and Responsibility
The board of directors in an incorporated company has accountability and responsibility for overall oversight of the company, which means that they’re responsible for approving an annual operating plan of the company, which would include approving financials and budgets. They give strategic advice and are responsible for management-level issues.
As an example, if a CEO wanted to form a partnership or raise a round of financing, that’s the kind of major strategic event that a corporate board would have to weigh in on and either approve or disapprove. On the other hand, advisory board members are retained to contribute their individual subject matter expertise which is much more narrow in scope than that of corporate board members.
In some cases, however, advisory boards can influence strategic decisions made by the board or management. For example, there may be specific strategy options confronting the board or management team and, in such situations, they may want to call in specific advisory board members such as the scientific advisory board. They would have no decision-making authority but could contribute an extra level of expertise to the board and/or the management team of the company.
The advisory board has no obligation to meet other than at the CEO’s discretion or request. If the CEO chooses to use them in that way, meetings can be held over phone calls or lunch. It’s not uncommon for an advisory board member to meet with one of the teams or with individual staff in a company. By contrast, a corporate board must, by law, have meetings periodically and most do so quarterly. These are generally done in person (or these days, virtually.) To make binding decisions they must have a quorum present.
Finally, a statutory board has an obligation to be well informed and knowledgeable of company operations given their fiduciary duties, whereas advisory board interactions with management and staff are much more informal and can include one-off meetings. Again, they don’t have a requirement to meet as a group; however, that’s up to the CEO.
It’s easy to tell from these differences that the structure of an incorporated company’s board is much more formal when compared to an advisory board. In our next post in this series, we will cover why you should consider a board of directors or an advisory board and how to know the right time to do so.