Advisory Board vs Board of Directors Pt 2

Boards (II) 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.

In the first part of this series, we discussed advisory boards including their functions and the legal/practical differences between them. In this article, we’ll cover why you should consider an advisory board and how to know it’s time to create one.

Why Should You Create an Advisory Board?

As we established previously, creating a board of directors is required by law in an incorporated company. On the other hand, whether and how to create an advisory board is solely at the discretion of the CEO. So, why do so many firms form an advisory board?

Expertise

In many situations, especially in early-stage companies, the CEOs do not possess all the knowledge they or their team will need to operate their business successfully. Having an advisory board comprised of subject matter experts is advantageous because of the supplemental knowledge and expertise they bring to the company as needed from time to time.

Easily Accessible

Because its creation is discretionary, versus that of a corporate board, the formation and function of an advisory board is a much less formal process. This flexibility creates the opportunity for one-on-one advisory sessions with the CEO or individual team members. By contrast, a corporate board of directors operates within a formal prescribed structure. Thus, while board directors are usually only accessible to management during pre-scheduled meetings, the services of an advisory board member may be requested whenever the need arises.

Credibility

In addition to the guidance that they give to the CEO and team, an advisory board is also very advantageous to the company’s public image because receiving professional support from well-known experts in their respective fields can be perceived as a tacit endorsement of the company’s prospects for success. This is especially important to pre-money and early-stage companies.

Growth

Although an advisory board can be created at any time within the life cycle of a private or public company, there are particular points in time when the contributions of an active advisory board can be the most advantageous. Examples could include a company that: is in startup mode or is scaling up; responding to a new competitive threat; planning a strategic pivot of the business model; going out for a round of funding; or planning to go public. In such situations as these, if the company doesn’t already have an advisory board, creating one would be worthwhile.

Statutory Board Interface

Finally, an advisory board may be created at the specific request of a pre-existing statutory board. A typical reason for this is that a corporate board more often than not is made up of investors. Despite being major shareholders in the business, members of a board of directors may not have the expertise needed to advise on critical decisions and may choose to fill this knowledge gap by building an advisory board.

It is also important to note that when considering taking advantage of the presence of advisors, a CEO ought to give a lot of thought to the personal goals and expectations of those advisors. Frequently, an early-stage company can’t afford to pay consultants. However, individuals with valuable domain knowledge or experience who show a sincere interest in the company’s vision and future, can often be persuaded to offer advisory services in exchange for equity in the company.

When Is It Time to Create an Advisory Board?

Choosing to create an advisory board is codependent on many different milestones in a company’s journey and the nature of the company itself. Determining the right time to create an advisory board is ultimately dependent on the opinion of the company’s executive board or CEO. However, early-stage companies, in particular, are wise to give it early consideration, especially if the advisor(s) will accept equity compensation.

Executive Board

As we stated earlier, in addition to the CEO, a corporate (or executive) board may also decide that it’s time for the company to utilize an advisory board. One reason for this? A corporate board does not maintain day-to-day contact with company management or staff, so it may decide to bring on subject matter experts in order to regularly provide in-person tactical advice to the CEO and senior management.

CEO

The right time to create an advisory board is often when the CEO recognizes a need for or a deficit in the expertise within the company and that it would be beneficial to bring in some experts. This may be a single advisor or a larger number depending on need. Each of these advisors is able to provide industry expertise in different aspects of the company’s activities.

Depending on the nature of the professional discipline a company may be lacking, the CEO may decide to hire a consultant rather than add to the advisory board. For example, regardless of industry, most companies require legal, financial or tax expertise. These types of skill sets may be retained as contract consultants rather than advisory board members. Consultants may play a more finite or project-based role versus the longer-term engagement of some advisors.

One might also wonder about the process of determining the total number of board members to retain. In the case of a statutory board, the number of individuals on the board is governed by the terms of the company’s by-laws. When a change to the maximum or minimum number of persons on a board of directors is to be made, the board must vote on a corresponding change to its bylaws.

For an advisory board, deciding upon the number of board members is up to the CEO, who may choose to increase or decrease that number, terminate a pre-existing advisory board member when one’s services are no longer needed, and/or enter into a new agreement with a different individual. Again, a given advisory board can have as many or as few members as deemed necessary by the CEO and is always subject to change.

Board Observers

In a post-money company, principal investors who may not otherwise be represented on the board, may choose to have an observer attend board meetings. This can occur for example, when the investor has limited expertise in the company’s business. Thus, the investor may prefer to have someone more knowledgeable attend meetings on the investor’s behalf. The observer’s function then is to interpret decisions and communicate their meaning and potential effect to that investor. The sitting board must give its prior approval to this arrangement.

It is important to note that board observers have no voting rights or decision-making authority. They attend board meetings strictly as observers. The board can establish rules of acceptable conduct with which the observer must comply. This may mean that the observer has limited or no opportunity to speak or contribute during the meeting.

In this article, we’ve covered how to decide if and when an advisory board should be created. In our next article in this series, we will cover how to form a board and the selection criteria for doing so.

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