Advisory Board vs Board of Directors Pt 4

Boards (IV) 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 our final article (Part 4 in this series), we’ll discuss how to compensate a board of directors and advisory board members.

Compensation packages can vary with the type of company and its life cycle. As companies advance to new stages in their maturation, they become more profitable. Although the compensation of boards can vary along with the revenue model for the company itself, benchmarking your compensation package against current trends is a good practice for maintaining an acceptable standard of board member compensation.

A compensation package is generally made up of cash and/or equity. In companies that are public or larger, these packages typically offer other benefits like pension packages or other incentives. Many companies have compensation committees that are charged with developing their current compensation packages.

There’s an evolving trend towards moving strictly to equity compensation which was triggered by a 1997 Blue Ribbon Commission report commissioned by the National Association of Corporate Directors (NACD), which is a national organization for professional director development. It recommended that cash and equity be the standard for board compensation and went on to say that the equity piece should be at least 50% of the total value of the compensation package.

As with many aspects of advisory boards, there are no preset guidelines for the compensation of advisory board members and compensation depends on the type of company, its revenue, and so forth. A lot of companies don’t offer any compensation to their advisors because often, advisors are willing to help the company by sharing their expertise and are happy to do so without compensation.  Here are some guidelines for compensating board members.

Research

Articles and pre-established data will be relevant in helping you benchmark your advisory board packages.

Cover Expenses

Regardless of its other features, an advisory board package should always cover any expenses incurred by board members while in service of the company. An example of this would be travel expenses. This is especially important in regards to board members who are not compensated, as in the case of a non-profit board.

Assess Equity Distribution

One may choose to use a formulaic method to determine how much their advisory board earns. For example, if an executive team is paid 10-20% of a company’s available, outstanding fully diluted shares as equity, their board of advisors could make between 1-2% of those shares. This method could vary depending on current best practices for advisory board compensation and the company type.  For example, as opposed to a capital appreciation play, a company that generates cash flow may choose to compensate its advisors in cash.

As we said in our previous articles in this series, companies should have an advisory board agreement for each of their members.  This agreement will usually contain a fixed term (typically two to three years) after which certain provisions are discussed. One should typically have a renewable vesting schedule and an accelerated vesting clause in case there is a merger or acquisition before those options fully vest.

Even if there is no compensation for advisors, there is a lot of intangible value to be had as an advisor. It can expand one’s network and professionally offer additional board experience which comes in handy for joining other boards in the future. Many people enjoy being mentors and sharing their knowledge with companies of interest, and so they’re happy to help out without being directly compensated. This situation often applies to membership on the board of directors for a non-profit, which doesn’t typically offer any type of cash or equity.

Many resources are available to help companies determine what suitable board member compensation might be, including the internet. Several organizations including the NACD offer help with determining proper compensation for boards. Compensation consulting groups can also help benchmark your compensation program.

Companies need to routinely review their compensation plans to ensure that they are continually benchmarked to the appropriate level of compensation for their firm or company. As compensation trends evolve, there’s a lot more scrutiny on board compensation, so this is all the more reason for companies to be diligent in their benchmarking and keep in alignment with laws like SarbanesOxley and Dodd-Frank. Directors and aspiring directors can find up-to-date information on compensation best practices on NACD’s official site.

Board member compensation differs within the structure of the committee. Committee members for boards of directors are an important function, especially in public companies governed by federal/state laws and regulations. In these companies, board members who might join an audit committee or finance committee and therefore spend additional time aiding the company will typically receive additional compensation.

A 2019 NACD article that about recent trends in compensation stated that the use of committee compensation is on a downtrend as boards seem to be streamlining and simplifying their compensation packages by opting to have committee compensation wrapped into their overall package. One way or the other, whether it’s part of your compensation package or a separate plan, it’s important to consider additional compensation for board members who serve on committees.

Due to equity compensation packages as well as the fact that major investors typically want representation on a board, it’s typical to find shareholders as board members. Whether they are venture capital or private equity investors, a significant investor will typically have themselves or a representative from their firm serving as a board member with the company in order to represent their investment along with that of the other shareholders in that company. Such people are referred to as investor directors.

Investor directors bring good governance and a wealth of knowledge to boards and are usually very helpful to the company. One survey states that early-stage companies with investor directors seem to perform better and raise more money from professional venture investors. They’re more likely to recruit a quality CEO and are more likely to reach the IPO stage.

One other survey says that 31% of early-stage (usually startup) companies have outside directors, but only one-third of those are investor directors, so about 10% of early-stage companies have investor directors. As they move along the pendulum growth stage, companies have more than 50% investor directors and two-thirds (75%) of late-stage startups have investor directors.

Boards are a major player in the operation of most firms. In this series, we have discussed 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’ve covered why you should consider a board of directors or advisory board, the right time to form a board, how to form a board, and the criteria for selecting board members as well as how to compensate board members of a board of directors or advisory board.

If you’ve enjoyed reading this series, you can find additional informative business content on our podcast.

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