May 16, 2018
To survive and thrive in a competitive marketplace, companies need to secure help and guidance from a wide range of sources.To do so, many companies create advisory boards, or more formally, a board of directors to help guide them and hopefully facilitate growth. If your company plans to go public, it will be required to put a board of directors in place. However, prior to that time, you may be faced with the decision as to whether to create a board of directors or an advisory board.
To determine which path makes most sense for your organization, here are some of the primary differences between a board of directors and an advisory board:
Board of Directors
Considerably more expensive to form, manage and maintain than an advisory board. Typically, board members are paid to attend meetings and are reimbursed for travel expenses. The bigger your company, the higher attendance fees are likely to be.
The role of the board of directors is legally defined by a set of bylaws or rules that spell out what matters the board will be involved in, how often it will meet, and how directors are elected, removed and compensated.
The board has a legal duty to the company and if mistakes are made, the members can be found liable. Without a directors and officers insurance policy (D&O) in place, potential directors may be reluctant to join the board and face potentially unlimited liability.
A popular misconception is that a board of directors serves at the discretion of the CEO and works in the best interest of the company’s executives. In fact, the board represents the interests of the organization and shareholders and it will place those interests above that of management.
A board of directors is likely to be more motivated — financially and legally — to help a company succeed. Also, since directors typically receive far more information from the company than advisory board members, they are conceivably able to make better, more informed decisions.
Although rare, a board has the power to remove the CEO. The likelihood of such an event is far higher if board seats are allocated to investors.
Advisory board members typically receive lower compensation for attending meetings. They often forgo a meeting attendance fee and travel expense reimbursement in exchange for a small equity stake in the company.
An advisory board is far less formal and able to “ebb and flow” with the needs of the CEO and executive management. Specifically, members can be added or removed with relative ease depending on the needs of your company.
Members, with very limited exceptions, can’t be found liable for mistakes that they make while advising the company. Therefore, there is no need to purchase D&O liability insurance. With less inherent risk, potential members may be more likely to accept a position.
Advisory board members are chosen and can be replaced by the CEO and management team. The top priority of an advisory board is to advise and assist the CEO and top managers.
Since the chances of being held liable for the advice they provide is highly unlikely, advisory board members may provide much more information than they would if they were on a board of directors. However, the free flow of information is a double-edged sword in that it may result in less forethought.
Advisory boards don’t have the authority to make decisions. They are only there to provide advice and ideas. Management makes the decisions.
Best Practices for a Board of Directors or Advisory Board
Regardless of which path your company chooses to pursue, there are best practices that can apply to both options. Consider the following:
- Choose wisely. To avoid “group think”, where people tend to think along similar paths, don’t engage individuals that possess experience and views that are similar to those of the CEO and executive management. Look outside your immediate network. Diversity of experience and thought can be translated into a competitive advantage. A prospective board member should have:
- A track record of success.
- High ethical standards that they aren’t willing to compromise.
- Industry knowledge or a willingness to gain the appropriate knowledge.
- Sufficient time to dedicate to the role.
- Identify current challenges. Before forming a board of any type, take stock of where the company is, as well as the future aspirations and challenges it will face. For example, if your company plans to enter a foreign market within the next year, it makes sense to include an individual with related experience on your board.
- Don’t over or under build. It is possible to have too many, or too few members in either type of board. A board could be too small to bring about change. Many corporate governance experts recommend that seven to nine board members are needed to be effective and accomplish all of a traditional board’s legally mandated responsibilities.
An advisory board can certainly be smaller than a board of directors and be effective, as it’s less formal in structure and nature. In either event, first identify the company’s challenges and the skills needed to address them, and then choose the optimal number of members. A small, yet ineffective board is just as problematic as a large, overstaffed board.
In the case of a board of directors, there are typically three to four crucial committees — audit, compensation, nomination, and executive. Each committee should have a clear mandate and meet regularly to discuss the issues it is charged with addressing.
As you can see, there are significant differences between a board of directors and an advisory board. By examining them, you can decide what type of board is best for your business. Keep in mind that an advisory board offers many of the benefits associated with a board of directors. Depending on the size and maturity of your company, it may be the most viable option to pursue.