The basic difference between a board of directors and a board of advisors is that the former is a legal requirement and has fiduciary duties to the shareholders of the corporation and the latter is not a requirement and bears no legal responsibility to the shareholders of the corporation. The board of advisors concept was initially prevalent in the bio and scientific start-up catogories and those boards consisted mostly of technical people that could bring high level technical expertise that wasn’t otherwise needed on a day-to-day basis. Eventually, other technology companies saw the utility of having a board of advisors and eventually the concept migrated to more than just bio and scientific start-ups.
Here are some other aspects of boards of directors and boards of advisors that may be helpful for you to know:
- Purpose and Responsibility: A board of directors is a requirement in any corporation (a board of managers is not a requirement in a limited liability company, but if you choose to form an LLC and intend to raise outside capital, then I highly suggest you put such a board in place). See my earlier post on choice of entity. A corporation is an entity that is not corporeal. Therefore, the board of directors represents the physical body of the corporation and has direct responsibility and fiduciary duties (such as the duties of care, loyalty and candor) to the shareholders of the corporation. A board of directors, however, does not manage the day-to-day affairs of the corporation. Managing the day-to-day affairs of a corporation is strictly a function allocated to management (i.e., CEO, COO, CFO). It is the board of directors’ obligation to oversee management, to make sure that management develops strategic plans, executes them and delivers value to the shareholders. A board of advisors, on the other hand, is not a requirement, but most start-ups have them anyway. A board of advisors has no legal responsibility or fiduciary duties to the shareholders. The purpose of having a board of advisors is to add a layer of diverse expertise above management that can offer support, advice and assistance without the corresponding responsibilities and fiduciary duties of directors. Both boards must be actively managed in order to maximize their usefulness.
- Size: There is no limit, but most boards of directors range in size from 3 to 10 or more. Most privately held start-ups will have a board of directors ranging in size from 3 to 5. Publicly traded companies tend to have larger boards of directors. You should structure the board of directors to include an odd number of directors so that there are no deadlocks. Most boards of advisors range in size from 5 to 20, depending on their focus and purpose. A larger number of advisors may exist in bio or scientific start-ups where more technical disciplines are required.
- Composition: Both boards of directors and boards of advisors are formed early in the company’s existence. The board of directors is formed at the time of incorporation and generally consists of one or more founders to start. A board of directors is usually guided by a Chairman. The board of advisors is generally formed shortly after the company is incorporated and initially consists of your well-connected start-up and emerging growth lawyer and accountant. Over time, both boards will grow. The board of directors, following funding, will grow to include investor representatives as well as independent directors. The board of advisors will grow during each phase of growth, by adding people that provide value during that phase. Founders should look outside their network when building their board of advisors and should seek diversity. Steer clear of building a reflection pool (i.e., a homogeneous board of advisors that look and think like the founders). The goal here is to bring the perspective of diverse disciplines – to build a true sounding board off which you can bounce ideas and issues. Do not build a group that ratifies and legitimizes poor decisions. Also, an important characteristic of any advisor that is chosen should be the ability to make key introductions to support services, vendors, customers and the like. Stay away from appointing family members to either board, unless their qualifications otherwise meet those laid out for either board (viewed objectively).
- Meetings: The frequency of meetings may change over time. There is a lot of decision making compressed into the first year of a start-up and, therefore, the frequency of board of directors’ and board of advisors’ meetings is high. In the very beginning, both boards may meet monthly and then eventually that schedule may move to bi-monthly or even quarterly. Management must take the initiative in making sure that board of directors meetings are run smoothly and efficiently and that board packages (consisting of an agenda and other materials requiring review by the board prior to the meeting) are distributed to allow ample time for review by the directors. The board of advisors may not have a set meeting schedule, with management only calling meetings when they require the special insight of the advisors on a particular issue or set of issues. However, if your advisor meetings are infrequent, make sure you nonetheless keep your advisors in the loop so that they have the benefit of legacy and historical event knowledge when helping you work through difficult issues. You don’t want to have to bring your board of advisors up to speed every time you need to vet an issue with them. Directors have an obligation to keep their discussion confidential, however, you should impose that same obligation on your advisors by way of a confidentiality agreement.
- Compensation: Both board members are generally compensated. The directors, given that some board meetings take place in person, are usually paid a small cash fee for attendance, plus reasonable expenses if they must travel. They may also earn an annual fee for their services, although this is unlikely in the start-up stage. The advisors, on the other hand, may or may not be paid a cash fee. The significant portion, however, of both directors’ and advisors’ compensation is usually received in the form of restricted stock or option grants. The goal is to align a directors’ or advisors’ interests with the shareholders’ interests by providing equity that vests over time.
Please let me know any comments you may have. I would love to hear them.