Many entrepreneurs I know are confused by the differences between an advisory board and a board of directors.
So, to explain in one sentence: advisory boards are voluntary and have no fiduciary responsibility. I recommend a small one for every startup, starting at inception, prior to a major investor or key business scaling initiative. This board is a good test drive for the more formal board of directors required later, when going public (IPO) or upon the interest of venture capital investors, and can give you plenty of great advice.
For both boards, members should be selected individually for their ability to independently add value to the expertise and experience of the management team, with no obligation or intent to add weight to internal views. The details of these considerations are outlined in The Board Book, the classic written by board expert and founder of The Board Institute, Susan F. Shultz.
Shultz provides a set of considerations that I recommend to every entrepreneur for deciding when and how to create the board that has the most value to a specific CEO and a specific business. These considerations include the following:
1. Are you looking for advice or a boss? Most founders and CEOs will not voluntarily establish a formal board of directors unless they are trying to attract a major investor, preparing for an IPO or planning for an acquisition. As an alternative, every CEO needs an advisory board to help them grow, which they can ignore or fire at their pleasure.
2. How much are you willing to spend on your board?Advisory Board members often serve for a nominal retainer, or one percent of the equity, whereas directors for even a small company would expect at least a five-digit retainer plus meeting expenses. Also, you should expect that much more of your time will be required to sustain a board of directors.
3. What role do you want in selecting board members? Board of directors members must be formally elected by stockholder votes for a stated term. Obviously, a CEO can recommend directors, but CEOs directly select advisors, and they are replaced when interests and needs change. Legally, directors are accountable for corporate conduct.
4. Do you expect involvement in company operations?Advisory board members rarely get involved in operational roles versus strategic issues, while specific directors often spend much time on executive compensation, processes to satisfy regulatory requirements, reviews of budgets, acquisition proposals and major policy changes.
5. How many board members need you work with? A board of directors must represent all constituents, so it often grows to ten or even twenty members, although I recommend keeping the numbers uneven (to eliminate tie votes) and fewer than ten. For advisory boards, I recommend three to five as max to limit costs and time spent for support.
The challenge is to avoid the mistakes that can compromise any board, advisory or formal, in its independence or effectiveness to the business. Shultz discusses many of these, but here are a few which are the most common in my experience:
- Failure to focus strategically rather than tactically. Most stockholders think only about the next quarter, and most CEOs worry about short-term survival. Since boards are a function of both of these, it’s hard to find boards able and willing to keep a proactive focus on strategy. They should tell you what you need to hear, not what you want to hear.
- Too many beholding insiders, friends and family. Insiders will tell you what you want to hear. Their allegiance, sensitivity to rank and familial biases make open discussions difficult, and interlocking directorships set up too many situations where directors either work for favors from each other or work against each other due to non-business issues.
- Lack of involvement and leadership by the CEO. Even with all the right people on the board, it’s still the CEO who sets the culture, drives the focus and makes the difference. The best CEOs balance the focus between strategy and selected current issues. They stay in touch, transparently provide info, and make board recommendations happen.
Every entrepreneur and every business needs at least a couple of outside advisors, if not a formal board of directors. As an angel investor, I judge readiness for investment by the presence or absence of a board, by the CEO’s relationship with them and by the quality of the advisors. It’s a resource that you can’t afford to ignore if you intend to stay competitive today.
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This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editors.