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February 11th, 2021

Cy MegninELEVATE PERSPECTIVE

Building an Effective Board of Advisors

By Cy Megnin, Entrepreneur-in-Residence, Velocities (South Central Indiana)

For the first few years of your startup, it’s common to be stuck between needing more knowledge and not being able to afford the people who already have that knowledge. It’s important to surround yourself with people who can point out your blind spots and give clarity to what needs to be done moving forward. One way to accomplish that is to recruit a board of advisors.

What is a board of advisors and how does it differ from a board of directors?

First, let’s talk about what a board of advisors is and what it is not. A board of advisors is a group of trusted business professionals, usually experts in their field who are handpicked by the CEO and/or founders to help guide decision making. They work directly with you and make recommendations to help grow the company. A board of advisors is not put in place by shareholders who have legal obligations to the company, nor is an advisor someone who has power to vote and change things within the company.

So, how does a board of advisors differ from a board of directors?

Although there are a few main differences between the two boards, the big one is that a board of directors has fiduciary responsibility and is governed by the corporate bylaws. This means they work for the shareholders. A company typically gets a board of directors when fundraising begins and/or if the company issues shares of the company to outside individuals. In that scenario, because they do have legal obligations, companies often obtain officers insurance (D&O). The fact that board members have a fiduciary responsibility means they can also be held liable for bad decisions and the D&O helps cover them and the company.

A board of advisors is great to fill gaps where the company might fall short. If you are a domain expert in your field but have never started a company, you may want to recruit a serial entrepreneur, someone with a wide network to help you raise money, or an expert in some other area you need shored up. Advisors can help optimize decision making before you have a formal board of directors.

Do you compensate a board of advisors? If so, how?

When preparing to write this perspective I sourced experiences from several people who I knew had worked or currently are working with a board of advisors and asked them a simple question: Do you pay them? I was shocked to learn there was no standard answer.

Anecdotally, I have always compensated a board of advisors with shares of stock (using the structure below). I heard from others that compensation can be anything from paying a stipend, equity, a combination of the two, or no compensation at all. There is a certain subset of people who just want to help you. Maybe they are investors in your company, maybe they were in a similar space and had an exit, or maybe they are part of the ecosystem and have an affinity for entrepreneurship in the region you live in.

In my opinion though, unless they are investors, make sure to compensate them because you’re asking for a meaningful amount of their time and want there to be an upside for them. It is also a good idea to tie the compensation to deliverables, or time spent, so everyone knows each side is doing their part.

As an example, for my boards of advisors in the past, which typically consisted of four people plus myself (note it does not need to be an odd number because there is no voting with a board of advisors), I compensate them with a half of a percent of stock for each and vest it over the course of one year with no cliff. In turn, I expect them to give the company eight hours per month, which can be all at once or more than likely an hour or two a week. If I am calling them to ask a quick question, I want them to have a vested interest in answering my call. Or, if you find out that it is not a good fit on one side or the other, it is easy to amicably part ways because of the vesting schedule (e.g., if we are three months into the arrangement and the advisor gets a new job thus not allowing them to spend as much time helping the company, they can simply step away but keep the three months of equity they have earned).

Example with easy numbers:

Say we have 2,400,000 shares for our company (we will get into authorized versus issued in another article)

½ of a percent = 12,000 shares

We are on a vesting schedule, which means they get 1,000 shares per month for a year in exchange for eight hours per month of their time. You do not have to use all of it each month and it does not roll over month to month.

If after three months we decide to part ways, the advisor owns 3,000 shares of the company (1,000 shares X three months) but the remaining 9,000 stay in the pool to be issued to new advisors or employees.

Where do you find a board of advisors?

A good place to start are the trusted advisors you already have, such as your lawyer, accountant, and banker. You can ask them to be on the board of advisors themselves or ask them for a referral to someone who might be a good fit. I would also look for experts in your industry, regardless of where they are located. With most meetings happening remotely anyway, I would find the best expert I could and just have them call in for the meetings.

Other terms you may hear in these conversations:
  • Board observer: Someone who has the right to attend a board of directors’ meeting but has no voting rights. These seats are often given away as part of a funding round, allowing investors to keep tabs on what is going on within the startup at a board level.
  • Business coach: Someone you hire to bounce ideas off and get direction or gain additional insight.
  • Peer advisor group: A group of individuals or startups at a similar stage. Unlike a board of advisors or board of directors, everyone is going through the same situation. (e.g., CEOs of fintech startups)
  • Vesting schedule: An incentive program set up by the company which, when it is fully “vested,” gives the individual full ownership of certain assets.
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