Advice or binding direction: What is the difference between an advisory board and a board of directors?
Monday, February 23, 2015/
It is invaluable to have experienced business people guiding your business. How can you obtain this help?
A senior employee is a considerable investment, and you may not need long-term permanent help. An external consultant can provide invaluable expertise, but may be short term and costly. A board of directors gives the company direction, but being a director is a commitment that comes with considerable legal obligations.
There is another alternative – appoint an advisory board.
What is an advisory board, why should your business have one, and what issues need to be addressed?
What is an advisory board?
An advisory board is a group of individuals who provide know-how and strategic advice to the business’ co-founders, managers, and board of directors (if it has one). There is no hard and fast rule about what level of experience the members have or in what field they specialise. An advisory board is made up of whoever the founders choose.
You should choose people with the skills, experience and/or connections to help you grow your business. Advisory board members with contacts in the industry are of very high value to your business. When choosing your advisory board, try to find experts with different skills and experience to the founders. Having a broad skill set is generally more valuable to the business than having expertise in the same area.
How much will an advisory board cost?
Members of advisory boards typically provide their expertise free of charge. Some startups might offer certain members a small amount of equity in exchange for a longer-term commitment to the business and as an incentive to stay on board.
What makes an advisory board different from a board of directors?
A board of directors is a shareholder-elected body that governs the company. The primary goal is to make decisions in the best interests of the company. Directors are in charge of business strategy, setting business goals, inspecting company accounts, and appointing senior executives, such as the CEO, to run the business. Board decisions are binding on the company.
An advisory board offers general advice on strategy, such as making directional recommendations based on their assessment of the business plan and offering ideas to test. Advisory board guidance is not binding on the company.
Under the law, members of an advisory board do not have to comply with directors’ duties.
What liability does an advisory board have compared to a board of directors?
It is crucial to know the important distinction between directors and advisory board members, so they understand the risks, duties and liabilities of each role.
Directors have director’s duties under the Corporations Act 2001 (Cth), the general law and the corporate governance documents including the Shareholders’ Agreement. Directors have fiduciary duties to the company, which include exercising due care and diligence when making company decisions, and acting in the best interests of the company, and to endeavour to ensure that the company does not trade while insolvent.
These duties are a risk for directors. If directors do not uphold these duties, they can be expelled from the board, face legal repercussions, and be penalised under the Corporations Act. Directors need to know their obligations and duties. It is good business practice to take out insurance for directors and officers of the company.
Advisory board members need to be careful that they are not inadvertently acting as directors. Under the Corporations Act, directors are defined in two ways: (i) people appointed to be directors, and (ii) people with sufficient influence and power over the decisions of a company. The latter are de facto or shadow directors. De facto or shadow directors can be held to have full directors’ duties and liability.
Key legal agreements – terms of reference and an Advisory Board Agreement
In setting up an advisory board, it is important to have an Advisory Board Agreement that establishes expectations, roles, and legal protections for the business and its advisory board members. This includes confidentiality, and that all intellectual property generated by the advisory board for the business belongs to the business. Your Advisory Board Agreement should clearly set out that members have no power or influence over the running of the company, and the advisory board is not empowered to instruct or direct the directors.
The more clearly this distinction is set out in the agreement, the more protected your advisory board will be from inadvertently taking on the liability that comes with director’s duties.
It is also a good idea to have a Terms of Reference, to give each member an overview of the other advisory board members, roles and obligations.
In conclusion, advisory boards can be an invaluable asset, and can assist in accelerating your business growth. A solid understanding of how an advisory board, and a strong Advisory Board Agreement, will allow you to protect the members from exposure to liability, and help your company benefit from their expertise.
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