Article adapted from Seraf: Portfolio Management for Early-Stage Investors

There is a lot of confusion amongst new entrepreneurs on the subject of advisory boards versus corporate boards of directors. Some of that confusion is justified because there is some conceptual overlap. But they are very different animals.

Think of it as a superset/subset relationship: a good board will provide some of the advice and guidance of an advisory board, but corporate boards also provide essential corporate governance, oversight and controls which are not the provenance of an advisory board. Corporate boards regularly meet face to face, whereas advisory boards generally do not. Advisory “boards” usually consist of individual advisors who have one-to-one relationships with the CEO and provide guidance and advice through less formal channels.

Once entrepreneurs grasp these distinctions, their first questions are: “Which one do I need, and when do I need it?”

Corporate Boards

In a theoretical world, a company would have a functioning corporate board right from inception. And technically it does under the law of the state in which it is formed, but at the beginning there are usually a bare minimum number of board seats, and they are typically held by the officers. These “day one” boards generally don’t meet and typically do only the minimum paperwork required by law. For a bootstrapping company struggling to build a prototype or find a product market fit, a formal board is functional overkill. Typically, raising outside funds (debt or equity) or gaining meaningful revenue are the triggers for beefing up a corporate board of directors.

Advisory Boards

Advisory boards, on the other hand, can be an essential source of advice, guidance, technical know-how and industry connections from day one. The power of an advisory board is hard to overstate – in some situations, they can absolutely make a company’s success via key customer introductions or investor connections or critical industry credibility.

Why are advisory boards so useful? Because a good advisory board is more focused on mentorship, growth, development and strategy, rather than reporting, governance, controls and the avoidance of downside risk. A great corporate board will try to focus on growth and development too, but as noted, they are not up and running in the early days and even when they are up and running, their governance responsibilities cannot be avoided, and can get in the way or at least take up a fair amount of board time. So in the early days the advisory board has an out-sized responsibility for mentorship and advice.

How does an entrepreneur go about finding these advisors and mentors? Some he or she will already have, even if they didn’t call them an advisory board member by name. They could be former professors, former bosses, relatives with industry connections, other people who know you well. The rest they get by networking. Since advisors can make an incredibly big difference, entrepreneurs should pursue great advisors with vigor. They need to assess where they are weak and need help, then ask everybody they know for suggestions on people who can help. Entrepreneurs should meet with potential advisors to see if they are a fit – even if they are not, the meeting will probably be helpful, and if it’s not, it is still valuable networking.

In selecting advisory board members, entrepreneurs should look for inter-personal chemistry, passion for the company’s focus area, capability to help, time and willingness. In some cases, there will be an exception for people who are really just lending their name and credibility and don’t contribute much time beyond the very occasional consultation – more on that below. But for the most part, entrepreneurs are looking for people who want to jump in, help out, and be there for them in the clinch.

Chief Synthesizing Officer

One note of caution: in running around and seeking all this advice, entrepreneurs and advisors must keep in mind that it is just advice. People’s opinions. It’s the entrepreneur’s company, it’s their vision, and they are the one who has been listening to the customers. Consider the case of new parents. The first couple times they go to the pediatrician, the doctor is undoubtedly the expert – the parents have no idea how to operate their new infant. But after living with their baby for a while and getting to know its quirks, the parents gradually begin to have increasingly strong instincts about what is going on – gas bubbles or something really wrong. Same thing happens to an entrepreneur with her company. If an advisor tells her to go in a direction that is strongly against her gut, she should get a second opinion. Maybe a third. She needs to synthesize what she is hearing with what she knows about her customers and what she is seeing in her market with her own eyes. Entrepreneurs shouldn’t let anyone talk them out of pursuing their dream or talk them into ruining their dream.

In terms of setting up an advisory board, here is a list of key issues for you to consider:

• Paying Advisory Board Members
• Length of Advisory Board Terms
• Making Your Advisory Board Work
• Confidentiality
• Exclusivity/Non-Compete
• Publicity
• Use of an Agreement With Advisory Board Members
• Ownership of Ideas
• Other Legalities

Payment

It is rare to pay advisory board members cash compensation. More typical is to give them stock, generally in the range of 0.25%-1.5%. Figure 0.5% in most cases, but more if the person is an absolute key driver of the company’s success or will be helping the company close critical early customer deals. (But see the vesting discussion below.) Companies will, however, need to reimburse board members for reasonable expenses incurred on its behalf, so founders should keep that in mind if they plan to meet frequently in person (which is unusual) and want to include someone who has to travel a great distance to get to them.

Term

Most entrepreneurs are new to the advisory board concept and so they don’t look far enough down the road. The company’s needs change as it progresses through the early stages of its development, so the ideal advisory board composition should change over time too. Companies should consider trying to give less stock, but with shorter vesting, so that they can rotate skills onto and off of the board over time.

Homework

It is true that some of the value of the board is window dressing for the sake of credibility, but founders are foolish if they stop there. They are giving away far too much valuable equity to let their advisory board members coast. A good CEO will constantly be doling out assignments, requests for assistance, questions, and floating ideas. To get the full value, they must engage advisory board members, so put them to work. (This applies to their regular Board of Directors as well.)

Confidentiality

Good CEOs will be very clear with the board when they want board members to keep information confidential and remind them often what they can and cannot say. A lot of companies leak from the top, but it is the CEO’s fault if she doesn’t over-communicate and over remind on this subject.

Exclusivity/Non-Compete

It is worth considering whether there are certain kinds of companies advisors should not simultaneously represent or do business with while in the inner circle of another company. Best for all involved if that is clarified up front before it is too late.

Publicity

Most advisory board members understand that a company will disclose their relationship, but not all of them do. In either case it is well-worth the CEO and board members reviewing whether there are any rules of the road which must be observed when disclosing advisory involvement. This is especially true with the “great catch” VIPs a company lures onto its board. Some people can be very sensitive to a company acting or writing in a manner that implies more of an endorsement than the advisor is comfortable giving. No upside in making an enemy out of a VIP.

Use an Agreement

It is worth having a short agreement spelling out the key issues in this list. Any corporate lawyer worth her salt can supply you with some templates you can look at and adapt, or this list itself can be adapted into a letter agreement.

Ownership of Ideas

A clause asserting that the company owns all rights in any ideas, discoveries or inventions which crop up during the course of the advisory work is worth its weight in gold; it can prevent major issues down the road when in due diligence for an exit or if the non-compete issue comes into play.

Other Legalities

Since the parties are doing an agreement anyway, it is worth clarifying that advisors are independent contractors, not employees entitled to benefits or overtime, and it is also worth putting in some language limiting liability to each other (but make sure that the limit on damages does not apply to [or at least is much higher in relation to] breaches of confidentiality).

Working on or with an advisory board can be a lot of fun and it can really turbo-charge both the pace of a company’s learning and the pace of its growth. With a little luck and some planning there is no reason a company cannot build a great advisory board. The good ones will go make it happen.