Starting a business is hard. Every day is fraught with difficulty and challenge, and rarely – if ever – does a startup move from conception to successful business without support, particularly from experienced business people.
That’s why one of the principal pillars of success for a startup is a board: a carefully chosen collection of individuals who – together with the company founders – can serve as a strategic resource to help guide the business.
Understanding the options
The two main types of boards – an advisory board and a formal board – perform slightly different functions, and have different levels of responsibility and duty. The first step for business founders is to understand the differences between them, and from there, focus on which structure will best suit their business at each stage of its development.
An advisory board is a group of external individuals who provide strategic advice or guidance to the founders. The group operates informally, with members typically either uncompensated or receiving a very small amount of equity from the startup (usually within the range of 0.1 percent to 0.5 percent).
A formal board, or board of directors, is the governing body of the company, with legal responsibilities and duties to the company derived from enforceable laws and agreements – namely the Corporations Act and the company’s shareholders agreement.
One of the primary differences between the two is that the decisions and recommendations of formal boards are legally binding, unlike those of advisory boards (which are merely ‘advice’).
However, this isn’t always as clear cut as it sounds. If an advisory board member fulfils the duties normally associated with being a director of a formal board, they could be classified as being a de facto (or shadow) director and end up having the same liabilities as a formal board director under the Companies Act.
In some startups, advisory boards operate as complete replicas of formal boards. They may even go through the same administrative processes, including running monthly board meetings and preparing future plans and budgets.
However, it’s important to understand that regardless of how involved it may be in the business, an advisory board is legally powerless to effect actual change in the business and possesses no voting rights around important decisions that could impact the business and shareholders.
In contract, a formal board has specific governance responsibilities. Most professional investors require that a formal board be installed at the time they make their investment, and that a representative tasked with protecting their financial interests must be a member of the board.
As soon as a startup takes on an investor’s capital, it should operate with a stricter regime of governance, and appoint a formal board to maintain the accountability of the company.
For startups that have received early stage funding (below $1 million) but may not require a large formal board, CEOs should still consider conducting the business as if a formal board existed. This includes preparing monthly accounts, meeting with advisors every month, and preparing future plans and budgets for alignment with the advisors.
For seeded companies, operating the business in this way will ultimately smooth the transition to a formal board later on in the company’s development.
Appointing board members
While there are no hard and fast rules regarding who should be on a board, it’s usually good to have a diverse mix of people, in terms of both experience and knowledge.
An experienced venture capitalist on the board is always essential, as they will be able to contribute to the business through domain knowledge and external networks. The venture capitalist’s personal networks may even provide a source of further capital, if needed. Another benefit is that venture capitalists usually have experience and knowledge gained from working with a number of early stage businesses, and can provide guidance based on their experiences with other businesses.
Companies should also seek to have a domain or functional expert on the board. A domain expert has deep knowledge of the startup’s domain or market sector and position in that market, and a functional expert has experience and knowledge in a specific functional area of the business, whether it be technology, marketing, sales, operations or logistics, for example.
When choosing board members, founders should assemble their board according to the value that each member will provide. And it’s equally important for founders to choose board members with whom they have a positive relationship. Most board members will sit on the board for the duration of the business, so founders will be working closely with them for quite some time. This makes positive relationship all the more important, to give the best chance of working together and resolving the inevitable challenges which beset all startups.
That said, founders should be careful to not go too far down this path and risk ending up with too many advisors – particularly those brought on purely for their expansive network. In my experience, advisors often exhaust their introductory network value very early on in the life of the business, and it can be awkward and difficult to untangle this working relationship later. Furthermore, if you have given them equity, you may not derive much future value in return for the equity they receive.
Timing: not who but when
As a general rule, unless their initial raise is over $1 million, startups rarely need to create a formal board until their second capital raise. It is wise, however, to consider an advisory board until the startup breaks the $1 million mark.
In our sector, typical initial raises are between $200k and $500k. At this level of capital, and in the early stage in the startup’s life, founders should be focusing on informal mentorship and/or guidance from the initial investors or other advisors.
In fact, if your business is still in the early stages of development, my strong advice is to select a handful of people who can really add value, rather than spending time building a large advisory board. At my venture capital firm, Right Click Capital, we frequently see many early stage pitch decks with elaborate advisory board pages, sometimes showing up to six to eight advisors organised to imitate a formal board. While well intentioned, experience suggests that spending valuable resources executing administrative formalities may not be the best use of their time.
In most cases, once a startup has a formal board operating, there is usually no longer a need for an advisory board, unless the business is in a very specialised area where expert advisors can add real value. A formal board with the requisite capabilities, experience and skillset is generally all that is needed.
The bottom line
There’s no question that most startups will benefit from some form of board at every stage of their development, whether that be a group of informal advisers, an advisory board, or a formal board of directors.
This makes it crucial that founders understand appropriate board procedures and roles, and when and how to best deploy them, in order to spend less time obsessing over board structures and more time developing their business.
Garry Visontay is a partner at venture capital firm Right Click Capital, investors in high-growth technology businesses. He curates a list of resources for Australian founders and tech investors at visontay.com.
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