To get high-level, specialised external, independent support with a focus on building the organization a business can have either non-executive directors or advisory board.
Both have advantages and disadvantages, and the following should make it easier for a business owner to decide what is best for their business.
Non-Executive Director
A non-executive director (abbreviated to non-exec, NED, independent director or external director) is a member of the board of directors of a company or organisation.
Chosen for their independence, calibre and specific personal qualities, they have no other affiliation with the company. They differ from the executive directors, who serve, or have previously served, as executive managers of the company.
However, all directors have the same legal duties, responsibilities, and potential liabilities and receive a fee for their services.
The directors represent the shareholders and should consider company and business issues from a broad perspective.
Role of a Non-executive Director
Diverse organisations have non-executive directors:
- Private sector
- Public sector
- Academic sector
- Not-for-profit sector
Their duties will depend on whether they represent the interest of shareholders in the private sector or the interest of society in a public organisation.
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A non-executive director's role is to represent the shareholders and enhance the board by providing a creative, dispassionate, and objective perspective and accountability.
Non-executive directors influence the balance of the board of directors and serve on committees such as risk and remuneration.
NEDs focus on board matters, are not members of the business management team and are not involved in the company's day-to-day management.
Other key NED responsibilities may include:
Strategy:
Non-executive directors should challenge and contribute to the development of strategy. As an external member of an organisation, the NED may have a broader view of factors affecting the company and its business environment than executive directors.
Performance:
Non-executive directors should monitor management performance in meeting agreed goals and objectives. Evaluate succession planning and monitoring and, where necessary, assist in removing underperforming senior management.
Risk:
Non-executive directors should ensure that financial information is accurate, and that financial controls and risk management systems are in place and working.
People:
NED's can benefit the company's and board's effectiveness through outside contacts and opinions.
They should help the business and board connect with networks of beneficial people and organisations.
Non-executives should also provide independent views on the following:
- Resources
- Key appointments
- Standards of conduct
Audit:
The board must ensure that the company accounts properly to its shareholders by presenting an accurate and fair reflection of its actions and financial performance. Accurate and timeous reporting requires the necessary internal control systems to be implemented and monitored regularly and rigorously.
A non-executive director has a vital part to play in fulfilling this responsibility even if there is a formal audit committee.
Training and education:
It is vitally important that all non-executive directors are aware of their duties and liabilities and develop the softer skills associated with the role, such as board behaviour and effective challenge.
In the UK, several organisations provide this type of training, such as the Institute of Directors and Financial Times.
Board Objectives and Appraisal Reviews
Reasons for undertaking a board evaluation might include the following:
- to address specific issues,
- to benchmark performance against other companies,
- the need to ensure that the board is doing its best.
Evaluating the board's performance ensures they carry out their duties and responsibilities effectively. Performance evaluation is critical in the current business environment, where companies face increasingly complex challenges and need strong leadership to navigate them.
Some organisations appraise non-executive directors based on general overall performance standardised benchmarks, such as those provided by organisations like the National Association of Corporate Directors (NACD) criteria or the Financial Reporting Council Report. Others also set specific individual objectives linked explicitly to the overall organisational goals.
Benefits of Non-executive directors
The following are benefits that independent directors should bring to a business:
- An objective, fresh, objective and usually innovative and perspective viewpoint
- Casting a critical eye over the company without preconceptions or prejudice
- Be able to act as a counsellor, sounding board and devil's advocate.
- Bring business knowledge and experience in specific areas. Many start-ups and high-growth businesses operate in a vacuum without looking at outside forces.
- Compensate in the key areas where management is weak, acting like a consultant.
Potential problems
With all the potential benefits, it may seem logical to have non-executive directors in a business. However, a NED can contribute to a breakdown in board relationships.
Executives may resent or be frustrated by non-executive contributions they perceive to be either ill-informed or inappropriate. These doubts can contribute to deteriorating board relationships, characterised by withholding information and mistrust.
As one executive described it:
'When a non-executive director displays insight and relevant knowledge, undertakes a role seriously, asks brave questions, and takes an interest in issues, the respect level rises. That person becoming approachable is cumulative in terms of the benefits that can come from that".
But the relationship can go completely the other way if,
"Well, they don't know anything about the business; they only ask the obligatory three questions. Then the respect gets lost between the parties, and you don't have a beneficial relationship".
Advisory board meeting
Advisory Board or Board of Advisors
An advisory board provides non-binding advice and support to the management of a corporation, organisation, or foundation. An advisory board's informal nature gives it more structure and management flexibility than a board of directors. Unlike the board of directors, the advisory board does not bear legal fiduciary responsibilities or have the authority to vote on corporate matters.
An advisory board comprises accomplished experts offering innovative advice and dynamic perspectives.
Some new or small businesses choose to have Advisory Boards to benefit from the knowledge of others without the expense or formality of the board of directors.
Function
The function of an advisory board is to help an enterprise with anything from marketing to managing human resources to influencing the direction of regulators.
Meeting regularly, these boards can provide strategic direction, guide quality improvement, and assess program effectiveness.
Entrepreneurs, especially in start-up companies or small businesses, may not want to dilute control of their business by establishing a board of directors with formal responsibilities and authority. An advisory committee may be a better solution for entrepreneurs who want access to high-quality advice and network in the industry.
An external group advisory board could also provide non-biased advice and accountability to entrepreneurs.
Roles and responsibilities of advisory board members
1. develop an understanding of the business, market, and industry trends,
2. provide "wise counsel" on issues raised by owners/directors or management,
3. provide unbiased insights and ideas from an external point of view (not involved in the operation of the business),
4. encourage and support the exploration of new business ideas,
5. act as a resource for executives,
6. provide a social networking platform for directors and the company,
7. encourage the development of a governance framework that enables sustainable growth of the company,
8. monitor business performance,
9. impose challenges to directors and management that could improve the business.
Reasons for creating an advisory board
The main reason to have an advisory board is to get expertise from outside the company. Advisory board members should provide the company with knowledge, understanding and strategic thinking of the industry or management of the company.
Where there is both an advisory board and a board of directors, the advisory board should strengthen the board of directors but not interfere with their authority. Companies should seek advisory board members whose qualities complement the existing board of directors and not mask gaps in knowledge or skill in the main board.
The former editor of The Economist, also an advisory board member, once said,
"They (advisory boards) are there to give focus to, or sometimes challenge, research and intelligence work done in the company. Thus, avoiding groupthink and providing direction on significant picture issues".
Creating and operating an advisory board
Answers are required to two key questions when creating and operating an advisory board:
- Who is trying to achieve what from an advisory board?
- How will the business of the board be conducted?
A lack of definition in answering these questions could lead to an advisory board that provides less value than a well-mandated one with a waste of resources and time for the enterprise and the advisory board members.
Mandate
Determine the required advisory board members by what is sought and expected by the enterprise. Advisory board members should have specific knowledge of distinct aspects of business, such as marketing, product development, and sales techniques, which are useful to the managers.
Focus
The advisory board must determine the committee's focus, whether broad or narrow. Individuals on an advisory board should share a common goal.
Advisory Board Size
The size of an advisory board influences the efficiency of delivering ongoing information and the effectiveness of organising board meetings. A large advisory board may result in managerial issues. Therefore, an advisory board should begin with the advisory board leader and grow from a small size to its ultimate number.
Group dynamics suggests the maximum size for an advisory board is eight members, which considers the need for enterprise people and other facilitators. Some advisory board mandates may require a more significant representation of a specific and number of constituencies.
Meeting organisation and frequency.
The functioning of an advisory board is affected by how effectively the group's activities are organised and directed. There should be regular fixed meetings held monthly, annually, or other.
For the members to provide considered advice, they must receive background information for discussion items. The background information must be timeous, concise, organised, understandable and informative, with enough details to give advisory board members a suitable foundation to advise on the business.
A skilled facilitator, administrator or corporate secretary is required to organise schedules of advisory board meetings and meeting materials. The facilitator or chair of the board should be committed and aware of time management for the meeting. An agenda could improve the organisation and time management for the meeting.
All matters discussed in meetings should be considered confidential.
Term of membership
Advisory board members could be appointed to specific terms, e.g., one, two or three years. The fixed time allows them to commit to the company and prevents them from getting too comfortable with their positions. The membership term is also important when it comes to the board's expansion as it ensures that the size of the advisory board remains efficient and manageable.
Compensation
Advisory board members serve an enterprise for several reasons, from personal loyalty to direct compensation.
Benefits of an advisory board
The benefits of having an advisory board over a board of directors may include the following:
Distance control
Multinational companies have local companies running their business in a particular foreign jurisdiction for lower costs, e.g., tax, price of raw materials, and organisational benefits. However, giving authority to an outside group of directors in the local company may increase the risks and instability of the multinational corporation.
Since an advisory board can operate in a different location, with diverse cultural and business norms, in a foreign language, global companies may choose to have an advisory board instead of a localised board of directors to avoid losing control.
Accountability
An advisory board can provide accountability to keep the business owner on track to achieve their overall business goals. They know that regular progress reporting at meetings creates positive pressure.
Preparation for a board of directors
Companies may choose to have an advisory board before they have a board of directors. Developing an effective board of directors requires a group of individuals with good chemistry and the combination of appropriate skills to propel the business. Starting with an advisory board allows companies to assess the commitments and capabilities of each individual and observe the chemistry between them before appointing them to the board of directors.
Higher efficiency
A board of directors can quickly grow to an unmanageable size. The growth can lead to organisational complexity and communication breakdown, leading to an ineffective and inefficient board function.
A smaller advisory board, without the complexity of authority involved in the board of directors, may work more effectively than a board of directors that grows as the corporation grows.
Formal advice
The complexity and speed of enterprises often make it difficult to seek advice on particular topics. Enterprises may also need help building trust in any person or group to provide ongoing and meaningful guidance. An advisory board can offer consistency, longevity and background knowledge as advisory board members provide reliable advice on issues. Advisory board members receive compensation for committing to their positions. The pay incentivises advisory board members to provide quality advice and ensures that they take requests for assistance seriously.
Less pressure on executives
Executives can express partially defined or tentative views to an advisory board since the advisory board's sole purpose is to provide advice.
This advisory role makes it easier for them to "test-drive options" before they face the board of directors, which demands definitive and assertive business decisions.
The board of directors assesses the CEO and establishes their compensation. While an advisory board may induce change in the company for the company's benefit, a board of directors affecting a difference in the company could suggest a lack of confidence in the senior management team. Board changes impose undue pressure on senior executives and could become a barrier for senior executives to express their issues and seek advice from the board. Thus, an advisory board could be a 'safe harbour' for senior executives to seek advice and test business options.
Directorial Input
Directors are still required to bring any changes to policy or financial matters to the board for direction. No director can make changes without board approval.
Focused input
An enterprise may need advice on a particular aspect of its business (such as marketing, product direction, customer service or contact network expansion). While the board of directors needs to consider all factors and go through a series of administrative proceedings, e.g., formal approvals and ratification, an advisory board can focus directly on a particular issue and give advice.
Drawbacks of an advisory board
The drawbacks of having an advisory board instead of a board of directors may include the following:
Less compensation
An advisory board deals with a narrower range of issues and carries no legal liability for its decisions. There may be less commitment for advisory board members compared to NEDs.
Their limited role is reflected in the lower compensation advisory board members receive compared to those on the board of directors.
Nevertheless, the compensation for advisory board members depends on several factors, including return on investments, time, organisation and cost.
Fiduciary duty and liability issues
An advisory board is not subjected to fiduciary duties or liabilities and therefore has less potential liability when providing advice.
Legislated liabilities, fiduciary, and other duties expose company directors to liabilities which include unpaid wages, unpaid taxes, environmental damage, etc. As a result of these penalties and fiduciary responsibilities forces directors to make decisions and establish policies to minimise risks.
Summary Non-executive Directors or Advisory Board
The final choice depends on many factors in the business. However, with flexibility in structure, role and responsibility starting with an Advisory Board and evolving into a board including Non-executive Directors may be the best option.
In both roles the choice of the individual members is critical for success.