Purpose of this article

This article enables the board of directors and C-Suite to begin the discussion regarding company purpose.

You may download a PDF of this article from: https://koorandassociates.org/wp-content/uploads/2021/03/what-is-the-purpose-of-your-company.pdf

What is purpose?

Purpose answers the question: Why does the company exist?

• Without cash paying customers, the company does not exist. One aspect of purpose is to address the problems and needs of cash paying customers who are able to and choose to buy the company’s solution.
• The company also impacts other stakeholders in its ecosystem which includes overall society. This may include providing value to them and extracting value from them. The stakeholders can also impact the value of the company. Some stakeholders may deny the company its social license to operate.
• What society needs does the company meet?
• Why should employees work for the company?

What are some perspectives regarding purpose?

• Only 7% of Fortune 500 CEO’s believe their companies should mainly focus on making profits.¹
• The top two employee priorities in a McKinsey survey were: contributing to society and creating meaningful work. These priorities were the focus of only 21% and 11% of respective company purpose statements.¹
• Larry Fink, in his 2018 letter to CEOs, said “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate…..Without a sense of purpose, no company, either public or private, can achieve its full potential…..And ultimately, that company will provide subpar returns to the investors.”²
• U.S. Business Roundtable in 1981 “Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.” “Business and society have a symbiotic relationship: The long-term viability of the corporation depends upon its responsibility to the society of which it is a part. The well-being of society also depends upon profitable and responsible business enterprises.”⁴

What is the value of purpose

Boston Consulting Group analysis revealed that the majority of companies with high purpose scores achieved above median long-term total shareholder returns.  The majority of companies with low purpose scores achieved below median long-term shareholder returns.³

What are the challenges of gaining value from purpose?

• Company purposes may be “…little more than catchy slogans and posers….so generic they could apply to just about any company….”⁴
• There are different legal and regulatory requirements around the world. e.g. The UK Corporate Governance Code states: “To succeed in the long-term, directors and the companies they lead need to build and maintain successful relationships with a wide range of stakeholders. These relationships will be successful and enduring if they are based on respect, trust and mutual benefit.” “A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.” “ The board should establish the company’s purpose, values and strategy……”
• What to do the legal and regulatory requirements actually mean when it comes to decision making by the board of directors and officers? The Further Reading section below has the “duty of care of directors and officers” from the Canada Business Corporations Act.
• There may be multiple purposes for a multi-national or multi-business unit companies.
• In a private company, the shareholders agreement may restrict a number of key decisions to the shareholders rather than the board of directors or C-Suite.
• Stakeholders may have different perceptions of what is value and how the company should allocate this value among stakeholders. It may not be possible to meet the expectations of all stakeholders.  There could be situations where a company decision or action does not satisfy any stakeholder.

How does a defined purpose enable a board of directors and C-Suite make difficult decisions?

The following are just a few examples of difficult decisions:

• Should employees be paid a living wage e.g. live above the poverty line in their community?
• What should the employer in a single company town do when the plant is not meeting profit objectives, and the middle aged work-force has no other options for employment?
• How much employment should be shifted to lower paid off shore staff?
• How much work should be done by lower cost contractors rather than employees?
• How should the companies profit be allocated among: employees, C-Suite, and shareholders?
• Should the company be lobbying the government to change laws to reduce the companies taxes or reduce environmental standards?
• Should the company be structured to minimize or eliminate taxes?
• etc.

Purpose is tied to values, morals, and ethics

The decision making and behaviour of the board of directors and C-Suite reflects both purpose and their values morals, and ethics.

 What are your next steps?

• Identify the stakeholders. Interview and survey stakeholders to determine how they perceive the company’s purpose, values, morals, and ethics. How do stakeholders perceive the company relative to other companies?  How has this perception impacted stakeholder actions?
• Collect the currently documented purpose, values, morals, and ethics. Where do the board of directors agree and disagree on these?
• Analyze key historical decisions of the board and CEO to identify the degree to which they demonstrated purpose, values, morals, and ethics. How do the historical decisions and behaviours of the board support the purpose, values, and morals.
• Create your own list of difficult decisions. Discuss how each board director and C-Suite member would make each decision.

Footnotes

¹ Purpose: Shifting from why to how, McKinsey Quarterly, April 2020

https://www.mckinsey.com/business-functions/organization/our-insights/purpose-shifting-from-why-to-how

² https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter

3 Ralph Gomory and Richard Sylla, “The American Corporation”, April 2013, page 6, The Wall Street Journal http://online.wsj.com/public/resources/documents/50b74ca9c91e6TheAmericanCorporation11292012.doc.pdf

⁴ Purpose with the power to transform your organization, Boston Consulting Group, May 2017

https://www.bcg.com/en-ca/publications/2017/transformation-behavior-culture-purpose-power-transform-organization

⁵ UK Governance Code 2018

https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.pdf

Further reading

 Canada Business Corporations Act – 2021 Jan 28 Duty of care of directors and officers

122 (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall

(a) act honestly and in good faith with a view to the best interests of the corporation; and

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

 Best interests of the corporation

(1.1) When acting with a view to the best interests of the corporation under paragraph (1)(a), the directors and officers of the corporation may consider, but are not limited to, the following factors:

(a) the interests of

(i) shareholders,

(ii) employees,

(iii) retirees and pensioners,

(iv) creditors,

(v) consumers, and

(vi) governments;

(b) the environment; and

(c) the long-term interests of the corporation.

Directors face five challenges in making decisions:

#1 Have the directors agreed upon which decisions are most critical, and agreed upon the criteria for selecting those decisions?

• Is the criterion: what has the greatest impact on long-term value creation and preservation?
• Are the critical decisions: setting the strategy; hiring/terminating CEO; approving CEOs strategic implementation plan; monitoring results of executing the CEOs plan?

#2 Do the directors understand the company?

A McKinsey survey of directors¹ revealed:

• 34% agreed their board fully comprehended strategies.
• 22% said boards completely aware of how firms created value.
• 16% said boards had strong understanding of industry dynamics.

#3 Does each individual director have the qualifications to make each critical decision?

• What have been each director’s past experiences in making each critical decision?
• What is each director’s relevant knowledge and experience regarding the industry, company strategy, and how the company creates value?
• What have been the past outcomes of each director assessing and selecting advisors?
• What are the value, morals, and ethics of each director?
• Do the directors have the interest, ability, and commitment to understand the company and its industry?

#4 Is there an effective board decision-making process?

• A McKinsey survey of executives² revealed 28% of executives thought good strategic decisions were frequent.
• Critical decisions are complex emotional, social, and political processes. Do the directors understand the typical flaws, and take mitigating actions?

#5 The director selection process is almost always flawed.

• Directors are ultimately responsible for the long-term success of the corporation.³
• The vast majority of public company directors fail to achieve long-term success.

Mark Leonard, CEO of Constellation Software, in his final annual CEO letter said:  “Qualified and competent Directors are very rare, and not surprisingly, the track record of most boards is awful. According to the 2017 Hendrik Bessembinder study of approximately 26,000 stocks in the CRSP database, only 4% of the stocks generated all of the stock market’s return in excess of one-month T-Bills during the last 90 years. The other 96% of the stocks generated, in aggregate, the T-Bill rate over that period. This means that 4% of boards oversaw all the long-term wealth creation by markets during that period. Even more disturbing, the boards for over 50% of public companies saw their businesses generate negative returns during their entire existence as public companies.”    http://www.csisoftware.com/wp-content/uploads/2018/04/Presidents-Letter-April-2018-Final.pdf

Few major companies survive for the long-term:

• 16% of major companies in 1962 survived until 1998.⁴
• Of the 500 companies in the S&P 500 in 1957, only 74 remained on the list in 1997. Only 12 of those 74 outperformed the 1957-1997 S&P index.  An investor who put money into the survivors would have done worse than someone who invested only in the index.⁴
• 31% of Fortune 500 companies went bankrupt or were acquired from 1995 to 2004.⁵
• 52% of Fortune 500 companies went bankrupt, were acquired, or disappeared between 2000-2015.⁶
• 50% of the S&P 500 will not be on the list in 10 years’ time.⁷
• Three-quarters of VC-backed firms do not even return all of the investors’ capital. Over 95% do not meet initial projections.⁸

Why are there so few qualified directors?

The background of many directors does not qualify them to make board-level decisions in today’s rapidly changing world.

• Many directors are business executive who were not CEOs or members of the C-suite. They were successful because they rose through the ranks of existing companies.  They never had to make company-wide decisions.
• Some directors are consultants, academics, and others who have never had major P&L or operational accountability.
• I wonder about why directors who are not qualified to occupy C-suite positions are qualified to make decisions such as whether to: hire a CEO or fire a CEO; sell the company; approve or reject the CEO’s strategy or budget, etc.

Your next steps:

• To enable discussion with your board and management, download the following one-page PDF.

What are the decision-making challenges faced by directors?

• Does each director state the board is ultimately responsible for the long-term success of the company? If the board does not agree on this, proceed no further.
• Document which are the critical board decisions.
• Define the value creation matrix: what skills, experience, values, morals, and ethics are required to make each of those decisions.
• Assess each director and remove the unqualified directors immediately, or at the next annual general meeting.
• Assess future director candidates using the value creation matrix.

This process must be repeated yearly.  In today’s fast-changing world, yesterday’s solutions are not always appropriate for tomorrow’s problems.  Remember: innovation, agility, and transformation start at the top – at the board.

 Footnotes

¹ “Corporate Boards need a facelift”, Eric Kutcher, McKinsey, May 04, 2018

² “The case for behavioural strategy”, McKinsey Quarterly, 2010 Number 2

³ Professor Didier and Estelle Metayer, “Does your board really add value to strategy?”, IMD, Global Board Center, https://www.imd.org/research-knowledge/articles/board-strategy/

⁴ “Creative Destruction – why companies that are built to last, underperform the market”, by Richard Foster & Sarah Kaplan

⁵ “Unstoppable” by Chris Zook, 2007, page 7

⁶ Accenture 2016

⁷ “2018 Longevity Report” by Innosight Consulting

⁸  Deborah Gage, “The venture capital secret: 3 out of 4 start-ups fail”, Wall Street Journal,  https://www.wsj.com/articles/SB10000872396390443720204578004980476429190, September 19, 2012

How can founders and investors create a Unanimous Shareholders Agreement?

1      Purpose of this document

2      How to read and use this document

3      What is a Founders Agreement?

4      What is a USA  (Unanimous Shareholders Agreement)?

4.1       What are the benefits of a USA?

5      How does a USA fit into the overall governance structure?

6      What are the stakeholder expectations?

7      What questions does the founders agreement address?

8      How does the term sheet reflect stakeholder expectations?

8.1       Questions to consider in the term sheet include:

9      How does the USA reflect stakeholder expectations?

9.1       Generic contents

9.2       Decision Making.

9.2.1        Shareholders.

9.2.2        Board of Directors.

9.3       Sale or transfer of shares

9.3.1        Forced shareholder exit

9.3.2        Shotgun provision.

9.3.3        Right of first refusal

9.3.4        Tag-a-long or piggyback.

9.3.5        Drag-along rights.

9.3.6        Option to purchase/call rights.

9.3.7        Option to sell/put right

9.3.8        Auction.

9.4       Issuing additional stock or options

9.5       Dispute resolution.

9.6       Information Rights

9.7       Amending the shareholders agreement.

 

1       Purpose of this document

This document is a tool to help the founders and shareholders of a private corporation develop a common understanding of expectations and objectives.  This common understanding can then enable lawyers to craft a USA (Unanimous Shareholders Agreement).  This tool can be used to both review an existing USA as well as craft a new or revised USA.

The critical action is to document the expectations of the founders and shareholders before starting to spend money on lawyers to develop a USA.  Once the expectations are documented, then any issue can be discussed and resolved, leading to a set of common expectations which can guide the lawyers.

This document poses a series of questions, to stimulate thinking and discussion.  This is not a comprehensive list of questions. It is up to the founders and shareholders to make decisions.  This document does not make recommendation nor does it provide legal advice.  Legal advice must be obtained from qualified lawyers.  A Strategic Advisor can help you think through your answers to the questions.

 

2       How to read and use this document

The co-founders and shareholders will be referred to as “stakeholders”.

The document is organized to 6 groups:

• What is a USA and what are the benefits?
• How does the USA fit into the overall governance structure?
• What are the stakeholder expectations?
• What is a founders agreement?
• How does the term sheet reflect stakeholder expectations?
• How does the USA reflect stakeholder expectations?

The point of view of each stakeholder should be documented for each question.

 

3       What is a USA  (Unanimous Shareholders Agreement)?

The Canada Business Corporations Act defines a USA as “…written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that restricts, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation.”  All shareholders must sign and be part of the USA

3.1      What are the benefits of a USA?

The USA typically contains provisions in two main areas: decision making and share transfers, which are particularly helpful in the case of deadlocks or an unexpected shift in share ownership as a result, for example, of the bankruptcy or death of a shareholder. A USA is generally recommended whenever there are two or more shareholders in a closely held corporation.

The process of establishing a USA defines expectations and creates provisions which will ideally prevent lengthy, expensive, and potentially damaging disputes in the future.

 

4       How does a USA fit into the overall governance structure?

Governance is simply the definition of who makes what company decisions and the process for making those decisions.

• The founders agreement may be used before there is any legal entity in order to define key decision making roles.
• The articles of incorporation may limit the actions and decision of stakeholders.
• The by-laws, which are approved by shareholders, limit the decisions and actions of the board of directors and management.
• The board of directors, according to the Canada Business Corporations Act “…shall manage, or supervise the management of, the business and affairs of a corporation.” The board of directors mandate may specify which decisions are reserved for the board
• Board of directors approved policies may constrain the decisions of management and the board. The board of course can approve an exception to any constraints it has placed on itself.  The Board of Directors committee mandates may specify which decisions are made by the committee.
• The Delegation of Authority to the CEO may specify that the CEO may make all decisions, subject to board of directors approved policies, and except those decisions specifically reserved for the board or shareholders. The Board of Directors and stakeholders still have the authority to veto any decision made by the CEO as well as make any decision which may have been delegated to the CEO.
• Loans, other financing, and other corporate agreements with third parties may have covenants which in specific situations may provide decision rights to third parties or limit the decision rights of the stakeholders.
• The USA may specify which decisions are reserved for shareholders and which for the board of directors. The USA takes precedence over any by-laws, board of directors decisions, board approved policies, and management decisions. A unanimous shareholders resolution may be able to make any legal decision, regardless of bylaws, existing unanimous shareholders agreement, or other governance documents, except for the articles of incorporation.  The company must file with Corporations Canada (if federally incorporated) to amend the articles of incorporation.
• Decision making authority and constraints may also be defined in other documents such as: Share Purchase Agreement or Investor Rights Agreement. Seek to reduce the number of documents which define decision making authority or constraints. Simplicity enables greater common understanding and reduces the costs of creating and maintaining legal documents.

 

 

5       What are the stakeholder expectations?

You should document the stakeholder expectations, which may include the following questions.  The intent is to identify where there are common expectations as well as disagreements. As the stakeholders review and discuss their expectations, they may revise their expectations.

The stakeholder expectations are the foundation for preparing the founders agreement, term sheet and USA.  When issues arise with the founders agreement, term sheet or USA, revisit and revise if necessary, the documented expectations. Do not attempt to come to agreement on expectations by spending large legal fee to revised term sheets and USAs.

In my experience, the agreement on stakeholder expectations may take several months.

• Why does the company exist?
• Why is the stakeholder involved?
  1. Make a positive impact on society?
  2. Have a positive impact on stakeholders reputation?
  3. Make money?
  4. Some other reason?
• What are the stakeholders’ specific objectives?
  1. Realize x times return on investment within y years?
  2. Sell the business within x years?
  3. Growing the value of the company year over year?
  4. What are the key milestones?
• What is the scope of the business?
  1. Geography?
  2. Nature of the business?
  3. What the business cannot do?
• What contribution will each stakeholder make?
  1. Capital?
  2. Introductions to potential customers?
  3. Introductions to potential employees?
  4. Introductions to potential suppliers?
  5. Expertise relevant to the business?
  6. Time devoted to the business?
• How will the stakeholder realize financial value from the business?
  1. Sale of equity?
  2. Sale of business, followed by cash to shareholders?
  3. Dividends?
  4. Fees, salary, or other compensation?
  5. Products and services provided by the business, perhaps at cost?
  6. Other ways?

 

6       What is a Founders Agreement?

The founders of a company may have an agreement before the company is incorporated and a shareholders agreement put into place.  This agreement may or may not be a legal document signed by the founders.  Even if signed, it may only be an intent rather than legally binding on future actions.

6.1      What questions does the founders agreement address?

The following are some of the questions a founders agreement may address.

• What objectives and timelines does each founder have for the startup and for themselves?
• Who gets what percentage of the company?
  1. Will the percentage depend upon vesting over time and continued involvement in the company?
• What will each founder contribute?
  1. Number of hours?
  2. Capital?
  3. Finding customers?
  4. Finding capital?
  5. Creating the product or service?
• How are key decisions made?
  1. Who will be the CEO?
  2. Unanimous? Majority? CEO only?
  3. What will be the founders salaries, if any?
• What if a founder wants to leave? Can the other founders buy the equity? And at what price?
• What happens if a founder becomes disabled or dies?
• What happens if a founder wants to sell the company or kill the company?
• What happens if it takes longer than expected to launch the company?
• Can a founder work on other startups while launching this company?
• What are reasons for removing a founder as an employee?
• What happens if a founder does not fulfill the founders agreement?
• If the business does not succeed, can a founder try again?
• How much of the company are the founders willing to give up for how much capital?

 

7       How does the term sheet reflect stakeholder expectations?

• Once the stakeholders have a set of shared expectations, with no fatal disagreements, a legal document know as the Term Sheet is prepared. The purpose of the term sheet is to outline the terms by which an investor will make a financial investment in company. The term sheet is not a legally binding document, with the exception of items such as confidentiality.
• There may be a negotiation process around the term sheet.
• Once the term sheet is signed, then the USA can be created (often with more negotiation) as well as the legal documents associated with funding and the other items in the term sheet.

7.1      Questions to consider in the term sheet include:

• What type of securities are being offered to investors? E.g. common stock? Class A preferred?
• What happens to the investors investment in the event the company is liquidated?
• What conversion rights, if any, will the security provide?
• What are the voting rights?
• What must be in the shareholders agreement?
  1. What will be the information rights?
  2. What key protections will the investor have?
  3. What pre-emptive rights will the investor have, to prevent dilution?
  4. What happens if any shareholder wished to sell?
  5. How are directors elected?
     1. Will the be a shareholder representative?
  6. How do you define “sale of the company”?
• What will be the size of the option pool?
• How many years will the share purchase agreement survive?
  1. Will there by any key representation and warranty items?
• What will be the founders terms?
  1. What will the founders transfer to the company e.g. intellectual property?
  2. Will the founders have an employment agreement?
  3. What are the terms regarding founders vesting?
• Will the company pay for investors legal fees?
• How long is the term sheet valid for?
• Will the founders be prohibited from soliciting other financing during the time the term sheet is valid?

 

8       How does the USA reflect stakeholder expectations?

8.1      Generic contents

Some of the generic contents include:

• Is there a table of contents for the shareholders agreement?
• Is there a statement that this is a unanimous shareholders agreement?
• Does the shareholders agreement relieve directors of obligations and liabilities regarding decisions make by the shareholders?
• Does the shareholders agreement prevail over articles of incorporation and by-laws?
• Is the business defined?
• Are the business objectives defined?
• Are there definitions and principles of interpretation?
• Confidentiality?
• List of shareholders and shares owned?

8.2      Decision Making

Which decisions are reserved for shareholders and which for directors? The following illustrates some possible decision.  These are neither recommendations nor advice as to who makes the decisions.

8.2.1     Shareholders

• Shareholder meetings
  1. How many shareholder meetings per year?
• Are there shareholder representatives and can those representatives bind the shareholders?
• What is quorum for shareholder meetings? Does the quorum consider any required representation from each shareholder?
• Do decisions of the shareholder representatives need to be unanimous?
• What decisions are reserved for shareholders?
  1. Changes to the shareholders agreement?
  2. Changes to capital?
  3. Changes to board size?
  4. Material changes to the business and business objectives?
  5. Mergers or acquisitions?
  6. Sale of the company or major assets?
  7. Going public via IPO or direct listing?
  8. Major financing?
  9. Approval of any contracts which limit the decision-making authority of the shareholders?
  10. Appointment of auditors?
  11. Appointment, termination, and compensation of CEO?

8.2.2     Board of Directors

• What happens if one of the directors dies or is incapacitated?
• Do specific stakeholders have the right to appoint a certain number of directors?
• Do founders have certain rights to nominate certain number of directors?
• Is the process for appointing board chair defined?
• How is director compensation (if any) set?
• What is the minimum number of yearly board meetings?
• What is the process for calling an emergency board meeting?
• What is board meeting quorum? What quorum requirements exist regarding director(s) nominated by each stakeholder?
• How many directors are required to approve a resolution?
• What are the specific decisions reserved for the board of directors, if any?
  1. Approval of strategic/business pans and related budgets? If so, what must be in these documents?
  2. Approval of material modifications to strategic/business plans and budgets?
  3. Appointment, termination, and compensation of all officers, other than the CEO?
  4. Financing?
  5. Capital expenditures?
  6. Dividends or other return of capital?
  7. Material accounting or tax policies?
  8. What committees, if any, of the board exist?
  9. What are the key responsibilities of each committee?
  10. How is the composition of each committee determined?
  11. Will the committees have any decision-making authority?
  12. What are the minimum number of yearly committee meetings?

8.3      Sale or transfer of shares

• What is the process?
• What are the restrictions?

8.3.1     Forced shareholder exit

• If a shareholder is an individual, what happens if: shareholder dies, is incapacitated, declares bankruptcy, divorces, etc.
• If a shareholder is a company, trust, etc. what happens if: there is a change of control, bankruptcy, change in leadership of the other company, etc.

8.3.2     Shotgun provision

• Is there a shotgun provision? (Usually only for a 50/50 two shareholder situation. Allows shareholder A to buy out shareholder B. After A makes the offer, then shareholder B can buy out shareholder A at the same price.)

8.3.3     Right of first refusal

• Is there a right of first refusal? (This gives a shareholder the option to purchase the shares of another shareholder before they are sold to a third party.)

8.3.4     Tag-a-long or piggyback

• Is there a tag-a-long right? (The minority shareholder has the option to block the sale of the majority shareholders, unless minority can sell at the same terms.)

8.3.5     Drag-along rights

• Are there drag-along rights? (The major shareholder has the option to force the minority shareholders to sell at the same terms)

8.3.6     Option to purchase/call rights

• Does a shareholder have the option to purchase the shares of another shareholder?
• What are the terms and conditions?

8.3.7     Option to sell/put right

• Does a shareholder have the right to force another shareholder to purchase the right holder’s shares?
• What are the terms and conditions?

8.3.8     Auction

• If there is a fundamental disagreement among the shareholders, is there an auction process. (Each shareholder would submit sealed bids for the shares in question. The highest bid wins the auction.

8.4      Issuing additional stock or options

• Who makes decisions regarding the size of the stock option pool and issues of stock options?
• Do existing shareholders have pre-emptive rights to purchase new shares issued?

8.5      Dispute resolution

• Is there a dispute resolution process?
• Is there binding arbitration?
• How is the arbitrator selected?

8.6      Information Rights

• What information must the corporation deliver to shareholders by what time?
• Must the corporation provide to shareholders other financial and business information requested by the shareholders?

8.7      Amending the shareholders agreement

• Is unanimous shareholder agreement required to amend the shareholders agreement or some percentage of the shareholders?

 

What is the value of a for-profit advisory board?

Advisory boards have a major impact on sales and productivity, comparing the three years after an advisory board vs the three years before an advisory board:  sales growth of 67% vs 23% and productivity growth of 6% vs 3%.¹

What is an advisory board?

A group of independent people who advise the CEO (or board of directors) on specific problems and meet on a regular basis.  The advisory board has no voting authority the and company has no legal obligation to follow advice.

The board is independent.  Ideally the members have no other business arrangement with the company other than being on the advisory board.  If the members have other financial arrangements, their advice may be biased.

How do you measure value?

There can be two sets of “hard metrics”, especially if it is possible to compare the times before and after the advisory board creation, as well as comparison of any improvements relative to industry benchmarks.

• What is the impact on sales, earnings, and productivity?
• What is the impact on key business milestones, growth, and innovation?

It can be difficult to establish a direct cause-and-effect relationship between the advisory board actions and business results.  A key indicator can be whether or not the advisory board impacts the decisions made by the CEO (or by the board of directors).

What are the major benefits of an advisory board, as perceived by companies with advisory boards?

85% believe that the advisory board had a significant impact on success.²

Some of the benefits, according to business leaders (rating on a scale of 1 to 10):³

• Is an essential tool 8.2
• Allows you to develop a broader vision 8.0
• Improves strategic business choices 8.0
• Forces management to look at the company 7.5
• Challenges the company’s management team 7.5
• Puts in place a better management structure 7.4
• Brings rigour in to the company 7.2
• Reassures shareholders and investors 7.2
• Avoids costly mistakes 6.7

What are some of the impacts of an advisory board, according to the business leaders (on a scale of 1 to 10):⁴

• Company vision 7.7
• Innovation 6.9
• Risk management 6.8
• Profitability 6.8
• Survival 6.6
• Sales growth 6.6
• Hiring the best employees 6.2

Who has advisory boards?

• 75% of SMEs (Small Medium Enterprises)⁵ have no board. 19% have a board of directors only. 6% have an advisory board (Half of those also have a board of directors)⁶
• 11% of companies with more than 100 employees have an advisory board.⁷

How do you recruit advisory boards?

56% of the advisories come from the company’s network, 8% from external recruiting such as associations, only 3% from company’s financial institution or investors.⁸

How do you organize an advisory board?

• You need to determine the skills and experience required on your advisory board. Look at you 3-5 year business forecast.  What are the opportunities and challenges over that time-horizon?  What is the talent (skills and experience) you need?  What are the talent gaps when you look at the management team (and board of directors) What is the talent you need on your advisory board.
• The written advisory board mandate must have the objectives, terms of reference and time commitment. Each advisor commits to reading preparatory documents, actively participating in the meetings and follow-up.  The mandate also addresses advisor out-of-pocket expenses and compensation (if any). If business development is a role, then there can be performance bonuses based on business development results.
• The mandate must be clear – are the advisors expected to act in the best interests of the owner(s) or the best interests of a broader set of stakeholders? For example, a recapitalization could provide capital to the owner but risk the long-term viability of the company.
• It must be clear how the company and advisory board interact. (e.g. meetings only with the CEO or including C-Suite members?  Are all questions (from management and advisors) funneled through the CEO?)  The advisory board may meet monthly, quarterly or as required.
• The role of the chair is crucial, working with management, the board of directors, and the advisory board members.
• The individual advisor roles must be clear, e.g. help develop business by opening doors, act as a company ambassador at social events, etc.
• Individual advisors bring specialized experience, knowledge and contacts which the board of directors does not have. The advisor capabilities are not a replacement for capabilities which should be on the board of directors or management, but rather be complementary.
• Each advisor must also have a degree of passion and interest in the business.
• The advisory board has simpler processes than a board of directors, does not require elections, term limits, committees, public disclosure, etc.

 Why don’t companies create advisory boards?

57% believe it is too much work.⁹

The creation of an advisory board does create more work for management, and more fact-based data collection and analysis.  The question for the CEO, board of directors, and/or owners is whether or not the increase in profitability warrants this additional work.

What does an advisory board cost?

The cost is driven by the value the advisors can create as well as the cash available.

• A small angel-investor-backed start-up may have a volunteer advisory board meeting on an adhoc basis or even once a year. Advisors will focus on survival issues, CEO coaching, and shifts in strategy.
• A growing company with 4-6 advisors may provide $15,000/yr compensation for each advisor, with more for the chair – and the time commitment may range from 60 to 125 hours a year. The advisors will focus on the long-term direction and initiatives which have a major impact on value growth and preservation.

Is your CEO or board of directors ready to create a formal advisory board?

The advisory board asks questions and challenges the CEO (or board of directors).  The advisory board does not prepare reports or analysis.

There are four criteria to determine if you are ready for an advisory board.

• There is a management team who can free up some of the CEO’s time. It can take the CEO 120-150 hours to setup and recruit and advisory board, plus another 60 hours per year for ongoing operations (this assumes 4 one day meetings per year of the advisory board).
• There is a strategic plan. This plan answers several questions:
  • Who are the target customers?
  • What problems or needs do they have?
  • What is your solution?
  • Why do the target customers perceive that your solution is a better value than the competition’s solutions?
  • Who is your team and what are their relevant skills and experience in understanding the customer and to deliver your solution?
  • How are you going to get customers?
  • What is your business model for delivering your solution?
• There is a 3-5 year financial plan, tied to the strategic plan. The financial plan has two components: the cashflow forecast, and the budget.  There is already a process in place to track budgets to actuals.
• You have a fact-based, analytical understanding of customers and their needs. This can include: identifying customer needs by reviewing notes of meetings and calls with customers, analyzing what customers buy and don’t buy, analyzing what customers look at in your newsletters and websites, focus groups, surveys, etc.  Once you have customers, the net promoter score survey becomes critical, especially as you analyze why the score changes.  You start your business with hopes and wishes as to what customer needs are.  As soon as you start communicating with customers, you must become fact-based.

If you don’t meet the above criteria, you are not ready for an advisory board.

 Next steps

To enable discussion with your investors, board and management, download the following one-page slide:

What is the value of a for-profit advisory board?

To create a formal advisory board, contact the Business Development Corporation of Canada, who have a proven process for creating advisory boards.

Footnotes

Advisory Boards: An untapped resource for businesses  March 2014  Business Development Bank of Canada https://www.bdc.ca/en/Documents/analysis_research/bdc_study_advisory_boards.PDF

¹ Page 1

² Page 10

³ Page 9

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⁵ Industry Canada definitions (2018 May 9): Small business: < $5 million in revenue, < 100 employees; Medium business: between $5 million and $20 million in revenue, 100 to 499 employees.

 Further Reading

Small company boards: Questions for advisors and directors.  CPA Canada https://www.cpacanada.ca/en/business-and-accounting-resources/strategy-risk-and-governance/corporate-governance/publications/potential-small-company-directors-advisors-questions

Survey: What is the role of advisory boards.     https://koorandassociates.org/further-reading/survey-what-is-the-role-of-advisory-boards/