Only a third of family businesses survive from the founding generation to the next. They often struggle with planning for the retirement, death or incapacity of the founder, or don’t have any plan at all.
The most likely source of guidance, the board of directors at the time of the founder’s death, may consist only of the successor owner. Management succession ideally occurs gradually during the life of the founder. Another predictor of success is when the owner cultivates promising talent who can aid in a smooth transition. However, more may be necessary to ensure that the successors are equipped to lead. The establishment of an advisory board is essential.
For many entrepreneurs, the decision to involve outsiders in their business is difficult. Some simply do not want to dilute their control by establishing an independent board of directors with formal responsibilities and authority. But appointing an advisory board can enable a family business to address challenging succession issues in an effective and timely manner. An advisory board can help a founder come to terms with management succession by enabling him or her to become comfortable with providing information to, and accepting advice from, an external group.
Because the owner is not giving up actual control, an advisory board is generally perceived as less threatening.
Typically, an advisory board would consist of family members, current key executives and/or trusted company advisors. This group can provide non-binding but informed guidance to the founder, and at his death, can transition into a more formal board of directors.
Establishing an Advisory Board
To begin with, the founder (and any existing board) should consider establishing a charter that defines the advisory board’s purpose, membership, meeting frequency, guidelines for the conduct of meetings, responsibilities of members and a disclaimer of fiduciary duties.
The first issues to be addressed by the advisory board should typically include developing a management succession plan, an ownership succession plan, a plan for an emergency transition of management (for example, if the founder dies unexpectedly), and an incentive and retention plan for key employees.
Like a board of directors, an advisory board should be built carefully. It will often be best to grow the board from a fairly small size. Group dynamics suggest a maximum size of eight or so, unless the advisory board’s mandate requires more significant representation. The advisory board should be composed of members who the founder respects and who are comfortable challenging the founder when appropriate.
Advisory board members tend not to be involved in the day-to-day affairs of the business. Accordingly, in order to be effective, members must be provided with suitable information. All too often, meetings are held with few materials being distributed in advance, with the result that meeting time is spent providing background information. While some data-dumping presentations are beneficial, they are less valuable than obtaining the advice of board members. That advice is likely to be more useful when it can be given after reflecting on relevant materials delivered well in advance.
Occasionally, concerns about confidentiality give rise to decisions to limit the amount of information provided to the advisory board. These concerns must be overcome through careful planning.
Because advisory board members do not act as corporate directors, it is possible to furnish them with relevant information without providing them with the additional information that would be needed by actual corporate directors.
Written confidentiality agreements may be helpful, not only as legal tools, but also to remind advisory board members of their commitment to confidentiality. It is a good practice to refresh confidentiality agreements periodically.
It is critical to recruit and retain thoughtful and active advisory board members. Despite best intentions, not every board member will prove to be a good fit. Since members may take removal as personal criticism, it may be useful to appoint members to specific terms so that an active step has to be taken to renew membership.
Compensation for advisory board membership can help to ensure that requests for assistance will be taken seriously and that thoughtful advice will be provided. This compensation will almost always be substantially lower than that required for corporate directors or comparably-skilled consultants. However, to obtain the desired benefit from an advisory board, the financial commitment may need to be substantial.
Advisory board members choose to serve an enterprise for a variety of reasons. These range from ties of personal loyalty to direct compensation. Consideration for service may consist of the prestige, camaraderie and personal networking benefits that are involved, a personal favor, interest in the mission of the business, cash or stock, stock options, reimbursement for the costs associated with meetings or retention as consultants.
No single formula is right; each enterprise should consider the sorts of payment mechanisms described above and their attendant benefits and risks.
Advisory board members are unlikely to face significant liabilities stemming from their duties. While actual directors expose themselves to a variety of legislated liabilities and to fiduciary and other duties that can lead to civil or regulatory liability, it is unlikely that an advisory board member could be subject to such duties.
Statutory responsibilities apply to corporate directors only. An advisory board member would have to take a much more active role in the management of a business than should ever be contemplated in an advisory board position before there could be any realistic risk that liability could be attached to advisory board members.
Developing an advisory board involves careful planning, but the effort will almost certainly result in a more successful transition of the business. An effective advisory board can serve as a powerful ally for the founder of a family business. It can make the transition from one generation of managers to the next less threatening for all involved and is more likely to result in the continued implementation of the founder’s vision.
Steven M. Burke is director of the Tax, Trusts and Estates, and Corporate Departments at the McLane Middleton law firm based in Manchester. Catherine H. Hines is an associate in the firm’s tax department. For more information, visit McLane.com.