How To Build An Advisory Board?

An advisory board is a critical tool for getting your business to the next level. These 5 tips will get the right people around your table.

One of the smartest growth initiatives a business owner can implement is an advisory board: a hand-selected group of advisors that believe in your leadership, are aligned with your culture and mission, and are committed to your success.

The vast majority of business owners who implement an advisory board fail to see a strong return on investment because they haven’t followed guidelines to pick the right advisors, and haven’t set them up for success.

If you are considering implementing an advisory board, follow these first steps to attract and recruit your best advisors:

1: Complete your Values, Mission, Vision, and Strategic Plan first.

To create a comprehensive board search document, you must have your foundational elements constructed. What do you stand for, why do you exist, and where are you going? You must be able to articulate this to any prospective board member. In addition, you must be able to share your target customer profiles and your competitive landscape.

It is not the advisory board’s job to complete this work.

2: Select Advisors That Are Ahead of You.

Choose advisors that have already achieved what you are trying to achieve so that you can learn from both their successes and their mistakes. You don’t want to sit around a table with others that are exactly where you are.

For example, a company is currently at $60 million in revenue. The company expects to double in 18 months. It’s CFO has never managed the finances of a $120 million company. Therefore, they defined a board seat to attract a financial advisor who has run a company with revenues of more than $100 million.

Another example is a professional services firm that has developed a suite of products they want to bring to the market. This requires a re-engineering of their business model. They created a board seat definition to attract experts that have successfully pivoted their business models, so that they could advise their business of the many potential pitfalls.

3: Make Sure Your Advisors Fit Your Needs.

Are you expecting your advisors to only work with your C-level execs? Or do you want them mentoring your other employees? Are you expecting them to be available during meetings? Or only show up quarterly? Are you expecting your advisors to make key introductions to customers or investors? These are just 3 of the many considerations you must think about when selecting advisors.

4: Start Small.

An advisory board takes on a life of its own. In addition to running your company, you will have to manage the individual and collective contributions. Start with no more than 4 advisors. If you successfully identify your needs, you will be able to prioritize your top 4 seats.

5: Institute a One-Year Agreement with Each Advisor.

An advisory board is an evolving, dynamic entity that will likely change as your business grows. You want the option of re-evaluating each advisor at the end of each year to determine if they are aligned with your goals for the coming year, and if they have met your expectations.

We advise businesses to institute a restricted stock agreement if they are giving equity to their advisors so that they can buy back the stock at the termination of their service.

Aligning Advisors to Your Holes and Goals

Selecting the right advisors is just as important as selecting the right employees. The wrong advisors will be a waste of time and money, and can potentially lead you down the wrong path.

Especially in today’s rapidly changing environment, companies must constantly evaluate what types of expertise they need. For example, an expert in cybersecurity is now a critical addition to any board.

The more intentional you can be when selecting your advisors in aligning them to the “holes and goals” of your organization, the more successful they will be in helping you achieve your growth objectives.

Edited excerpt from Inc.

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What Is Corporate Social Responsibility (CSR)?

Corporate social responsibility (CSR) is a self-regulating business model that helps a company be socially accountable—to itself, its stakeholders, and the public. By practicing corporate social responsibility, also called corporate citizenship, companies can be conscious of the kind of impact they are having on all aspects of society, including economic, social, and environmental.

To engage in CSR means that, in the ordinary course of business, a company is operating in ways that enhance society and the environment, instead of contributing negatively to them.

Understanding Corporate Social Responsibility (CSR)

Corporate social responsibility is a broad concept that can take many forms depending on the company and industry. Through CSR programs, philanthropy, and volunteer efforts, businesses can benefit society while boosting their brands.

As important as CSR is for the community, it is equally valuable for a company. CSR activities can help forge a stronger bond between employees and corporations, boost morale and help both employees and employers feel more connected with the world around them.

Key Takeaways

  • Corporate social responsibility is important to both consumers and companies.
  • Starbucks is a leader in creating corporate social responsibility programs in many aspects of its business.
  • Corporate responsibility programs are a great way to raise moral in the workplace.

For a company to be socially responsible, it first needs to be accountable to itself and its shareholders. Often, companies that adopt CSR programs have grown their business to the point where they can give back to society. Thus, CSR is primarily a strategy of large corporations. Also, the more visible and successful a corporation is, the more responsibility it has to set standards of ethical behavior for its peers, competition, and industry.

Example of Corporate Social Responsibility

Starbucks has long been known for its keen sense of corporate social responsibility and commitment to sustainability and community welfare. According to the company, Starbucks has achieved many of its CSR milestones since it opened its doors. According to its 2019 Global Social Impact Report, these milestones include reaching 99% of ethically sourced coffee, creating a global network of farmers, pioneering green building throughout its stores, contributing millions of hours of community service, and creating a groundbreaking college program for its partner/employees.

Starbucks’ goals for 2020 and beyond include hiring 10,000 refugees, reducing the environmental impact of its cups, and engaging its employees in environmental leadership. Today there are many socially responsible companies whose brands are known for their CSR programs, such as Ben & Jerry’s ice cream and Everlane, a clothing retailer.

Special Considerations

In 2010, the International Organization for Standardization (ISO) released a set of voluntary standards meant to help companies implement corporate social responsibility. Unlike other ISO standards, ISO 26000 provides guidance rather than requirements because the nature of CSR is more qualitative than quantitative, and its standards cannot be certified.

Instead, ISO 26000 clarifies what social responsibility is and helps organizations translate CSR principles into practical actions. The standard is aimed at all types of organizations, regardless of their activity, size, or location. And, because many key stakeholders from around the world contributed to developing ISO 26000, this standard represents an international consensus.

By Jason Fernando in Investopedia

Top 2 Ways Corporations Raise Capital

Running a business requires a great deal of capital. Capital can take different forms, from human and labor capital to economic capital. But when most people hear the term “financial capital,” the first thing that comes to mind is usually money.

While it can mean different things, it isn’t necessarily untrue. Financial capital is represented by assets, securities, and yes, cash. Having access to cash can mean the difference between companies expanding or staying behind and being left in the lurch. But how can companies raise the capital they need to keep them going and to fund their future projects? And what options do they have available?

There are two types of capital that a company can use to fund operations: debt and equity. Prudent corporate finance practice involves determining the mix of debt and equity that is most cost-effective. This article examines both kinds of capital.

Key Takeaways

  • Businesses can use either debt or equity capital to raise money, where the cost of debt is usually lower than the cost of equity, given debt has recourse.
  • Debt capital comes in the form of loans or issues of corporate bonds. Equity capital comes in the form of cash in exchange for company ownership, usually through stocks.
  • Debt holders usually charge businesses interest, while equity holders rely on stock appreciation or dividends for a return.
  • Preferred equity has a senior claim on a company’s assets compared to common equity, making the cost of capital lower for preferred equity.

Debt Capital

Debt capital is also referred to as debt financing. Funding by means of debt capital happens when a company borrows money and agrees to pay it back to the lender at a later date. The most common types of debt capital companies use are loans and bonds, which larger companies use to fuel their expansion plans or to fund new projects. Smaller businesses may even use credit cards to raise their own capital.

A company looking to raise capital through debt may need to approach a bank for a loan, where the bank becomes the lender and the company becomes the debtor. In exchange for the loan, the bank charges interest, which the company will note, along with the loan, on its balance sheet.

The other option is to issue corporate bonds. These bonds are sold to investors—also known as bondholders or lenders—and mature after a certain date. Before reaching maturity, the company is responsible for issuing interest payments on the bond to investors. Because they generally come with a high amount of risk—the chances of default are higher than bonds issued by the government—they pay a much higher yield. The money raised from bond issuance can be used by the company for its expansion plans.

While this is a great way to raise much-needed money, debt capital does come with a downside: It comes with the additional burden of interest. This expense, incurred just for the privilege of accessing funds, is referred to as the cost of debt capital. Interest payments must be made to lenders regardless of business performance. In a low season or bad economy, a highly-leveraged company may have debt payments that exceed its revenue.

Example of Debt Capital

Let’s look at the loan scenario as an example. Assume a company takes out a $100,000 business loan from a bank that carries a 6% annual interest rate. If the loan is repaid one year later, the total amount repaid is $100,000 x 1.06, or $106,000. Of course, most loans are not repaid so quickly, so the actual amount of compounded interest on such a large loan can add up quickly.

Equity Capital

Equity capital, on the other hand, is generated not by borrowing, but by selling shares of company stock. If taking on more debt is not financially viable, a company can raise capital by selling additional shares. These can be either common shares or preferred shares.

Common stock gives shareholders voting rights but doesn’t really give them much else in terms of importance. They are at the bottom of the ladder, meaning their ownership isn’t prioritized as other shareholders are. If the company goes under or liquidates, other creditors and shareholders are paid first. Preferred shares are unique in that payment of a specified dividend is guaranteed before any such payments are made on common shares. In exchange, preferred shareholders have limited ownership rights and have no voting rights.

The primary benefit of raising equity capital is that, unlike debt capital, the company is not required to repay shareholder investment. Instead, the cost of equity capital refers to the amount of return on investment shareholders expect based on the performance of the larger market. These returns come from the payment of dividends and stock valuation.

The disadvantage to equity capital is that each shareholder owns a small piece of the company, so ownership becomes diluted. Business owners are also beholden to their shareholders and must ensure the company remains profitable to maintain an elevated stock valuation while continuing to pay any expected dividends.

Because preferred shareholders have a higher claim on company assets, the risk to preferred shareholders is lower than to common shareholders, who occupy the bottom of the payment food chain. Therefore, the cost of capital for the sale of preferred shares is lower than for the sale of common shares. In comparison, both types of equity capital are typically more costly than debt capital, since lenders are always guaranteed payment by law.

Example of Equity Capital

As mentioned above, some companies choose not to borrow more money to raise their capital. Perhaps they’re already leveraged and just can’t take on any more debt. They may turn to the market to raise some cash.

A startup company may raise capital through angel investors and venture capitalists. Private companies, on the other hand, may decide to go public by issuing an initial public offering (IPO). This is done by issuing stock on the primary market—usually to institutional investors—after which shares are traded on the secondary market by investors. For example, Facebook went public in May 2012, raising $16 billion in capital through its IPO, which put the company’s value at $104 billion.

The Bottom Line

Companies can raise capital through either debt financing or equity financing. Debt financing requires borrowing money from a bank or other lender or issuing corporate bonds. The full amount of the loan has to be paid back, plus interest, which is the cost of borrowing.

Equity financing involves giving up a percentage of ownership in a company to investors, who purchase shares of the company. This can either be done on a stock market for public companies, or for private companies, via private investors that receive a percentage of ownership.

Both types of financing have their pros and cons, and the right choice, or the right mix, will depend on the type of company, its current business profile, its financing needs, and its financial condition.

By Claire Boyte-White in Investopedia

Please contact Albert A. van Daalen for advice and support in Investment Services.

What Is the Lehman Formula?

The Lehman formula is a compensation formula developed by Lehman Brothers to determine the commission on investment banking or other business brokering services. Lehman Brothers developed the Lehman Formula, also known as the Lehman Scale Formula, in the 1960s while raising capital for corporate clients.

Key Takeaways

  • Lehman Brothers developed the Lehman formula to determine the commission an investment bank should receive for arranging client transactions.
  • Large investment banks work with corporations to raise capital, often through an initial public offering (IPO), a merger or acquisition, or through a spinoff.
  • For their services, an investment bank can charge flat fees for each transaction, earn commissions based on the dollar amount of the transaction, or a combination of both.
  • The Lehman formula structures the investment banking fee on a percentage of the transaction amount based on a set of tiered fees.

Understanding the Lehman Formula

As a provider of global investment banking services, Lehman Brothers needed a way to clearly convey to its potential clients the fees they would charge for their services. The advantage of the Lehman formula is that it’s easy to understand and easy for the client to quickly get a ballpark estimate on how much their transaction might cost them in fees. It’s not uncommon for large investment banking firms to assist clients with transactions worth hundreds of millions or billions of dollars. The Lehman formula structures the investment banking fee on a percentage of the transaction amount with a set of tiered fees.

How Investment Banks Earn Their Fees

Investment banks work with companies, governments, and agencies to raise money by issuing securities. An investment bank might help a company that has never issued stock to successfully complete its initial public offering (IPO). Other typical services that investment bankers provide include offering merger and acquisition (M&A) advice, developing reorganization strategies, or helping a company through a spinoff.

Investment banks make money in various ways. The can charge flat fees for each transaction, earn commissions based on the dollar amount of the transaction, or a combination of both. In the case of an IPO, an investment bank might provide underwriting services. The bank might buy stock in the IPO and then sell the shares to investors. The difference between what the bank purchased the IPO shares for and what they earn selling them to investors is the bank’s profit.

Examples of the Lehman Formula

The original structure of the Lehman Formula is a 5-4-3-2-1 ladder, as follows:

  • 5% of the first $1 million involved in the transaction
  • 4% of the second $1 million
  • 3% of the third $1 million
  • 2% of the fourth $1 million
  • 1% of everything thereafter (above $4 million)

Today, because of inflation, investment bankers often seek some multiple of the original Lehman Formula, such as the double Lehman Formula:

  • 10% of the first $1 million involved in the transaction
  • 8% of the second $1 million
  • 6% of the third $1 million
  • 4% of the fourth $1 million
  • 2% of everything thereafter (above $4 million)

A Brief History of Lehman Brothers

Lehman Brothers was previously considered one of the major players in the global banking and financial services industries. However, on Sept. 15, 2008, the firm declared bankruptcy, largely due to its exposure to subprime mortgages. Lehman Brothers also had a reputation for short selling in the market.

A subprime mortgage is a type of mortgage that is normally issued by a lending institution to borrowers with relatively poor credit ratings. These borrowers will generally not receive conventional mortgages given their larger-than-average risk of default. Due to this risk, lenders will often charge higher interest rates on subprime mortgages.

Lenders began issuing NINJA loans—a step beyond subprime mortgages—to people with no income, no job, and no assets. Many issuers also required no down payment for these mortgages. When the housing market began to decline, many borrowers found their home values lower than the mortgage they owed. Interest rates associated with these loans (called “teaser rates”) were variable, meaning they started low and ballooned over time, making it very hard for borrowers to pay down the principal of the mortgage. These loan structures resulted in a domino effect of defaults.

The bankruptcy of Lehman Brothers was one of the largest bankruptcy filings in U.S. history. Although the stock market was in modest decline prior to these events, the Lehman bankruptcy, coupled with the prior collapse of Bear Stearns, significantly depressed the major U.S. indexes in late Sept. and early Oct. 2008. After the fall of Lehman Brothers, the public became more knowledgeable about the forthcoming credit crisis and the recession of the late 2000s.

By Julia Kagan in Investopedia

What Is A Retainer Fee?

A retainer fee is an amount of money paid upfront to secure the services of a consultant, freelancer, lawyer, or other professional. A retainer fee is most commonly paid to individual third parties that have been engaged by the payer to perform a specific action on their behalf. These fees, almost always paid upfront, only ensure the commitment of the receiver. In addition, retainer fees usually do not represent the total final cost of the services provided.

Key Takeaways:

  • A retainer fee is a payment made to a professional, often a lawyer, by a client for future services.
  • Retainer fees do not guarantee an outcome or final product.
  • Portions of retainer fees can be refunded if services end up costing less than originally planned.

Understanding Retainer Fees

A retainer fee is an advance payment that’s made by a client to a professional, and it is considered a down payment on the future services rendered by that professional. Regardless of occupation, the retainer fee funds the initial expenses of the working relationship. For this reason, these types of fees usually remain in a separate account from the hourly wages of the consultant, freelancer, or lawyer. This ensures that money is not used for personal purposes before the services are fully performed.

The most common form of retainer fee applies to lawyers who, in most cases, require potential clients to provide an upfront retainer fee.

Example of a Retainer Fee

For example, a lawyer may charge a $500 retainer fee. If the lawyer charges a total of $100 an hour, the retainer covers all services up to the five-hour limit. The lawyer then bills the client for the cost of any additional hours they invest on behalf of the client.

In this example, if a trial case takes 10 hours of the lawyer’s time, the lawyer charges the client an additional $500, which comes to $1,000 when including the retainer. If the client’s case is resolved prior to reaching the five-hour limit, the lawyer refunds the remaining portion of the retainer to the client. If the case is resolved in three hours, for example, then the lawyer would refund $200 to the client.

Earned Retainer Fees vs. Unearned Retainer Fees

An unearned retainer fee refers to the initial payment of money that is held in a retainer account prior to any services being provided. Retainer fees are earned once services have been fully rendered.

In the example above, the retainer is considered unearned until the court case is closed and finalized. These unearned fees do not belong to the person performing the tasks, in this case, the lawyer until work actually begins. Any unearned retainer fees that are not used can be returned to the client.

Earned retainer fees, on the other hand, refer to the portion of the retainer that the lawyer is entitled to after work begins. Earned retainer fees may be granted to the lawyer bit by bit, depending on the number of hours worked. Distribution of retainer fees can also be based on tasks or milestones. For example, a lawyer may receive 25% of the retainer fee after completing the pre-trial process.

By Olivia Lagarde in Investopedia