Board Observer Rights
Venture capital firms and other equity investors commonly request the right to have an observer attend the board of director meetings of their portfolio companies. A board observer isn’t a director and therefore doesn’t have voting rights, generally doesn’t have a fiduciary obligation to the company or its shareholders, and typically doesn’t have the same right to indemnification to the same extent as actual members of the board of directors.
There is also no statutory or common law right that ensures investors will have the right to participate in board meetings, to have an observer attend board meetings, or to receive the information provided to board members.
Rather, these types of rights and obligations among the company, the investor and the observer are grounded solely in contractual agreements negotiated (or not negotiated) by the parties. Accordingly, there should be some thought and analysis around the creation and negotiation of these rights and obligations.
In some situations, a VC firm that is a major investor (i.e., investing over a certain dollar threshold in the financing round) with the right to appoint one or more members to a portfolio company’s board of directors may desire an ‘observer’ to attend board meetings, along with the VC’s director representative, as a way to train a more junior associate in the VC firm and/or to provide administrative support for the director representative (who may be serving on multiple boards).
In other situations, a VC that’s investing a comparably smaller amount than other investors (and who therefore does not have an actual representative member on the board directors) may desire an observer simply to obtain more information about its investment or to be able to provide input on the affairs and strategies of the company.
Regardless of the underlying investor reasons, since investors don’t have board participation rights without these types of specifically negotiated contractual commitments of the company, it’s common for investors to negotiate for them.
The company will want to consider the reasoning behind the investor’s request, as well as any potential negative impacts of having the influence of an additional person (albeit in a nonvoting capacity) present during the board’s discussions and deliberations.
And practically speaking, the lead investor will want to sign off on any other investor having the right to a board observer. Still, it is typical for a company to give certain major investors board observer rights, subject to certain company-protective provisions.
For example, the company will almost always make this right subject to the major investor maintaining a certain number or percentage of shares of preferred stock purchased at the initial closing of a financing round.
The agreement defining board observer rights will provide that the observer doesn’t have voting or veto rights over matters presented to the board of directors. It’s also standard that an observer be subject to confidentiality and non-disclosure obligations to the company.
Other company protections that are typically considered non-controversial include the right of the company to exclude the board observer from certain discussions and information if the observer’s attendance or access to information could result in a conflict of interest, or if the VC firm holding the observer right has a position in a competitor to the company, etc.
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