Board Seat, Board Observer, or Information Rights?
Are you considering investing in a new startup? Whether you are a potential investor or a startup founder trying to think like an investor, it is essential to understand the most common ways in which investors obtain information about the company they are investing in and how they can have and exercise governance rights. Before any equity financing agreements are reached, and even before the term sheet, what should investors be considering when it comes to watching their investments?
Generally speaking, there are three forms of representation that are the most common: board seat, board observer, and information rights, with very different price tags. A board seat carries fiduciary duties and liability exposure, while observer status and information rights result in the most visibility with less risk. Our startup lawyers can explain in more detail.
Board Seat
When it comes to board composition for a startup or any other corporation, a board seat (also known as a board director seat) is a formal position on the board for the investor that comes with voting rights. As a result, not only does an investor holding a board seat participate in decision-making processes, but they actually have a voting say and thus a “direct say in company decisions,” according to HSBC. For investors, a board seat also comes with fiduciary duties and liability exposure, as we noted above, so it may be an investor’s preference to have board observer rights instead of holding a board director seat.
Board Observer
How are a board observer’s rights different from a board director’s? A board observer does not have voting rights (and thus has less visibility and liability exposure), but a board observer still participates in board meetings and can play a significant role in discussions and decision-making processes leading up to a vote. Beware of the broad exclusion rights for an observer. The company will want the right to exclude an observer if there is a conflict of interest or competitive activity, but they sometimes ask for that exclusion to extend to sensitive or confidential information, which can be interpreted incredibly broadly.
Information Rights
Information rights result in an investor having the least amount of involvement in the company while still being able to keep a watchful eye on their investment. With information rights, an investor does not attend board meetings but instead receives regular updates about the company, which may occur on a monthly basis, a quarterly basis, or at another agreed interval. These rights to financial and operational information concerning the company are typically negotiated during funding in an Investor Rights Agreement (IRA).
Match Your Board Rights to the Risk You Want
Do you have questions about what exactly it is that investors and founders are agreeing to in the process of equity financing and the granting of governance rights and company ownership? Investors and founders alike should have a clear understanding of the distinctions among board seat, board observer, and information rights prior to entering into an agreement. If you have questions or want to learn more, one of the startup attorneys at Triumph Law can speak with you today. Contact our firm to learn more about the legal assistance we provide for individuals and entities involved in startups.
Source:
hsbcinnovationbanking.com/il/en/resources/understanding-board-composition