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Board observer rights: How should they be structured?

Last year, after OpenAI’s CEO Sam Altman’s sudden departure, a key investor, Microsoft, brokered an agreement that brought him back into the company. As part of the deal, Microsoft also received a board observer role. This observer role provides them with closer insight into OpenAI’s governance. How does board observer right work and how should they be structured?

Angel investors and venture capitalists (VC) want to monitor their investments and get latest updates on startups in which they invest. One way that investors can access this information is by being granted board observer rights. In this post we  will go through the basics of the board observer rights and things you should know as a founder when dealing with an investor requesting for such board observer rights.

Board observer rights  – how does it work?

A board observer is a contractual right provided to a specific investor in a company. The terms of the appointment and the rights of a board observer are usually found inside the shareholders agreement or a board observer side letter. 

An investor who has been granted with board observer rights may appoint a board observer. The company will ensure that the nominee receives all notice to meetings including the board papers. The observer may attend meetings of the startup or company’s board of directors. The observer is also usually entitled to participate in board meetings and present his or her views during the meetings, and report back on relevant events to other members of their investment team. 

Ordinarily, observers are not afforded voting rights. However, if it is a financial investor like a VC or a corporate, such investor may have likely addressed this non-voting issue by imposing an affirmative vote requirement on certain reserved matters (which is incorporated inside the shareholders agreement). 

Considering that there is no specific formula on who gets to be a board observer, any investor with at least 1% stake and 10% stake may negotiate in the investment condition that he or she may be granted the board observer rights.

Unlike directors of the company, board observers are not formal members of the board. Legally, board observers are not bound by the statutory and fiduciary duties imposed on the directors of the company. Because of compliance and governance issues, the current industry practice is that investors may usually prefer to have the board observer status as opposed to nominating a director in the company. For instance, a company that fails to comply with the statutory filings or employer’s obligations may expose directors to criminal liabilities in their personal capacity and are personally liable. 

Conclusion

Board observer rights are not defined under the companies law. In other words, the scope of the board observer rights that will be granted by the company to a board observer are usually covered inside a shareholders agreement or a side letter.

If you are planning to raise funds and looking for a startup lawyer on how to ensure that the investment agreements and documents are industry standard and legally compliant, please contact us today for a free initial legal consultation.

Disclaimer: The content provided on this website does not constitute legal advice but are for general informational purposes only. It may not be the most up-to-date legal information after the published date. To seek professional legal advice, please book in a free initial 30 mins legal consult with us.

Picture of Izwan Zakaria

Izwan Zakaria

Izwan likes to write about startups. He enjoys working and mentoring entrepreneurs and founders. He is also a startup lawyer at Izwan & Partners.

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