Term Sheets: What are management and observer rights?
This week we continue our series on key VC financing deal terms.
This week’s question: What do I need to know about management and observer rights?
Our answer: Management rights are typically granted through a management rights letter (MRL). An MRL provides investors with rights to consult with management on significant business matters and propose regular meetings to review strategic progress. It may also grant information and inspection rights, including access to financials, facilities, and non-confidential records to monitor business performance. Observer rights may also be granted, allowing an investor’s representative to attend board meetings in a non-voting capacity and receive all board materials. These rights typically terminate if the investor’s equity stake is below a minimum threshold or there is a major liquidity event (e.g., sale, merger, or IPO). Our recommendation is to ensure that the rights you offer are standard based on consulting with your startup’s counsel and using NVCA model documents as a baseline.
Key Considerations
1. Observer v. Director Negotiations. While lead investors may ask for an MRL as a standard non-negotiable part of their investment, a board seat v. a board observer is often negotiable. Observer rights are often a useful compromise (especially in early-stage rounds) when you're looking to limit the number of formal board seats. Be strategic about how you make decisions about these roles because they will shape your startup’s future fundraising, governance and board composition.
2. Carveouts. Ensure that you restrict access to information or attendance in meetings for board observers if it would be necessary to preserve attorney-client privilege, trade secrets, or protect confidential proprietary data. You should have guardrails to protect your company’s most sensitive information.
3. Eliminate Redundancy. You may want to push for the investor to have either a board seat or a board observer role, but not both, to avoid redundancy because a board member already has access to financials, can consult directly with management, and has inspection rights as part of their duties. For example, if an investor already has a board seat and wants a board seat, then you can make the observer seat conditional on the investor losing the board seat.
Why It Matters
Management and observer rights enable investors to participate in financing rounds without triggering fiduciary duties. When thoughtfully negotiated they strike a balance of transparency, influence, and control between founder autonomy and investor oversight, while MRLs build investor confidence by providing access to the company without the startup ceding agency over its mission and financial health.
