Investor Directors & Observers
When seeking investment to grow your company, an investor may wish to appoint a director to the company’s board. This provides the investor with comfort and a level of control in your company; and helps to further the working relationship between the two of you.
How will appointing an Investor Director affect my business?
The first concern that many business owners may have when they hear the proposition of an investor director is that they will lose control. However, whilst the person nominated by the investor to be the director will form part of the board and typically will receive the same rights as other directors (usually the right to receive information about the company and to receive notice of, attend and participate in, board meetings), this fear is vastly unfounded. Typically, an investor is only likely to ask for board representation if their investment represents a sizeable slug of the equity, usually at least 10%. The investor director(s) in most circumstances should only ever represent one third of a three-person board and two fifths of a five-person board. Accordingly, in such circumstances they will not hold a direct voting majority over you and your other founding members, albeit the consent of an investment director may be necessary for certain matters.
What can an Investment Director control?
Matters requiring the consent of an investor director can vary depending on the nature of the investment and may extend to matters such as engaging employees (perhaps over a certain salary threshold) or entering into certain contracts (again, perhaps those which are in excess of an agreed financial threshold). At the very least, key matters such as transferring shares, incurring significant debt, making acquisitions, disposing of the entire or a significant part of the business, undergoing an exit and entering into an insolvency event will all require investor director consent. This is because these events all directly impact on the investor’s investment and therefore the investor will, understandably, require input on and control over such decisions.
The circumstances that require investor director consent, the investor director’s conduct and the investor’s right to appoint an investor director in the first place will usually be granted and governed either by a shareholders’ agreement or the company’s articles of association. Depending on the nature of the investment and the relative bargaining positions of your company and the investor, these matters may be open to some negotiation.
How will appointing an Observer affect my business?
As an alternative to appointing a director, an investor may wish to appoint a board observer, who will attend and observe board meetings but who does not formally sit on the board. The rights held by a board observer will mostly mirror those of an investor director’s, especially in respect of receiving company information, save for one fundamental difference: an observer does not have any vote on board decisions. As with investor directors, the rights of any observer will usually be granted by either a shareholders’ agreement or the company’s articles of association.
When considering if an investor director or board observer would be more appropriate for your company, there are some advantages of utilising observers that should be noted in particular:~
- If your company has received multiple rounds of equity investment, providing a board position to each investor may lead to an ultimately unmanageable board that will only prove to stunt your company’s growth. By each investor having a board observer, the investor still receives an informed view without being an administrative burden on your company.
- Additionally, observers can provide greater flexibility to your company particularly if your investor is an institutional investor as they can send various members of their team to the board meeting as the observer(s), therefore providing a great variety of expertise and guidance to your company.
However, the appointment of a board observer over an investor director is not without its disadvantages. Notably, as the observer is not a director of the company, they do not owe the company the usual legal duties that protect the company. Nevertheless, key duties such as confidentiality will almost certainly be catered for through the investment documentation to provide your company with the necessary protection.
What would be best for my business?
Ultimately, the decision on whether you have an investor director, an observer or a combination of both will depend on the fit with your business. There is no single formula proven to work in all circumstances and achieving a working environment that functions for your company and your investor will be significant in making both the investment and your growing business a success.
If you’re going through an investment process and are contemplating allowing an investor a position as either a director or observer, or if you have any queries more generally about the investment process, please get in touch with Kirsty Simmonds or you can give us a call on 0345 070 6000.