Building a board is one of the first distinct steps in maturing a startup. You move from informal chats to structured governance. As you raise capital, you will encounter investors who demand a seat at the table.
Sometimes that seat comes with a vote. Sometimes it just comes with a voice.
This is where the concept of a Board Observer comes into play.
A Board Observer is an individual who is permitted to attend board meetings and receive all information provided to the board members. However, they do not have the legal right to vote on corporate matters.
They are essentially a passive participant with specific contractual rights to be in the room.
The Rights of an Observer
#The primary currency of a Board Observer is information.
While they cannot cast a vote on key decisions like budgets, hiring, or strategic pivots, they are generally entitled to the same information packet as the voting directors. This includes financial reports, operational updates, and strategic decks.
Observers typically have the ability to participate in discussions. They can ask questions. They can offer advice. They can influence the room.
However, their rights are contractual rather than statutory. This means their power is defined entirely by what is written in your Investors’ Rights Agreement or a side letter.
It is important to note that the board can exclude observers from certain parts of a meeting. This usually happens during executive sessions or when discussing sensitive legal matters.
Observer vs. Director
#The distinction between an Observer and a Director is not just about voting. It is about duty.
A Board Director has a fiduciary duty to the company and its shareholders. They must act in the best interest of the corporation. If they fail to do so, they face legal liability.
A Board Observer usually does not have fiduciary duties. They represent their specific firm or interest group. They are there to monitor their investment rather than govern the company legally.
This lack of fiduciary duty creates a unique dynamic. The Observer can advocate purely for their own interests without the legal conflict that a Director might face.
Strategic Considerations
#Why would a founder agree to having Observers?
It is often a negotiation tool during fundraising. You might have a significant investor who did not lead the round but put in enough capital to warrant insight into the company.
Granting an Observer seat allows you to satisfy that investor’s need for oversight without diluting the voting control of the current board.
It can also be a testing ground. You might use an Observer seat to vet a potential future independent director. You get to see how they interact with management and other board members before giving them a legal vote.
The Privilege Risk
#There is a specific legal nuance regarding attorney-client privilege that founders must understand.
Privilege generally covers communication between the company and its lawyers. Board Directors are within the circle of privilege because they are legal fiduciaries of the company.
Because Observers are third parties without fiduciary duties, their presence in a meeting where legal advice is discussed could potentially waive that privilege.
This means that if you are discussing a lawsuit or a regulatory issue with your general counsel, having an Observer in the room might make those conversations discoverable in court later.
Founders need to ask their counsel how to handle these specific scenarios. When should you ask the Observer to leave the room? It is a procedural question that requires a strict answer.