No, you don’t have to give a board seat to your new investor if you don’t want to.
In practice, there are a lot of investors out there that do not even care whether they get a board seat or not. In our work as a startup lawyer, we’ve come across early-stage pre-seed venture capitals that do not even bother appointing a board member to their portfolio companies (despite having such a right in the first place spelt out in their shareholders agreement).
If you’re a first time founder, this can be confusing when you ask around and discover that there are also investors out there that would walk away from a deal if you won’t give them their right to appoint a board member in your startup.
So what’s with the different perspectives?
Why certain investors do not ask for a board seat?
Firstly, there’s no company law that says that you need to give a board seat to everyone that decides to invest in your company. although there law is silent on how many directors that a private company needs to have,
In practice, coming on board as a director in a startup (as an investor nominee rep) comes with a set of legal risks. As a director, you are expected to ensure that you perform your duties and obligations in the best interest of the startup’s business. This means that being ready during board meetings and to know about the startup’s ongoing business dealings to add value during the board meetings.
Also, if you’re a director, there are various statutory duties that will be imposed against you in your personal capacity if the startup fails to comply. The usual example is when it comes to employment laws. If a startup hires people and the startup ended up failing to ensure that the usual statutory deductions and salaries of the staff are paid on the time, the directors of the startup can be personally liable. In other words, you can get fined and sued in court with your name appearing as one of the defendants in a court case.
Another reason is due to the practical commitments issues. If you’re a venture partner in an early stage venture fund, it may not be possible for you to be sitting as a board member for over 10 investee companies in your portfolios.
So what are the alternatives I can suggest to my investor?
Board observer as the usual alternative
The most popular alternative by venture funds and investors nowadays would be to appoint a board observer instead. Just take note that under the companies law, there is no such thing as a ‘board observer’. The right to appoint a ‘board observer’ therefore is a contractual agreement that can be agreed upon between shareholders for a certain shareholder (i.e. the investor) to get additional rights such as notice to attend board meetings, receive all the board pack (eg, minutes, reports, and board agenda) that will be discussed during the board meeting including presenting his or her views as an observer during the board meetings (as and when such meeting is convened).
It’s not really necessary
Now that you know there is no legal requirement to have an investor be given the right to appoint a board member, the investor can still control your key major decisions as a founder in your startup using the reserved matters clause (usually incorporated in the shareholder’s agreement). Therefore, the question as to whether the investor gets a board seat is academic.
“Capping” the right to a board seat
Another usual option that you can suggest to the investor if the investor insists on having such a right is to “cap” the right (for such an investor to appoint a director) in your startup based on a certain threshold. For instance, so long as the investor holds a certain number of shares or equity interest in your startup. For instance, if a VC subscribes to ordinary shares in your company and holds 10% equity interest on a fully diluted basis, you can put in an agreement that the right for such VC to appoint a director will subsist until the 10% is diluted.
What this means is that when you decide to start your next funding round, assuming that the VC decides not to join in and participate in the future round to maintain its equity interest the current VC’s shares may likely end up getting diluted and as a result, they would lose such right.
In practice, every time there is a new investor that is coming into your company, the entire shareholders agreement may end up getting re-negotiated again. So you want to spend time doing due diligence on your own potential investor (whether it is an angel investor and its pros and cons) if they are indeed a right fit and share the same vision with you in terms of the growth trajectory for your company.
So the next time you talk to an investor that insists on having a board seat in the company you should be able to push back and carefully suggest several alternatives in the industry.