Day-to-day management of a UK company is delegated to the board of directors. Unless they are also (or have the right to appoint) directors, shareholders have, in fact, little involvement or day-to-day visibility in relation to how their companies are run. Typically, shareholders only have a say on key constitutional or statutory decisions (such as changes to the articles of association) and have limited access to company information. As a result, having some level of board involvement or oversight in relation to their investee companies is a key requirement of venture capital ("VC") investors.
Director appointment rights
It is not unusual for VC investors to require a right to appoint one or more non-executive directors to the board of an investee company (whether or not they make the appointment(s) in practice). A board seat provides visibility over strategy and performance, as well as a formal role in decision-making, making it an important tool in protecting the investment.
However, there is an important caveat.
All directors of UK companies are subject to the statutory directors’ duties set out in the Companies Act 2006 (as well as other fiduciary duties). Those duties include the duty to promote the success of the company for the benefit of the members as a whole and the duty to exercise independent judgement. This means that a director appointed by an investor cannot (at least legally) simply do what they think is in the best interests of that investor. This can create practical tensions where the interests of the company and the appointing investor diverge.
As a consequence, some investors may choose not to appoint a director, knowing they have the right to do so should they feel the need arises. In any case, how conflicts of interest are managed will be carefully set out in the investee company’s articles of association.
Board observers
Instead of (or as well as) the right to appoint a director, an investor may negotiate the right to appoint a board observer.
The right to appoint an observer sits somewhere between full participation in the board (through a nominated director) and having no routine involvement in the management of the investee company. While observers are typically entitled to attend board meetings and receive board materials (and even speak), they have no voting rights. As such they give investors access to board-level information and discussions without assuming the responsibilities of a director.
Observer rights are contractual and are usually set out in the investment agreement and/or the articles of association of the investee company.
Observers are often used where:
- the investment is relatively small;
- there is a need to minimise the size of the board; or
- the investor does not wish to incur the legal duties and potential liabilities of being a director.
In such scenarios, the investor will rely on protections within the investment agreement to ensure the right of veto over key management decisions that may impact its investment.
Notwithstanding the more limited role of an observer, they will have access to sensitive information about the investee company, and so companies need to consider confidentiality, conflicts of interest and the ability to exclude observers from board meetings in certain circumstances.
The role of non-executive directors
Depending on the size of the company and the investment, some investors may require the board to have a certain number of non-executive directors ("NEDs"). While NEDs do not have day-to-day involvement in the business (this is left to the 'executive' directors) they can provide oversight, business/sector experience and strategic input and they can also enhance the credibility of the company.
Even though NEDs have a more restricted role than executive directors, they are subject to the same directors' duties.
The investor and the founders may also agree to the appointment of an 'independent' director. An independent director is a non-executive director without prior ties to the founders, the investors or the company. They can bring crucial business or sector expertise to the company, help 'professionalise' the operations of the board, and provide an important arbiter/casting vote in the event of management and investors being evenly split on key decisions. It is not unusual for the independent director to act as chair of the board of directors.
Board committees
As a company grows, investors may expect the company to adopt a more formal governance structure, including board committees. Board committees can give focused oversight of key areas and provide additional control mechanisms.
Common examples include:
- Audit committee – overseeing financial reporting, risk and internal controls.
- Remuneration committee – setting executive pay and incentive arrangements.
- Nomination committee – addressing board composition and succession planning.
In VC-backed companies, committees usually include NEDs to safeguard independence and counter-balance management influence.
It is important that board committees have clear written terms of reference to define their remit and authority.
Practical takeaways
For companies:
- Consider carefully board composition at each funding stage, including the value added by NEDs and independent directors.
- Be mindful that directors appointed by investors must act in the company's interests.
- Consider using observer rights where appropriate to balance access and control.
- Consider introducing committees as the business grows and governance becomes more complex.
For investors:
- Assess whether a seat on the board is truly necessary or whether the right to appoint an observer is sufficient.
- Be mindful of the legal duties and potential liabilities of directors (including NEDs) and the need to actively manage conflicts of interest.
- Ensure governance rights are practical and clearly documented.
