Explaining investment terms: Board of directors / board observer
Venture capital investors require that the company has an appropriate board of directors. In accordance with what is regarded as UK corporate governance best practice, investors usually prefer the board to have a majority of non-executive directors (i.e. directors who are not employees of the company). Although having a majority of non-executives may be impractical for small companies, it is usual for such companies to have at least one or two non-executive directors. One or more of the non-executive directors will be appointed by the investors under rights granted to them in the investment documentation. Some investors will never appoint a director because of potential conflicts of interest and liability issues, and will instead require the right to appoint a board observer, who can attend all board meetings, but who will not participate in any board decisions. In general, the board of directors tends to meet once a month, particularly for early stage companies with active investors on the Board.
In many cases, investors will require that the Board has a Remuneration or Compensation Committee to decide on compensation for company executives, including share option grants (see Employee share option plan), as well as an Audit Committee to oversee financial reporting. These committees will be made up entirely, or of a majority, of non-executive directors and will include the directors appointed by the investors. Each of these committees should have its own mandate set out in writing.
By law, like all directors, the investor directors' responsibilities are to act in the interest of the company rather than as a representative of the funds that they manage (see Duties and liabilities of company directors). Often venture capitalists separate the investment decisions for the funds invested in the companies, from the investor director's decisions, in order to avoid conflicts of interests for the investor directors. This separation is typically done by having another investment executive representing the funds' interests when dealing with the company with respect to the investor consent matters.
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