Are Board Observers A Good Idea For A Startup?
A shorter version of this story was published in Crunchbase News on 10/28/2024.
A well-rounded board can be the difference between scaling the next unicorn and languishing in the land of mediocrity, so let’s tackle the strategic question of whether your startup’s board should be limited to regular board members (voting) or allow board observers (non-voting) to join.
Genesis of Board Observers
Board observers have existed for decades, initially emerging as a way for investors to monitor their investments without wielding full voting power. Over time, their role has evolved, with more startups and private companies embracing this structure. While approximately 20–30% of corporate boards include board observers, the percentage is even higher among private companies, especially in sectors that rely heavily on VC funding.
Pros of Having Board Observers
- Access to Expertise and Diverse Perspectives: Board observers can bring invaluable insights and a fresh perspective, especially if they have deep industry knowledge.
- Additional Source of Sales Leads and Investments: Observers often have a network that can be used to identify new business opportunities and potential investors.
- A Stepping Stone to a Regular Board Seat: For emerging leaders, serving as an observer is a great way to gain experience before transitioning to a full board member role.
Cons of Having Board Observers
- Access to Confidential Information: The more people have access to sensitive information, the harder it is to maintain control.
- Potential Over-Influence: Even without a vote, observers can sway board decisions, sometimes unduly.
- Unclear Roles: The lack of clarity around what observers should and shouldn’t do can lead to confusion and inefficiency.
- Complications During Crises: Having observers in high-stress situations can slow decision-making or create awkward dynamics when tough calls are needed.
What Legal Experts and VC Thought Leaders Think
Not surprisingly, legal and financial professionals have substantial differences of opinion on the value of having a board observer. The most significant argument of those in favor is the objectivity an independent observer brings to the table, as well as a way for VCs to monitor how their investment is doing:
Nizan Geslevich Packin, Professor of Law, Baruch College — “This role is particularly valuable within the VC and startup ecosystem, where board observers help maintain a crucial balance between investor control and entrepreneurial freedom. Their presence can significantly impact a company’s strategic direction, providing a discreet yet influential way to guide company strategy and governance.”
Attorney Stan Doida at Doida Crow — “Angel investors and venture capitalists often look for ways they can monitor their investments and gain pertinent information on startups in which they invest. One way investors and investment firms can access this information is by being granted board observer rights.”
Many venture capitalists oppose including board observer positions on a board primarily object due to the complexity and lack of consensus it can create:
Brad Feld, Co-Founder of Foundry — “Over the last few years, I’ve become very anti-board observer. I’ve been on several boards where the CEO didn’t allow board observers in the meeting. I’ve been on several boards where there were observers in the room, but they weren’t allowed to sit at the board table and could only “observe”…the quality and level of discussion in the board meeting was dramatically higher.”
Mark Suster, Partner at Upfront Ventures: “My golden rule is you should try to get legal or verbal agreement that board observers are silent unless called on and set the tenor as such or you’ll find that your 5-person board is really an 8-person “board.” This is true for whatever reason the board observer is present.”
I recently conducted a LinkedIn survey about the value of including a board observer on a startup board. Most respondents (62%) thought it would be of marginal value, while about a quarter thought it would be worth doing. The balance of the respondents weren’t sure about the value of doing this.
When A Board Observer Might Be Right For A Startup (and Some Alternatives):
- Securing New Investors: If having an observer is a critical factor in getting a new investor on board, that might be worth doing, but consider whether creating a regular board seat for them might be a better solution.
- Need for Expertise or Sales Leads: If their expertise or network is crucial, that could be worthwhile, but consider hiring them as advisors or consultants as a viable alternative.
- Training Up-and-Coming VC Partners: While it’s beneficial for VCs to train their partners, if you decide to do this, try to ensure that adding a board observer seat doesn’t decrease your board’s overall effectiveness.
Conclusion
While board observers can offer valuable insights, most startups may find the risks outweigh the benefits. A streamlined, unified board with clear accountability often leads to more effective decision-making.
Thomvest works with founders and business leaders who have created an outstanding branded portfolio of fintech, proptech, cloud infrastructure, and cybersecurity companies. We’d love to hear from you if there is something we can do to help your startup succeed in any of these categories (including helping you build a great board). You can reach me at kip@thomvest.com.
