The Invisible Man – the role of board observers – what are they and do we need them?

When one considers a traditional board meeting, one often envisages a private meeting between statutory directors making vital company decisions away from prying eyes. However, in light of a sometimes turbulent economic landscape, risk-averse investors are increasingly demanding more transparency regarding how the business is run. As a result, the concept of board observers is becoming a popular mechanism in private companies, as businesses attempt to strike an effective balance between the directors retaining ultimate control over corporate governance and the investors receiving sufficient goodwill for their investments. So what exactly is a board observer, and what are the associated benefits and challenges in relation to their appointments?

Challenger or passive presence?

A board observer is an individual who is permitted to observe and participate in director board meetings without formally being able to vote. Typically, board observers are majority shareholders, or their representatives, who are appointed either via contract or the company’s articles of association rather than statute. Board observer rights are often provided as a compromise for not having a formal directorship. Given that the majority of decisions affecting the day-to-day operations and management of the company are usually reserved to board level, board observer rights provide investors with the necessary confidence and comfort that their investments are being put to good use and that the directors are dealing with the business appropriately. It is almost becoming a given right or expectation that investors be offered more than dividends for their money, and many major investors are now requiring more immediate access to company information in order to safeguard their investments.

Whilst undeniably observers can provide valuable input in a discreet yet influential manner, in the past board observers have generally been barred from speaking at board meetings. Yet this is gradually changing and we are seeing previously silent observers, or “the invisible man” one may say, being given speaking rights and the opportunity to participate in the company’s decision-making process as an extra perk for their investments. However with no formal voting rights, observers cannot always fully make an impact on how the business is run, and this limitation can sometimes lead to frustration when their seemingly invisible voices go unheard. Conversely, directors may feel that some board observers do not merely observe, and instead take up too much air time in the board room, which can be laborious for directors who often only have short quarterly meetings to cover numerous agenda items. This can, moreover, lead to conflict especially if directors, acting reasonably in the best interests of the company, fail to adopt the observers’ potentially well-considered and rationalised recommendations.

It may be that the directors perceive that an observer may have a conflict of interest on a particular topic and cannot therefore be deemed to be truly objective and impartial, even though observers are not technically subject to fiduciary duties like their director counterparts. That being said, although not having any official responsibilities towards the company, an observer should still take care not encroach on being regarded as either a shadow director or a “de facto” director of the company. The Companies Act 2006 defines a shadow director as merely “a person in accordance with whose directions or instructions the directors of the company are accustomed to act”. Therefore, board observers should ensure that that it is clear that any contributions they make during board meetings are merely suggestions and are not intended to be directions or instructions to which the directors must adhere, to avoid being subject to formal director duties themselves.

Unseen benefits

Despite the possible tension on board dynamics, observers undoubtedly bring with them a range of unique benefits which are conducive to helping drive the company forward. Such advantages include the observers’ industry knowledge and sector expertise, offering seasoned insight, different perspectives and fresh ideas which can be especially important for early stage companies with relatively little experience. Indeed, having board observers can also be a cost-effective method of gaining access to ongoing advice and support when navigating uncharted issues as they arise, without the financial commitment of directorial expense.

Companies may even get more value beyond the money received when observers open up their networks and introduce the board to new industry contacts. This is equally true when considering an observer’s unofficial role in bridging the gap between the board’s interests and company shareholders’ concerns. In addition to facilitating improved communication and transparency, observers can also contribute to enhanced corporate governance and accountability, by keeping directors accountable in relation to the relevant legal and regulatory standards. Ultimately, notwithstanding the non-financial gains, companies need investment to grow and scale, and board observer seats offer a more attractive proposition for investors and may be the deciding factor in whether to invest.

With observers becoming more commonplace in the board room and taking a more visible role in influencing companies’ progression, rather than focusing on any perceived pitfalls and limitations, companies should harness such opportunities for growth, and acknowledge that any seemingly minor challenges in dealing with board observers may actually be a small price to pay for the wealth of knowledge and harmony which they can bring to the table.

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