(Originally appeared in the July 25th, 2018 'Across the Board' publication, a Board Director, Board Advisor, C-Level, and Business Newsletter reaching 24,500+ thought-leaders and visionaries in over 65 countries with articles focused on leadership, strategy, and governance topics - sign up here)
Most Board Directors associate the role of Board Observer with an individual who attends company Board meetings, but is not an official member of the Board of Directors. A further drill-down typically associates a Board Observer as a role enacted during a company's funding round, where some investors will request the right to appoint a representative to attend and witness formal Board meetings - with certain situations allowing investors the option to appoint a Board Observer other than themselves to the role.
Venture Capitalists (VC) generally participate in Boards in one of two ways – as an actual Board Member(s) and/or as a Board Observer(s). VC Board Observers are almost always minority equity holders, although it is not uncommon for a lead investor to hold a Board seat for the partner and request a Board Observer role for their associate on the deal. Some VCs will specifically request Board Observer seats as a way of getting the benefits of being on the Board, but without the increased legal liability and workload. Investors are notoriously involved in many deals with competing available time, so offered Board Observer roles can be a trade-off between no involvement vs. limited involvement of a knowledgeable investor. Board agreements require the venture firms to specifically designate the Board Observer(s) position, but it is more commonly designated as a seat at the Board table reserved for someone from the venture firm other than the Board Member.
In the Private Equity (PE) model, Observation Rights are sometimes granted to the Bank and/or the Mezzanine lender. "It’s all subject to the loan negotiations," states Michael Lorelli, Operating Partner at Falconhead Capital and Director of four companies. "In practice, when they push for it, the selfish motive on their part is to keep an inside eye on their loan. The more constructive ones play a helpful role, err on the side of being less vocal, and hold their comments for very important debates where they really have an insight. They also get copied on all documents that go to the Board." Kendra Jalbert, Vice President at Private Equity Info, offers a unique concept to further leverage PE Board Observers. "A Board Observer may be in the perfect position to smooth potentially rocky relationships between CEOs of PE portfolio companies and Board Members. As a trusted advisor, a Board Observer could be the key to improving communication and synergy by providing feedback on, or establishing, a customized working relationship protocol."
In public companies, the topic of Board Member legal liability is top of mind, with any Director of the corporation able to become a potential target if things go off the rails. The Sarbanes-Oxley Act of 2002 is quite specific regarding Board obligations, as well as potential criminal penalties that can be imposed, including individual fines of up to $5 million and prison terms of up to 20 years for negligence, dereliction of duty, or outright criminal behavior. These increased risks have brought to the surface in many organizations the option of increased formal roles of Board Advisors and Board Observers - by both the Board as well as individuals seeking to serve on Boards.
Some Boards feel that Board Observers should attend meetings, but not participate in any way. However, in many cases, Board Observers are invited to be active participants in meetings, although they are not able to vote on any Board matters. Additionally, Board Observers are sometimes requested to recuse themselves from certain portions of Board meetings to avoid any attorney/client privilege situations, which legally covers Board Members, but not Board Observers. Interestingly, although Board Observer arrangements are not uncommon, there is currently little case law directly addressing the rights, duties, and potential liabilities of Board Observers when they are active participants in Board matters. This fact leaves much of the interpretation and working arrangement of Board Observers to the individual Board and the organization.
Conversely, the alternate and repackaged definition of a Board Observer has somewhat of a different meaning and purpose today. A Board Observer can also mean an experienced and seasoned consultant, executive, or advisor, engaged for a set period of time to attend and 'observe' actual Board meetings for the purpose of offering structural and operational insights - all with the intent of making the Board more efficient and effective. Witnessing an in-action Board during a scheduled Board meeting leverages the benefits of seeing first-hand the operational aspects, body language, delivery, structure, efficiency, and format of meetings. These first-hand experiences then culminate into a formal action plan for immediate remediation.
Larger organizations are known to leverage Board Observers in this manner for input into formal studies and governance initiatives, usually under the direction of the Audit & Risk Committees. Mid and small-size organizations typically engage Board Observer services for the purpose of correcting Board inefficiencies and for the infusion of best practices. I have personally seen a huge uptick of requests for these services over the past 10 months across private, public, and nonprofit organizations, and have been told that it is viewed as a way of meeting continuous improvement goals without the initial need of committing to longer and potentially more rigorous action plans.
Both highly-functioning Boards, and those requiring remedial focus, gain from unbiased and direct feedback. A skilled and experienced Board Observer, as described in our alternate and repackaged definition, is a great option for organizations looking for 'quick wins' and for fast input on needed remedial action - especially prior to engaging in strategic or larger-scale initiatives. Flexibility of these types of engagements is desirable and can be applied to a single Board meeting or a series of Board meetings for additional trending statistics. With today's pressures, what Board couldn't use a few 'quick wins'?
How will you leverage a Board Observer to increase your Board's effectiveness?
Independent Director | Outside Director | Strategist | Board Macro-Influencer | Speaker | Author
About the Author: In addition to sitting on numerous Boards, Mark A. Pfister is a 'Board Macro-Influencer,' a certified Board Director, author, and advises public, private, and nonprofit Boards in efficient and effective operations. Known as 'The Board Architect,' he is also the inventor of the 'Board as a Service' (BaaS) engagement model and an expert project manager frequently consulting on strategic global initiatives in their initiation and operational phases...<< read full bio here >>