The Board Whisperers: The Pivotal Role of Board Observers

A board whisperer, someone who would potentially excel in navigating and influencing boardroom dynamics, plays a critical role in ensuring effective governance, strategic alignment, and the successful implementation of key initiatives within an organization. Understanding the potential of such a role in the intricate realm of corporate governance, a new and strategic position has emerged: that of the board observer. These observers, which are persons without the voting rights typical of traditional board members, have become essential in linking ambitious startups with their venture capital (VC) backers. They hear what is happening in the board room, they have access to the materials the board is working with, and they advocate for investor interests without the formalities and direct liabilities associated with board membership, allowing them to operate in a unique advisory capacity.

Board observers enjoy the privilege of attending board meetings where they can participate in discussions, ask questions, and offer their expertise, yet they do not carry the authority to vote on resolutions or directly influence board decisions. Appointed typically by specific shareholders or groups of shareholders, they monitor the activities and decisions of the board, representing their appointers’ interests without the burden of fiduciary duties.

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.

A January 2024 survey by the National Venture Capital Association (NVCA) indicates that 82 percent of surveyed investment entities and VCs now use board observers. Moreover, all investors with more than 500 million dollars in assets under management (AUM), which was the lowest bracket of AUM per investors surveyed, indicated that they are already using board observers in their portfolio companies, showcasing that preferred and more sophisticated investors broadly utilize this corporate governance tool. This widespread adoption highlights their role in enhancing board transparency, mitigating litigation risks, and navigating antitrust and regulatory considerations.

The role of board observers is defined contractually rather than through statutory board responsibilities, which allows them to circumvent the direct fiduciary duties typically associated with board membership. This contractual basis is especially relevant in areas sensitive to antitrust laws and foreign investment regulations, where direct board involvement could lead to potential legal complications.

For instance, the strategic relationship between OpenAI and Microsoft showcases how board observers can facilitate strategic alignments within legal boundaries. Microsoft’s decision to take a non-voting observer seat on OpenAI’s board allows it to gain valuable insights into governance practices without overstepping antitrust laws that a direct board position might breach.

Board observers also play a pivotal role in managing compliance with regulations from the Committee on Foreign Investment in the United States (CFIUS), which scrutinizes foreign investments for national security concerns. By enabling foreign investors to appoint board observers, companies can provide non-controlling insight into operations, balancing the need for foreign capital with national security interests. Recently, CFIUS has sought to close potential loopholes by limiting the use of board observers in such contexts.

Moreover, board observers help ensure compliance with the Employee Retirement Income Security Act (ERISA), especially for VC and private equity firms managing pension plan investments. They offer a layer of oversight that aligns investment decisions with ERISA's stringent requirements, thus protecting pension plan assets and enabling proactive management without crossing into direct fiduciary responsibility.

The legal landscape for board observers varies significantly across jurisdictions. While our recent paper focuses mainly on the US VC and startup eco-system, it briefly explains and explores how English law is different as it includes the concept of shadow director, a person who is not officially appointed as a director but whose instructions or directions the officially appointed directors are accustomed to follow and is subject to many of the same legal duties and liabilities as a formally appointed director. In the UK, therefore, a shadow director liability could apply if an observer’s influence is extremely pervasive—a stark contrast to the US scenario, including under Delaware law, where courts might be more deferential to VCs’ offsetting contractual arrangements.

A notable legal precedent in the US that highlights the benefits of board observers is the appeals court decision in Obasi Inv. Ltd. v. Tibet Pharms. Inc. This ruling, which focuses on securities regulation rather than corporate governance but is nevertheless very relevant to the corporate governance context, emphasized that board observers, because of their non-voting status and limited involvement, do not carry the same legal liabilities as traditional board members, at least under securities laws.

As corporate governance continues to evolve, the role of board observers is expanding, necessitating a thorough examination of their ethical implications, potential conflicts of interest, and their overall impact on corporate transparency and accountability. The nuanced perspective board observers bring is prompting a revaluation of traditional governance models, heralding a new era of governance innovation that prioritizes transparency, strategic alignment, and efficiency.

The authors’ complete article can be accessed here.

Nizan Geslevich Packin is a professor of Law at Baruch College, CUNY, and a Senior Lecturer at the University of Haifa Faculty of Law.

Anat Alon-Beck is an associate professor at Case Western University’s School of Law.