Observer Seat

What is an observer seat?

Observer Seat (in German: Beobachtersitz, Beobachterstatus) is the contractually granted right to attend the meetings of an advisory board or supervisory board without being a member of that body. An advisory board (Beirat) is the voluntary advisory and oversight body that many GmbHs (German limited liability companies) set up after a financing round. The observer (board observer) receives the meeting documents and can, as a rule, take part in the discussion but has no vote. The observer's position resembles that of a guest with speaking rights at a club meeting: the observer hears everything and may comment, but votes are taken without him or her.

Observer seats are agreed in financing rounds, usually in the participation agreement or the shareholders' agreement, in some cases additionally in the rules of procedure of the advisory board. They go to investors whose stake is not sufficient for a seat of their own and to co-investors who invest alongside the lead investor (the investor who leads the round). Strategic investors and some funds choose the observer seat deliberately, because membership of the body brings duties and liability (status as a corporate body). The English term is often retained in German contracts.

Rights under an observer seat

The scope follows solely from the agreement. Four elements are customary:

• Right to attend: invitation to all ordinary and extraordinary meetings, with the same notice period as for the members,
• Right to information: receipt of the meeting documents, minutes and written circular resolutions at the same time as the members,
• Right to speak: participation in the discussion, unless the agreement excludes it,
• Representation: where applicable, the right to appoint a deputy for individual meetings.

Having no vote does not mean having to remain silent. An observer can take part in the discussion, unless the agreement expressly provides for a pure listener status. The observer does not count towards the quorum or majorities and has no approval rights. The observer's influence is practical in nature: it rests on information, expertise and the ability to raise concerns before a decision is made.

Legal classification in Germany

Not a member of a corporate body

Corporate bodies (Organe) are the bodies through which a company acts and is supervised; at a GmbH these are, for example, the management, the shareholders' meeting and an advisory board established by the articles of association. The observer does not belong to the body and is therefore not a member of a corporate body. The duties of care and confidentiality that apply to members of an advisory or supervisory board do not apply to the observer by virtue of office. The observer's duties arise from the agreement that grants the seat, in particular from a confidentiality undertaking. The observer therefore is not liable to the company like a member of a corporate body, but only to the extent that contractual duties are breached or the observer is obliged to pay damages under general law.

In the US market, this distinction is described by means of fiduciary duties, the duties of loyalty and care of the members of the governing body, which an observer does not bear. There is no direct equivalent in German limited liability company law. In German law, the status as a member of a corporate body and the contractual agreement are decisive.

Limits in the supervisory board

With the voluntary advisory board of a GmbH, an observer seat can be shaped largely freely, as a rule also with an optional supervisory board, that is, one set up voluntarily by the articles of association. The framework is narrower for the supervisory board of a stock corporation (Aktiengesellschaft) and for the co-determined supervisory board of a GmbH. There, under Section 109(1) of the German Stock Corporation Act (Aktiengesetz, AktG), persons who do not belong to the body should in principle not attend the meetings; experts and informants can be called in only for individual items. A standing observer seat can hardly be implemented there. When a company grows into co-determination, existing observer rights therefore need to be reviewed.

Confidentiality and competitors

Because the observer is not subject to a confidentiality duty as a member of a corporate body, the observer seat needs an express confidentiality rule (NDA). It should bind the observer personally and the investor that nominates the observer. Within the investor, it should limit onward disclosure to the persons concerned with the investment, and it should continue to apply beyond the end of the observer seat.

Particular limits apply where the investor is itself a competitor or holds interests in competitors. With strategic investors from the same industry, for example the investment arm of an industrial company (corporate venture capital), a competition law question arises. The exchange of competitively sensitive information such as prices, terms, customer lists or product planning can infringe the cartel prohibition (Section 1 of the German Act against Restraints of Competition, GWB, and European law). It prohibits competitors from entering into agreements and from exchanging information that restricts competition. Graduated rules are therefore customary: redacted documents for certain topics and exclusion from individual agenda items. Where necessary, a defined group of persons is added who may see sensitive data without passing it on to the investor's operating business (clean team).

The body should also have the right to exclude the observer from individual deliberations. Occasions include negotiations with the investor itself, a sale process in which the investor is a possible buyer, or personnel matters concerning the management.

Observer seat in a financing round

The negotiation usually turns on three questions: who receives an observer seat, how long it lasts and how many observers the body can accommodate. The seat is usually tied to a minimum shareholding and ends with the next financing round or when the stake falls below the threshold. It is advisable that the number of observers not exceed the number of members, because a large group of participants makes open deliberation harder.

For founders, an observer seat is often the compromise when several investors claim a seat but the body is to remain small. For investors, it can be the preferred form because it secures information without bringing the liability and conflicts of interest of a member of a corporate body.

Practical example: observer seat for a strategic investor

A medical technology company closes a Series A with three investors. The lead investor receives a seat on the three-member advisory board. A co-investor with 7% and the investment arm of a manufacturer from the same industry with 5% each receive an observer seat. The following is agreed:

• Both observers receive invitations and documents at the same time as the members and may take part in the deliberations.
• The observer seats end as soon as the respective investor's stake falls below 3%, and at the latest with the closing of the next round, unless that round provides otherwise.
• The observer of the strategic investor receives documents on prices, customers and development planning only in redacted form.
• The advisory board can exclude both observers from individual agenda items.
• The observers and the nominating investors sign a confidentiality agreement that applies for three years beyond the end of the seat.

Two years later, the company considers a sale, and the manufacturer is among the possible buyers. The advisory board excludes its observer from all deliberations on the sale process. This keeps the auction process unaffected, and no bidder receives information that is not available to the others.

Distinctions: observer seat, board seat and information rights

• Board seat: membership of the body with a vote, duties as a member of a corporate body and liability. The observer shares the information, not the responsibility.
• Information rights: entitlements to reports, information and inspection without attending meetings. The observer seat goes further because it makes the deliberation itself accessible.
• Experts and guests: are called in for individual agenda items and have no permanent right to attend.
• Board meeting: the meeting that the observer attends. Convening, procedure and minutes follow the rules of procedure of the body.

Common mistakes

• Role not regulated. If it remains open whether the observer may speak and which documents the observer receives, the observer's role is disputed at every meeting.
• No confidentiality duty. Without a contractual rule, the observer is not bound by the confidentiality that applies to the members of the body.
• Competitor with full access. If a strategic investor receives prices, customer data and product planning unfiltered, competition law risks and competitive disadvantages arise.
• No right of exclusion. If the body cannot exclude the observer from individual items, negotiations with the investor or a sale process cannot be discussed in confidence.
• Open-ended observer seats. Without a threshold and an end date, observers accumulate over several rounds whose stake no longer justifies a seat.
• Observer provided for in a co-determined supervisory board. Where Section 109(1) AktG applies, a standing observer seat cannot be implemented.

Frequently asked questions

May an observer speak in the meeting?

As a rule, yes. The lack of a vote does not rule out taking part in the discussion. Only if the agreement provides for a pure listener status does the observer merely listen.

Is an observer liable like an advisory board member?

No. The observer is not a member of a corporate body and is not subject to liability as one. The observer is liable for breach of the duties assumed by contract, above all confidentiality, and otherwise under general law.

Does an observer receive the same documents as the members?

In principle yes, and at the same time. Exceptions apply to topics involving a conflict of interest or a competition law risk; here documents are redacted or withheld.

Can an observer seat lapse?

Yes, if the agreement provides for it. A minimum shareholding, an end with the next financing round or termination in the event of a breach of confidentiality are customary.

Must an observer seat be set out in the articles of association?

Not necessarily. For a voluntary advisory board, a provision in the participation agreement or the shareholders' agreement is sufficient. So that the rules of procedure of the advisory board do not conflict with it, the right to attend should be anchored there as well.

The Roemer Capital view

When more investors in a round claim a seat than the body can sensibly accommodate, an observer seat often carries the agreement. Roemer Capital makes sure that it is limited in time or tied to a threshold and that confidentiality and exclusion rights are settled before the participation agreement is signed.

Roemer Capital looks particularly carefully at strategic investors. An observer who attends meetings for a possible later buyer can influence competition among bidders in a sale process. The exclusion rules for a sale scenario therefore belong already in the financing round. The legal implementation rests with the company's law firm.