Information rights provide transparency into the company’s operations by allowing investors to have access to certain information about the company. Typically, these rights are reserved for major investors and are outlined in the IRA.
Information rights allow an investor to receive annual, quarterly, and monthly financial information from the company. Investors may also be able to inspect the company’s books and records and observe board meetings in a non-voting capacity. Access to this information allows investors to evaluate the company’s performance and offer insight into the company since most investors are not on the Board.
The financial information provided to investors typically includes balance sheets, statements of income, cash flows, budget comparisons from past and current year’s budget, and cap tables for the company. The IRA will sometimes contain a requirement that the financial information be audited and prepared in accordance with GAAP.
Companies can be hesitant to provide information rights to all investors as it decreases their ability to control where the information goes. Companies may worry that investors will share the financial information with a competitor or that the investor itself might operate a competing business. While directors have a fiduciary duty to protect the company’s information, investors are not bound by the same fiduciary duty. Thus, by limiting information rights to major investors and including a confidentiality provision in the information rights section, companies can reduce the number of investors with access to such confidential information and ensure that investors with access to such information are bound by confidentiality provisions.
Standard information rights generally require the company to deliver:
Such information must be delivered within an agreed upon time period after year-end. There may also be a requirement that the annual financial statements be audited and certified by independent public accountants that are nationally or regionally recognized.
Standard information rights generally require the company to deliver quarterly financial statements and a current cap table, within a certain time period after each quarter-end.
Occasionally, information rights will also require the company to deliver monthly financial reports.
In fulfilling information rights obligations, companies must sometimes provide a budget and business plan for the following fiscal year before year-end.
These business plans are normally approved by the Board, and include:
Founders generally prefer to deliver unaudited financial information and to postpone the delivery of the information.
This is largely due to the cost and time associated with preparing financial statements. Auditing and delivering a company’s financial history is a significant operational and financial undertaking, and founders prefer to postpone this practice until they can meet this task without disrupting their business.
Investors prefer the opposite. Investors want to receive financial information as soon as possible. Most investors also have their own audit practices that require reviewing the financials of their portfolio companies.
Despite their preference, many investors of early stage companies are lenient because they understand that imposing a stringent turnaround time for financial information can distract the founders from running the company’s core operations, not to mention it can be very expensive.
Inspection rights permit investors to visit and inspect the company’s premises, examine its books and records, and discuss its affairs, finances, and accounts with company officers (such as the CEO, CFO, etc.). Inspection rights are usually granted upon request and only to major investors who are not competitors of the company.
Even with these rights, companies do not have to provide trade secrets or other information that may be confidential or protected by attorney-client privilege.
Founders do not want sensitive information falling into the hands of competitors. This scenario is especially acute in situations where a strategic is investing as she may have several portfolio companies that are in the same industry. For this reason, companies will often include competitor carve-outs to inspection rights.
Investors prefer to have as much access to company information as possible, with few exceptions. Inspection rights are especially important to investors who do not have a representative from their venture fund sitting on the Board as they are not as privy to the day-to-day operations of the company. Investors should note that the NVCA version of the IRA has optional language that states that the investors waive their statutory information rights under Section 220 of the Delaware General Corporation Law (or similar rights under other applicable law). Investors should look out for this optional language in the IRA.
Observer rights allow an investor to have a representative attend all meetings of the Board in a non-voting capacity, and to receive all board materials provided to directors.
Observer rights are not granted to each investor and are typically only granted in the case of a lead investor not designating a board seat or there being multiple lead investors, in which case some lead investors may be given board observer rights vs. being offered the ability to hold a board seat.
Early-stage companies may be more open to granting investors board observer rights as it allows the company to invite investors to the board meetings without having to increase the board size. As the company and Board grows in size, companies will be less likely to offer board observer rights in an effort to keep the Board meetings as manageable and efficient as possible.
Lead investors prefer to designate a board seat, but if they cannot, they still want the right to observe board meetings in a non-voting capacity. Non-lead investors are typically not granted board observer rights, but may be able to negotiate them via a side letter.