Major investors want to understand what’s happening at the startup they invested in, and rightly so. This term ensures that the founders are committed to provide certain investors (i.e., major purchasers) standard information, inspection rights and management rights letter (collectively referred to as information rights). Major purchasers can be defined as investors who invested above a certain negotiated threshold. Generally, the entrepreneur wants this threshold to be high to limit the number of people privy to sensitive financial information. Financial Information includes (i) information rights, (ii) inspection rights and (iii) management rights letter.
Information rights specify what information the startup must provide to the major investors and what frequency they must deliver that information. For instance, standard series information rights require the company to provide quarterly and annual unaudited financial reports to major investors. It’s the investors’ responsibility to use that information to give feedback and advice to the founders, and of course to keep it confidential.
Inspection rights allow the major purchasers to inspect the startup should they find the need to. Inspection rights simply means that the Company will permit each major purchaser to visit and inspect the Company’s properties, to examine its accounting and records and to discuss the Company’s affairs, finances and accounts with its officers, all at such reasonable times. This right just allows investors to do what they should be doing, communicating with the entrepreneurs and staying informed about the business.
Management Rights Letter
For regulatory purposes, investors often ask for a management rights letter. This letter generally grants investors additional rights and / or access to the company’s financial information and governance. Investors need a management rights letter in order to obtain an exemption from the regulations under Employee Retirement Income Security Act (“ERISA”). ERISA requires these funds to have “management rights” of the operating companies (i.e., to “substantially participate in, or substantially influence the conduct of, the management”) that these funds invest in. ERISA also requires these “management rights” to be contractual and in writing.
The management rights letter is usually presented in a one- to two-page written contractual agreement that is separate from the Series Seed documents. VC funds that invest with pension plan assets always request for management rights letters as a best practice. Obtaining a management rights letter is a common practice in the U.S., and it rarely becomes a controversial matter.
In the Series Seed term sheet, the financial information preference is as follows:
Purchasers who have invested at least [$________] (“major purchasers”) will receive standard information, and inspection rights and management rights letter.
Thus, once the major purchaser threshold is set, any investors that meet that threshold have the right to information and inspection. The company also agrees to enter into a management rights letter with them.
If you liked this mini-guide, ensure to read our comprehensive guide on SEED funding as well.