Various documents are involved in the process of venture capital investment, one of them is a management rights letter also known as an MRL, which is sometimes requested by venture investors.
An MRL ensures that the investors have access to the essential information regarding the working of a company, and grants various other necessary rights that are discussed further. A management rights letter is delivered to each investor who requests one prior to the closing date, and not necessarily to all of the investors participating in the financing round.
It is a separate binding agreement used by investors to secure rights that are sometimes regulated in documents subject to change, such as an Investors’ Rights Agreement, or a Stockholders/Shareholders Agreement, to ensure a venture investor retains rights it considers essential, regardless of changes in these documents.
As such, this document involves various important clauses and the startup founders and investors must be aware of the same for better negotiation. This article addresses these important issues and focuses on the concept and terms of the management rights letter, and examines the rights enumerated in the same.
As discussed above, a management rights letter ensures that certain investors will have ongoing access to financial and other key information regarding the working of the company on a timely basis (quarterly/ monthly/ annual). It mandates that the company will deliver to the holders of this letter annual, quarterly (and sometimes monthly) financial statements, reports, business summaries and other relevant information, such as budget and business plans. The letter further provides that the holders of this letter will be granted access to the company facilities and personnel.
Other contractual rights, in addition to the right to financial information and inspection rights, are enumerated in the management rights letter, and it includes the following:
- The right to consult with and advise the management of the company on important issues.
- Pursuant to the previous right, the investor shall also be entitled to receive copies of notices, minutes, consents and other material the company usually provides to the company’s directors.
- The right to examine the books and records of the company and inspect the facilities. This right also includes the right to request information regarding the general status of the company’s financial condition and operations.
An important carve out limiting these rights is usually regulated under a special clause limiting all of the foregoing. The right of the company to withhold information it considers a trade secret, or information that the disclosure of which would adversely affect the attorney-client privilege between the Company and its counsel.
An important addition to these carve-outs, would be the company’s right to qualify the provision of information and access by an independent non-disclosure agreement, limiting the disclosure and use of such information, a statement that the information would not be used for any purpose other than for monitoring the investment, and that the company may further withhold information from competitors.
Lastly, a startup company must ensure the letter is terminated when investors lose interest in the company, or when the company undergoes an IPO, a SPAC transaction or any other listing of a company securities, imposing periodically reports, but in parallel prohibiting insider trading.
In US transactions, the management rights letter also exempts venture capital investors investing in a startup from various federal regulations under the ERISA (Employee Retirement Income Security Act of 1947). ERISA is a federal law that limits the management of pension plan assets. This law places certain obligations on the institutional investors who are pension funds. Consequently, when a pension plan invests in any venture capital fund, it is bound by the ERISA requirements. Complying with these regulations can be very hectic, and to get exemptions from the same, a venture fund requests startup companies to sign a management rights letter.
From the above discussion, it can be concluded that the management rights letter serves an essential purpose for investors and provides necessary privileges of company oversight. In certain circumstances, it also helps investors to obtain certain ERISA exemptions, as discussed above.
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