Management and Information Rights
Information rights require the company to provide investors with a certain level of information. State corporate law requires a certain level of disclosure (e.g., the articles and bylaws), but investors may require a higher level of record maintenance and disclosure. The rights are generally assured in a management rights letter, which has a secondary function beyond assuring disclosure rights to investors. The management rights letter may exempt VC firms investing a startups from certain federal regulations.
In short, ERISA (Employee Retirement Income Security Act of 1974) places specific requirements on certain institutional investors who are pension funds. Pension funds hold the plan assets in trust and invest a percentage of their investment portfolio in alternative assets, such as venture capital. Plan managers have fiduciary duties to the beneficiaries of the fund assets. As such, ERISA limits the ability of fund managers to undertake certain activities (further the IRS places requirements on the use of assets to qualify for certain tax treatment). When the pension fund invests in venture capital funds, this means that the fiduciary duties of fund managers also applies to the managers of the venture capital fund. To avoid this classification, the venture capital fund must qualify for an ERISA exemption; particularly, it must qualify under DOL regulations as a “venture capital operating company” (VCOC). To qualify as a VCOC, the venture capital fund must invest 50% or more of its assets in operating companies. An operating company is a company primarily engaged in a business other than capital investment. Further, the venture capital fund must have management rights in those companies and actively engage in management of at least one of those companies each year. This means substantially participating in or influencing the conduct of company. The management rights letter establishes this relationship between VC firm and portfolio company.