What are they?
A letter agreement between a company and an investing venture capital fund which provides the fund with certain "management rights" that allow it to substantially participate in, or substantially influence the conduct of, the management of the portfolio company.
Why are they important?
A management rights letter is critical for any venture capital fund that is seeking to rely upon the venture capital operating company (VCOC) exemption in order to avoid its assets from being subject to the Employee Retirement Income Security Act of 1974 (ERISA) and the onerous requirements that would be imposed thereunder (which would include managers of the fund becoming personal fiduciaries under ERISA with respect to any private pension plans that invest in the fund and becoming subject to a set of strict prohibited transaction rules and conflict of interest and self-dealing issues as a result of the fund manager's receipt of performance fees in the form of its carried interest).
As background, private pension plans constitute a meaningful percentage of the investors in venture capital funds. The assets of such pension plans are subject to ERISA. When a venture capital fund takes in investors who are themselves subject to ERISA, the fund will want to avoid the assets of the fund from also becoming subject to ERISA. There are two exemptions that a venture capital fund can seek to rely upon in order to avoid such an outcome:
1. The Not Significant Participation Exemption (ie, the 25 percent test)
- If less than 25 percent of each class of equity interests of the venture capital fund (and a fund typically only has one class of equity interest) is held by investors who are subject to ERISA, then the assets of the fund will not be subject to ERISA.
- In determining whether the 25 percent threshold has been surpassed, investments by public pension plans and non-US pension plans are not counted towards the threshold.
2. The VCOC Exemption
- If the venture capital fund qualifies as a VCOC, then the assets of the fund will not be subject to ERISA.
- In order to qualify as a VCOC:
- at least 50 percent of the fund's assets must be invested in operating companies in which the fund has direct contractual management rights (which is where the management rights letter comes into play) and
- the fund must exercise such management rights with respect to at least one operating company that it holds an investment in
- The 50 percent requirement must be met on the date the venture capital fund makes its first investment.
- The securing of a management rights letter by a venture capital fund is critical in that it is the means through which the fund has direct contractual management rights in its underlying portfolio companies.
What should they contain?
A management rights letter should secure as many of the following rights as possible for the investing venture capital fund:
- The right to appoint one or more directors to the board of the portfolio company
- The right to regularly informally consult with and advise the management team of the portfolio company
- The right to receive quarterly and annual financial statements of the portfolio company, including the annual auditor's report
- The right to examine the books and records of the portfolio company
- The right to receive copies of all documents, reports, financial data and other information that the fund may reasonably request and
- The right to appoint a person to serve as the corporate officer of the portfolio company
Potential traps
- Rights that a venture capital fund secures and shares with other investors do not count as management rights for purposes of meeting the VCOC exemption (ie, the rights must be individual to the fund). Thus parallel funds or related co-investment funds should each obtain separate management rights letters.
- Portfolio company investments, which are made by a venture capital fund indirectly through a special purpose vehicle, which is not wholly owned by such fund can be an issue in situations where the special purpose vehicle only holds a minority position in the underlying portfolio company. In that scenario, the special purpose vehicle will not be treated as an operating company for purposes of the VCOC exemption due to the fact that it is not primarily engaged, directly or through a majority owned subsidiary, in the production or sale of a product or service other than the investment of capital.
- If a venture capital fund seeking to rely on the VCOC exemption makes an investment which does not qualify as an investment in an operating company prior to making its first investment in an operating company, then such fund can never qualify as a VCOC.
Takeaway
A management rights letter is a key aspect for venture capital funds when investing in companies, as it enables funds to raise capital without subjecting the activities of the fund to the various restrictions imposed under ERISA. Requests for management rights letters are fairly common in today's market and do not impose significant burdens on the companies from whom such letters are sought.
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What are they? A letter agreement between a company and an investing venture capital fund which provides the fund with certain "management rights" that allow it to substantially participate in, or substantially influence the conduct of, the management of the portfolio company.
What is a major investor rights side letter? ›
Side letters can define board appointment rights not fully detailed in the main financing contracts. An investor may negotiate additional board seats or observer rights through a side letter agreement, which gives the investor more control and insight into the company or fund's operations.
What is a management rights agreement? ›
What is it? A management rights letter, sometimes called a venture capital operating company (“VCOC”) letter or an “MRL” for short, is a contract between an investor and a portfolio company that grants the investor certain rights to participate in the management and operation of the portfolio company.
What is the difference between a side letter and a management rights letter? ›
An MRL is a very specific type of side letter. If an investor is asking for a side letter, there's a good chance they are asking for a broader set of rights than they would receive under a standard MRL, although sometimes the “MRL-specific” rights are combined within a larger side letter.)
Why do I need a management rights letter? ›
A management rights letter is critical for any venture capital fund that is seeking to rely upon the venture capital operating company (VCOC) exemption in order to avoid its assets from being subject to the Employee Retirement Income Security Act of 1974 (ERISA) and the onerous requirements that would be imposed ...
What does an investors rights agreement do? ›
An investor rights agreement (IRA) grants certain rights to and outlines obligations for companies and their investors. We highlight the main topics and best practices for drafting an IRA.
What are major investor rights? ›
Major investor rights refer to the contractual privileges and protections granted to investors, particularly those who provide significant funding to a company by hitting ownership thresholds or taking over specific percentages of particular funding rounds.
What is the purpose of a management rights clause? ›
This Management Rights Clause (Collective Bargaining Agreement) is generally used by employers in their collective bargaining agreements to confirm or establish the discretion and autonomy to run their operations. A management rights clause is a mandatory bargaining subject.
What is the purpose of the management agreement? ›
A business management agreement formalizes the working relationship between a business and its manager. The contract will include information such as budgeting, the percentage of business revenue owed to the manager, and confidentiality requirements.
What are three things a management agreement should contain? ›
Management Contract
This should include the terms and period of the contract, the policies pertaining to the management of the premises, management fees, and the authority and powers that are given by the owner to the agent.
Management Letter means a letter prepared by the auditor which discusses findings and recommendations for improvements in internal control, that were identified during the audit and were not required to be included in the auditor's report on internal control, and other management issues.
What matters are included in management letter? ›
Contents of Management Letters
The management letter must include: significant weaknesses and areas for improvement identified in the current engagement. repeat issues - matters identified in previous years that management has not yet resolved satisfactorily. Repeat issues must be appropriately labelled.
What should be included in a management letter? ›
Management letters summarize lessons learned during audit fieldwork on how to improve various aspects of the company's operations. For example, a management letter might report a significant increase in the average accounts receivable collection period from the prior year.
What is the management right of control? ›
Management override of internal controls can hinder the company from achieving these goals, because it prevents those internal controls from functioning properly. Unfortunately, such overrides are fairly common because the management designs, implements, assesses, and maintains these controls in the first place.
What is rights in management? ›
What are management rights? Management rights are the rights of an employer to run its business without interference. The right to hire. The right to discipline. The right to discharge.
What is a VCOC letter? ›
A management rights letter is critical for any venture capital fund that is seeking to rely upon the venture capital operating company (“VCOC”) exemption in order to avoid its assets from being subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) and the onerous requirements that would be imposed ...
What is the purpose of a side letter? ›
The main purpose of a side letter is to clarify the main contract terms. However, a side letter can also add details or change the main contract terms. Typically, a side letter will contain administrative and commercial terms, whereas the main contract will contain the standard terms of a transaction.
Are side letters enforceable? ›
Although the usual intention is that side letters will create legally enforceable rights and obligations, this is by no means guaranteed, even if the document is entitled “side letter”. In some cases, a side letter will have nothing more than moral effect.
What is the meaning of investor rights? ›
Investors have the right to clear information about costs, charges and fees. Investors have the right to a clear description of the firm's privacy policies regarding protection of personal (nonpublic) information. Investors have the right to a response from firm management to any complaint.
What is the purpose of an investment letter? ›
The letter presents the basic terms of the investor's proposal and acts as a mark of their commitment to proceed through negotiations to reach a formal agreement. Once an agreement and formal purchase contract is made, the investor will obtain partial ownership of the company or real estate under its terms.
