With investors more concerned than ever that senior dealmakers might quit flagship funds in the wake of the coronavirus, lawyers say key-person clauses are coming in for heightened scrutiny.
Data from Private Equity International’s LP Perspectives 2021 Study revealed more focus on succession issues and retention plans in due diligence. Inadequate key-person clauses were cited as one of the most contentious areas of fund documentation, with half of investors saying they lead to the most disagreement during negotiations.
Lawyers say LPs are increasingly looking for much tougher provisions to come down hard on GPs for unresolved key-person events. Geoffrey Kittredge, partner and chair of Debevoise & Plimpton’s European funds and investment management group, says: “We see some increase in investors looking to treat the key-person event as a ‘semi for-cause’ event. Some are asking for more severe consequences for an unresolved key-person trigger than has traditionally been the case, such as a haircut to the carry, though they will not necessarily get GP agreement.”
Classifying a key-person trigger as a ‘for-cause’ event allows for the removal of the general partner, which typically leads to some loss of carried interest. It is seen as a draconian approach, but is nevertheless being increasingly pushed by investors anxious about losing key talent.
“I find it objectionable because a key-person event may not be a ‘bad act’ on the part of the GP or within the GP’s control,” says Sam Kay, partner in the funds department at Travers Smith. “But for various reasons, probably due to bad experiences in the past, certain LPs are pushing quite hard to say that any breach of the key-person provision gives them a right to remove a GP on a ‘for cause’ event. That’s controversial, and if I’m acting for the GPs I push back hard.”
More common, according to John Rife, another partner in the funds team at Debevoise, is a push to get a reduction in the management fee.
“The most frequent economic consequence I see investors pushing for is, once a key-person event triggers a suspension of the investment period, an immediate step-down in the management fee calculation to the post-investment period rate, rather than that step-down only happening if the key-person event is not remedied and the suspension becomes permanent,” Rife says.
“I have investors asking for that on every fundraising at the moment, while there are only a few where I see them pushing for broader economic consequences or removal rights linked to the key-person provision.”
Today, key-person clauses are also extending out to cover more people. Kittredge says: “Key-person clauses started off with just one or two people but, as firms develop, the key-person triggers become more complex and more about teams or combinations of senior and mid-level executives and investment professionals. That’s natural and will continue.”
Kay adds: “There are often questions about the amount of time that people are required to spend on particular funds. With a lot of the GPs diversifying their platforms, you have individuals within the organisation that may be on investment committees for private equity, infrastructure and credit funds. As an LP you need to accept that, so devotion of time requirements are weakening a bit but investors still expect quite a high bar.”