Line of succession

In his recent letter of resignation from Alchemy Partners, co-founder Jon Moulton told the firm’s LPs that he disagreed with the appointment of successor Dominic Slade. While such departures have remained rare in the industry, the likelihood that they may increase amid the ongoing economic difficulties means that firms may want to start thinking about succession plans earlier than they expected.

Moulton’s resignation letter that was leaked earlier this month recommended that Alchemy’s “Investment Plan” fund be liquidated and its portfolio broken up, a potentially messy process as the firm has an unusual funding structure whereby a new pot of capital is raised every year. The move came shortly after the surprise departure of former PAI Partners chief executive Dominique Mégret amid an “internal coup”, which caused the firm to recently offer investors the chance to halve their commitments to its €5.4 billion fifth fund.

In the future more firms’ leadership structures may be affected by poor fund performance and a lack of

Kevin Ley

financial incentives that have kept many top people in the past. Such departures could be also be triggered by a loss of confidence by limited partners in a GP, or bad acts by the GP, with investors most likely following one of two possible courses of action.

First, if bad acts cannot be proven quickly, or the LPs wish to take action for reasons other than cause, the LPs often can invoke a “no-fault” provision allowing investors to suspend the investment period, remove the general partner or dissolve the fund, typically by a supermajority LP vote. Second, if a GP has been found to have been engaged in some kind of bad act, such as fraud, gross negligence or willful misconduct, the GP typically can be removed by a majority or sometimes supermajority vote of the LPs.

However, such actions have historically been rare. A more likely scenario remains a key-man provision triggered by a dispute among GPs or the departure of a top executive such as in the recent Mégret retirement.

Such provisions are being triggered more often as the pioneering generation of buyout chiefs are reaching retirement age. Meanwhile, as new funds have come to market over the past several years, these key-man provisions are also being modified or loosened up in anticipation of future retirements or because the number of key persons has increased due to the dramatic growth in many PE firms.

Such considerations mean that general partners should start thinking hard about issues regarding succession. “Five years before you think someone is going to retire, a PE firm’s principals had better think hard about what the key-man provision in their next fund is going to say,” said Michael Harrell, co-chair of the global private funds group of Debevoise & Plimpton, to PEO's sister publication PrivateEquityManager.com. “You don't want to include Paul Smith, for example, as a key man in the fund you are raising next year if you think he is going to retire in three years. PE firms need to think carefully about succession planning, and that plays into the partnership agreement and LP relationships. “

In most cases, LPs are entrusting investment decisions to a team, not an institution, so they want to know that the team will be there for the balance of the life of the fund. As the recent examples of Moulton and Mégret demonstrate, firms may be dealing with these kinds of issues much earlier than they expected.