Quasi keyman

In November, EQT’s Conni Jonsson announced that he was stepping down as managing partner in March 2014; his replacement will be partner Thomas von Koch, who was also part of the firm’s original founding team. As succession planning goes, this appeared (at least from the outside) to be pretty seamless: a well-qualified successor in situ, a sensible transition period, and the minimum of fuss.

Succession planning is clearly a big issue for many long-established firms at the moment, as the original founders look to hand over the reins to the next generation. And for those US firms who are thinking about it, there’s an important new angle to consider. 

GPs required to register with the Securities & Exchange Commission (SEC) are now subject to the Investment Advisers Act of 1940. This includes a provision that they cannot “enter into, extend, or renew any investment advisory contract … if such contract fails to provide, in substance, that no assignment of such contract shall be made by the investment adviser without the consent of the other party by the contract.” 

Unfortunately the SEC hasn’t exactly given crystal-clear guidance on how that provision should apply in a private equity context. But according to industry lawyers’ current interpretation, “contract” means the limited partnership agreement, “assignment of such contract” means transferring control to new management and “the other party” means LPs.  In other words, SEC-registered GPs are now effectively subject to a key-man clause, regardless of whether or not they officially have one. 

Lawyers say the provision means managing partners with a significant amount of control must gain LP consent before transferring this control to a colleague, third-party firm or investor. 

A good rule of thumb is a 25 percent test, says Robert Sutton, a private funds partner at law firm Kirkland & Ellis. “Any time you anticipate someone at the firm gaining more than 25 percent voting control, or dipping below it, it’s worth considering whether to seek approval from LPs.” 

This may not always be required – for instance, if no change in actual control ultimately occurs, perhaps because someone else continues to hold a majority voting stake. But it’s still worth asking the question, he says.  

Even without speaking to their lawyers, most GPs are already alive to the fact that key-man provisions will need to be reviewed when a senior partner is ready to retire, for instance. Before that key-man partner can cash out his or her ownership shares – and make way for the next generation of leadership – investors may need to be consulted (perhaps via an LP advisory board) before he or she can enter retirement.  

However, what fewer GPs will know is that if they’re SEC-registered, the SEC will want to see full documentation of that LP consent – if the partner’s retirement results in a change in control as per the Advisers Act.  

Another potentially problematic scenario could be if an ageing founder starts dividing power among a group of senior partners. Once those partners acquire significant influence and control, then again, Section 205 of the Act may be triggered. 

Moreover, limited partnership agreements that do not explicitly address the Section 205 rule should operate as if they do, the SEC warned the private equity firms under its purview last year. In a worst case scenario, violating this section could even nullify the entire LPA, it suggested. 

To reiterate: there are no hard and fast rules yet about what constitutes “assignment” in a private equity context. But it’s an issue worth bearing in mind for any SEC-registered firm thinking seriously about succession planning.