GPs dilute key-man provisions in hot fundraising market

To the outside world, Vista Equity Partners has always been about Chief Executive Officer Robert Smith. He is the face of and the driving force behind the firm, which has risen quickly into elite status.

And so it’s fitting that in past funds Robert Smith has been the hinge on which key-man provisions get triggered. Should he leave or take a diminished role, LPs get the option to vote to end the investment period.

But the firm has switched it up in its sixth fund, which is in the market targeting as much as $10 billion. For Fund VI, the key man is triggered only if both Smith and co-founder Brian Sheth leave the firm or take on diminished roles.

This change came about after Dyal Capital bought a minority ownership stake in Vista’s management company. It’s unclear why that led to the change.

Key-man provisions have been changing in recent years, moving from one or two of the most senior executives to multiple professionals.

LPs don’t necessarily like this change as they see it as diluting the effectiveness of the key man. If the trigger resides with multiple professionals, the provision will be less likely to be triggered. The firm, however, could be losing its most significant people, with the remaining key executives of lower importance.

“Of all the actively managed strategies, few depend more on the talents and abilities of the fund manager than private equity,” according to the Buyouts Insider 2016-2017 PE/VC Partnership Agreements Study. “The best-performing managers can double or triple an investor’s money over time; less fortunate investors, stuck with lemons as managers, can lose nearly everything.”

According to the study, 73.3 percent of North American buyout firms have key-man provisions, while 78.3 percent of international buyout funds come with key-person protections.

Of those North American firms that have a key-man provision, 81.8 percent include automatic suspension on investments if the key man is tripped. And 58.8 percent of North American funds with automatic suspensions allow LPs to vote to extend the investment period, the study said.

Interestingly, the resulting action from a key-man trigger can differ from fund to fund. For North American buyout funds, 70 percent suspend further capital calls, 35 percent prohibit further capital calls, 15 percent terminate the fund and 12.5 percent have some other kind of response, the study said.

We’ve also heard of some emerging-markets limited partners, mostly development finance institutions working with new firms with scant experience, asking for fairly draconian key-man protections.

Mara Topping, a partner at law firm White & Case, said some LPs are asking for a provision that would classify any unresolved key-man issues as “for-cause” events. Such an event could lead to a “for-cause” removal of the GP, which typically leads to some level of carried-interest loss, either one-fourth or the entire amount after removal, Topping said in a past interview.

“It’s extraordinarily rare. I’ve never seen it in developed markets, only in emerging markets,” Topping told Buyouts.

Like other terms in today’s hyper-aggressive fundraising environment, LPs are accepting terms they may not like in order to get a slice of an in-demand fund.

With this sort of flexibility, GPs are likely to spread the key-man risk among multiple people, leaving LPs that much more vulnerable to getting stuck with a lemon.