Return to search

Editor’s Letter: Key-person provisions and GP minority stakes: an awkward conversation

Key-person provisions lately are a hotly debated topic, with some GPs setting up several individuals, rather than one or two, as key people on a fund.

This has the effect, at least from the LP perspective, of diluting the impact of a key-person provision. After all, a key-person provision that names one or two people actually seems enforceable. On the other hand, a group of, say, four of five individuals seems less likely, even if one or two of the most important people leave.

I recently learned that key-person provisions exist not just within the context of a fund. Firms that sell minority stakes to third-party investors can also have key-person provisions governing their minority ownership agreements. And these key-person provisions can differ from those governing the funds.

This could make for an awkward conversation, if you ask me.

Some quick background: Generally minority-stake deals occur when a third-party investor buys a passive, non-voting stake in the management company of a PE firm. Such interests usually provide the third-party investor with economics like revenue sharing, including slices of the management and/or future profit sharing.

These deals are highly negotiated and often come with key-person arrangements that can differ from the key-man identifications in the firms’ funds. A GP-stake key-person trigger could lead to early buyback of an investor’s interest in a management company, among other things.

I imagine this is a brutally honest conversation, when an outside investor comes in and lets a firm know that the guy whose name is on the door isn’t actually all that important. This is the sort of anecdote I sometimes hear from LPs — that the well-known executive who built the business is no longer actually in the trenches finding and executing the great deals. The real value drivers are actually the mid-level, next generation of leadership.

Unfortunately, LPs don’t necessarily have the pull to demand fund-level key-person arrangements that better identify who is actually creating value at a firm. They may want to commit to the fund and don’t have much flexibility to demand such a stark key-person change.

A third-party investor, on the other hand, does have that sort of leverage, especially if their investment means a liquidity event for the guy whose name is on the door.

Such situations are what lead to talented, next-generation-type leadership to leave firms they have helped build and form their own shops. It’s a tough situation but is helping expand the industry in interesting ways.

What situations have you seen, where a GP-stake key-person arrangement differs from the fund key-person identification? Hit me up at cwitkowsky@buyoutsinsider.com.