Year of the Key Person: Part I

What happens when valued investment professionals leave before the end of a fund's life?

It’s worth reiterating that we are in the business of understanding where capital comes from. We are not concerned about where it goes (i.e., the investments made using raised capital).

In this vein, I want you to understand the relationship between those who seek capital and those who allocate it. And within this fast-growing industry, there are more and more people affected by the governance provisions of the documents that govern privately managed pools of investable capital.

2025, I predict, will be the year of the Key Person. Today’s post will focus on explaining how this concept operates on paper.

Recall that in the United States, a private fund is generally recognized as being exempt from the regulations of the Investment Company Act of 1940 under sections 3(c)(1) or 3(c)(7), and it is usually structured as a limited partnership. That is to say that unlike pools of capital generally agnostic to the income or wealth base of their investors (such as mutual funds), 3(c)(1) and 3(c)(7) funds may only enjoy their exemptive privileges by drawing capital from a select group of investors that meet a higher standard of income, investment holdings, or wealth.

These investors are known as “accredited investors” ($200K+ in income or $1 million+ in wealth) for 3(c)(1) funds and “qualified purchasers” ($5 million+ in investments) for 3(c)(7) funds.

There are some caveats, but for now we don’t need to worry about them in these pages.

Almost all private equity (PE), hedge, growth equity, and venture capital (VC) funds domiciled in the United States are 3(c)(1) and 3(c)(7) funds.

That’s where capital comes from.

Now let’s briefly revisit how such a pool of capital is relationally structured between those who seek to manage it and those who allocate and entrust it to them, via the limited partnership.

The limited partnership has a general partner (GP) which manages the actual assets of the partnership (“partnership” and “fund” are interchangeable here) for a fee and at least one limited partner (LP), which occupies a largely passive role involving a commitment of capital in return for a profit at the end of a predefined period, typically 10-12 years.

The primary document governing a limited partnership, often domiciled in the US state of Delaware, is the limited partnership agreement (LPA).

What’s a Key Person?

Key person provisions are designed to protect LPs in a private fund by giving them certain rights if an individual or group of individuals essential to the fund’s success (the “Key Persons”) departs or experiences a significant event outlined in the LPA.

Newer funds might just have one or two Key Persons, but mature investment management businesses—often running several strategies (VC, PE, private credit), each of which may have multiple funds (Fund I, Fund II, etc.)—can have 5 or 6 key persons.

These individuals are often veterans that specialize in certain industries, like healthcare or real estate, and there are certain events that may trigger rights LPs can exercise if the key persons no longer actively manage the assets of a fund.

The LPA provision looks something like this:

“Key Person Event” means, with respect to any Key Person, (i) the death or Disability of such Key Person, (ii) the termination, for any reason, of such Key Person’s employment or engagement with the General Partner or any of its Affiliates, (iii) the failure of such Key Person to devote substantially all of such Key Person’s business time to the business of the Partnership and the Funds, or (iv) such Key Person’s disqualification to be a Key Person.

A tricky point involves the seemingly innocuous “substantially all of such Key Person’s business time.” This language is often not explicitly defined.

This doesn’t mean that the Key Persons work exclusively for the fund. However, I think most experts would agree that this time does involve most of a Key Person’s working hours and that the management of the fund in question takes precedence over other activities. Still, it is hard to track the precise amount of time an investment professional commits to a fund.

Perhaps a clearer principle is that the Key Person should not be working for a fund that deploys a competing or similar investment strategy to the fund in question. Ultimately, Key Persons are usually required to demonstrate a “good faith” effort, effected through a genuine dedication to the fund as their primary professional activity. (Good faith is, from an LP perspective, a low bar, as compared to something like “commercially reasonable efforts” or the even higher “best efforts” standard—a topic for another time!).

As for other activities, Key Persons can manage predecessor funds, provide advisory services to non-competing businesses (such as mentorship for a start-up that is irrelevant to the fund’s investment strategy), teaching at a university, industry conference participation, sitting on the board of a charity or non-profit, and personal investing activities. These are common examples, but each LPA may have its own restrictions.

What Do GP-LP Negotiations Look Like?

If a key person event happens, such as a senior team member leaving or becoming incapable of fulfilling the required duties, the GP must inform LPs. At that point, the fund’s investment period (the window during which new investments can be made) may be suspended, usually anywhere from 90-180 days. LPs get a say in whether the investment period should continue, usually through a supermajority-in-interest vote. Some funds permit the termination of the suspension through a LP advisory committee (LPAC) vote. Recall that the LPAC consists of a few influential LPs which make certain decisions on behalf of the whole investor base.

It’s worth noting that a fund can typically still make add-on acquisitions for existing portfolio companies, just not new investments. The fund can also pay its expenses, manage existing investments, repay any debts, and satisfy other liabilities.

If the suspension remains unresolved, this can result in the automatic termination of the investment period.

In larger investment managers, you can also have multi-tiered key person structures.

Let’s say LPs are concerned that if a senior partner leaves, the fund might go off the rails. They might push for a broader definition of “key persons” to include not only the senior partners but also key members of the investment team. This can create multiple tiers of key persons. For example:

• Tier 1: If one or two of the senior principals leaves, the investment period gets suspended.

• Tier 2: If a larger chunk of the investment team (say, 5 out of 10 people) exits, the same thing happens.

This looks like a safeguard for LPs. But for GPs, there’s a trade-off. Including junior team members as key persons could mean they gain leverage to renegotiate their terms, potentially requesting a larger share of carried interest. Imagine a junior partner, previously a quiet player in the background, now being able to say, “Hey, I’m a key person now, so I’d like a bigger piece of the pie, or I might walk.”

The silver lining for GPs is that a multi-tiered Key Person provision can also help with succession planning. If LPs start recognizing more junior team members as Key Persons, it paves the way for the next generation of fund managers. It allows the GP to gradually transition leadership to the up-and-coming stars, all while reassuring LPs that the fund’s performance won’t fall off a cliff when senior partners eventually step down.

One final note on LPAC composition. It’s important to note what we mean by “super-/majority-in-interest”: the term refers to LPs whose combined capital commitments represent more than X% of the total capital committed to the fund. For example, in a $1 billion fund, LPs contributing a total of at least $500 million would constitute a majority-in-interest. This type of vote could be used to make decisions like approving major fund actions or changes in fund terms.

Think about these voting thresholds as a weight of capital commitment, rather than as a percentage of the voter base. So, 50% of the majority vs. 50% in-interest are two different things: one means 50% of all LPs, the other means the percentage of LPs whose combined capital commitments to the fund exceeds 50% of the fund’s total capital.

I am not a math whiz, and I thought “huh??” the first time I had to work through this concept. Don’t worry if it takes some time for this to sink in.

Next time, we will talk about key person events and succession in a slightly broader context, at the intersection of the legal and the commercial.