Year of the Key Person: Part II

How do we understand the formal business that a private fund is a part of? And how do founders and their investment professionals structure their ownership in that business?

In the prior post, we explored the dynamics between fund managers and their investors, focusing on the importance of “Key Person” provisions in private funds. These provisions protect investors by outlining actions if essential individuals, such as senior managers or industry veterans, leave or become incapacitated. Key Person events can trigger the suspension of the fund’s investment period and require investor votes to determine whether to continue or terminate investments.

Today, we will take a look at Key Persons and the “upper-tier” structure of an investment manager: the entities that exist in harmony with the fund itself and permit the proper functioning of an investment management business that manages capital collected from outside investors.

Saying “I’m a VC” or “I’m a GP” is often inaccurate. Similarly, calling yourself an “investor” doesn’t fully capture the role. The more precise title is “investment manager.”

Many young professionals, especially in their 20s, like to claim they’re investors in their bios, but that’s like the high schooler who claims to have the latest phone, only to conveniently “forget it at home” when asked to show it off. The reality of being a VC means disclosing that you’re managing other people’s money for a fee—a bit less glamorous and more akin to being a financial advisor.

It’s easier to rely on public ignorance of the investment world and call yourself an investor. It sounds cooler, and it’s a great conversation starter.

But let’s be clear: on paper, you’re the owner of an investment management entity that operates a fund for a fee. You also own, either fully or partially, the GP entity, which collects carried interest. In some cases, the investment management entity and the GP entity are the same, especially for smaller or early-stage firms.

The hardcore real-deal businesses, if you ever look at their official LinkedIn, will often start off their description under the “About” page as “X Capital Partners is an SEC registered investment adviser…”

That’s their way of saying to the world and to their investors, “I’m legit.” Though to be fair to VC manager, they don’t have to register as investment advisers with the SEC and usually operate as “exempt reporting advisers.” A conversation for another day!

All in all, setting up an investment fund is challenging, but establishing and maintaining the business that manages it can be even more so.

And honestly, this difficulty perhaps explains the ignorance with which cowboy VCs and the like use these loosely defined terms in the wrong way.

The Upper Tier

To reiterate, it’s crucial to understand that a fund doesn’t operate in isolation. In a limited partnership structure, the fund exists alongside at least two other key entities: the general partner (GP) and the investment manager.

Limited partners (LPs)—typically long-standing institutions like endowments, foundations, pension funds or insurance companies—provide the capital to a limited partnership. However, if you’re raising capital for the first time, you as the fund manager need your own entity to enter into a limited partnership agreement (LPA) with your LPs.

That entity is usually the general partner (GP), typically structured as a limited liability company (LLC). LLCs offer significant advantages: they provide flexibility in structuring management rights, allowing multiple “members” (the LLC equivalent of partners) without exposing them to unlimited liability. Like limited partnerships, LLCs also benefit from a pass-through tax structure—allowing business income to be taxed at the individual owner’s tax rate, avoiding double taxation at entity level—making them a popular choice for fund managers.

In an LPA, you’ll often see something along the lines of the following in the preamble:

This Limited Partnership Agreement (the “Agreement”) of Oreo Fund I, a Delaware limited partnership (the “Fund”), is made and entered into as of January 11, 2025, by and among Oreo Fund I GP LLC, a Delaware limited liability company as the general partner (the “General Partner”) and each of the persons the names of which are set forth under the heading “Limited Partners” on Schedule A as a limited partner (each a “Limited Partner” and collectively the “Limited Partners”). Oreo Management LLC, a Delaware limited liability company, serves as the manager of the Fund, (the “Investment Manager”).

If you can understand the paragraph above, you have grasped the structural foundation of a standard private funds business.

It helps to start at the top, with the investment manager entity, which sits above both the fund and the GP entities.

The separation of the GP and management company entities serves several key purposes for fund businesses:

1. Limited Liability Protection: the GP is the entity that assumes all legal liability for the fund’s decisions and operations. If the fund were to face legal issues or disputes, the GP bears that risk. By keeping the GP separate from the management company, the fund structure shields the management company’s assets—such as office space, employees, cash and other operational resources—from any liabilities arising from the fund’s activities. This is like putting the operating assets of a business in a different “box” from the more high-risk assets of the fund, protecting them from being pulled into potential legal or financial trouble.

2. Flexibility Across Funds: the management company often works across multiple funds, whereas each fund has its own separate GP. Think of the management company as the “general contractor” responsible for overseeing various projects (i.e., individual funds). By having a single management company that can work across different funds, a firm gains scalability. It can raise new funds over time without having to recreate the entire operational structure from scratch. The same management company might manage Fund II, Fund III, and so on, while each fund has its own GP tailored to its specific strategy and needs. Note that the management company also serves as the official investment adviser (except for VC managers) and, at some point, must register as an investment adviser, since it is managing the money of others for compensation, with state or federal regulators.

3. Tax Efficiency: the management company is the typical recipient of the management fee, which is usually taxed as ordinary income, charged by the fund to its LPs. This fee compensates the management company for providing the personnel, office space, and other resources to manage the fund’s operations. On the other hand, the carried interest—representing the profits the fund generates for its LPs—flows through the GP entity. This carried interest is typically taxed at a lower capital gains rate, which is more favorable than ordinary income tax rates. In this sense, the GP is like a “pass-through” vehicle for carried interest payments, which are ultimately distributed to the investment professionals who manage the fund (your managing directors, vice presidents, and perhaps a few lucky analysts). The investment professionals who are owners (or members) of the GP entity are typically entitled to this carried interest because they are the ones making the key decisions and actively deploying capital in the fund.

The structure of the GP and management company ties directly to Key Person clauses in a fund’s LPA. If you recall, Key Person provisions specify that certain individuals—typically the senior investment professionals or fund managers—are crucial to the success of the fund. If these key persons are unable to fulfill their roles (due to death, illness, departure, etc.), the fund’s investment period may be suspended or terminated or other actions may be taken, like appointing new Key Persons.

The reason this is important is that the Key Persons are generally affiliated with the investment manager, not necessarily the GP. The management company provides the people, resources, and infrastructure that allow the GP to make decisions and deploy capital. If the Key Persons leave the firm, it could trigger a number of LPA clauses. Since these individuals are typically entitled to the carried interest flowing through the GP, their departure could impact the fund’s operations.

Successions and Departures

As the private fund management industry has matured, succession planning has become a key issue. Many successful founders are aging and face the challenge of transitioning leadership. While some resist handing over control, others struggle to create standardized procedures that ensure continuity without over-relying on a few key individuals. The best fund managers build a strong ethos tied to their vision, often expressed through flexible values that adapt to change. However, institutionalization has its limits—too much can undermine effectiveness, while too little can jeopardize long-term continuity.

There are plenty of things you can institutionalize:

• You can hire the smartest people—every top investment management firm excels at this.

• You can craft proprietary trading algorithms so effective they’re practically classified.

• You can assemble a revolving door of board members, from former cabinet secretaries to retired shortstops turned investors.

• You can create memorable branding and launch brilliantly executed partnerships.

But LPs? Well, that’s a different game entirely. As Anthony Hagan so astutely put it:

Shared battle scars tend to bring people closer. Being committed (in real-time) to a fund that has gone through fundraising, deal-specific, transition- or succession-related, macro-induced, and/or act-of-God events, and has successfully emerged, builds a true bond.

When LPs praise a GP, they often highlight moments where the GP demonstrated resilience by overcoming tough situations—these “battle scars” are common among younger, growing managers. For established firms, however, the hardest days of fundraising are usually behind them.

With a strong reputation, attracting capital for the next fund becomes a much easier task. LPs are eager to de-risk their portfolios, and what safer place for a pension fund to invest than with a reputable manager?

But this smooth path raises a crucial question: will LPs continue to back these established firms when the charismatic founders who built their reputation move on?

And the founders may not be the only ones to leave. Senior and mid-level personnel, often riding the success of the firm, may depart for more lucrative opportunities, launch their own businesses, or to avoid waiting for succession plans to unfold.

The challenge lies in institutionalizing the qualities that made the founders successful—things like charisma, audacity, and sheer magnetism—which are hard to replicate. If you could institutionalize these traits, LPs wouldn’t revere them as much as they do. So, what happens when an institutionalized firm can no longer capture the unique qualities that set it apart? Does it lose its competitive edge?

Does it slip from being a “top decile” or “top quartile” manager into the cold, unremarkable expanse of mediocrity (i.e., “reversion to the mean”)?

Similar to the people in Lake Wobegon, most fund managers like to claim that they’re “above average”. But can they all really be?

Despite its increasing maturity, the private funds industry is still relatively young. The future is far from certain.

And while maturity brings the rewards of stability and prestige, it also carries the risk of extinction—often at the very moment a firm reaches its peak.

While many fund managers successfully navigate the competitive landscape and scale their operations, it's important to remember that not all make it to the next level. Some may stall after their initial funds or face challenges that prevent them from raising subsequent rounds. These “zombie” firms, stuck between past success and future potential, can struggle to adapt to evolving market conditions, shifting personnel, or underperforming investments.

Recognizing that the journey for fund managers isn't always linear is crucial. Success isn’t guaranteed, and the path forward can be fraught with setbacks. In the future, we’ll explore what happens when managers encounter these challenges and how some find ways to pivot, while others unfortunately fade into obscurity.