Limited partners investing in Africa-focused private equity and venture capital funds are increasingly prioritising key man risk, as evidenced by several recent opinions we’ve issued on the topic. In one of those cases, a key man in a private fund departed to set up his own fund with a similar investment thesis & strategy. A dispute then arose as, to the extent to which the key man could legally leave the fund as well as establish a fund with a similar investment strategy. In this update, we clarify the scope and application of key man risk within the context of private funds and provide some insights on the allocation of key man risk in partnership agreements.
Key Man Risk. What is it?
This is the risk that a key man ceases to devote time, capacity and attention to the business of a private equity/venture capital fund for any reason. Such reasons may range from death, disability, retirement, disagreement or a goodwill departure of one of the key persons in a private equity or venture capital fund.
For limited partners, one or more key men must always be available during the life of a fund. The reason is because limited partners are bound to provide the capital committed when requested by a fund manager, until the end of the investment period and cannot generally withdraw their capital or transfer their limited partnership interests. Within this context, key man clauses can help limited partners protect their interest against losses that may occur during the life of a fund and provide the assurance that a fund will continue to execute on its investment strategy.
Who is the Key Man?
It’s helpful for limited partners to think about key man risk as a fluid and not static concept. Although the key man is usually one or more promoters of a fund, it may become necessary to identify senior investment professionals, junior management professionals as well as entire teams as key men. It’s also helpful to define the key man as being representative of a specific category or persons based on experience, qualification and dependency, thereby expanding that category by default and without having to amend the partnership agreement.
Key men are usually required to devote all, majority or a substantial majority of their time to the fund. It is often critical for fund managers/general partners to proactively address and plan ahead for key man events and to address issues relating to availability of non-founding key men as well as the risk of competition, when they engage prospective key men.
What Happens When a Key Man Risk Crystallizes?
A key man event is a significant one for partners because the notice of a key man event will ordinarily trigger a suspension of the commitment period and lead to a temporary freeze drawdowns and management fees. However, general partners will be able to call capital to pay for fund expenses, make follow-on investors and complete on-going portfolio investments. The rights of the limited partner to suspend the fund’s investment period, in the event of a key man event, will ordinarily be enforceable in Nigerian courts as local limited partnership laws allow partners in a limited partnership to freely determine how the partnership is structured.
From a documentation standpoint, it is prudent for the rules around replacing a key man to be clear and executable in the short term[1] and for limited partners to reserve the rights to terminate the commitment period where a remediation plan is not agreed within a period of time. It’s also advisable to provide detailed clauses to address key man events that occur after the end of the commitment period in the partnership agreements.
Final Analysis
Given that the departure of a key man can significantly impact the business of a private fund, it is prudent for general partners/fund managers to pay close attention to contractual arrangements between the promoters of a fund and contractual arrangements with senior management. Usually, limited partners will request some information on the shared work history and degree of alignment between key men, during a fund diligence exercise, it may also be prudent for limited partners to conduct some limited diligence on the exact nature of the legal relationship between key men in a private fund as some clean up may become necessary, prior to closing.
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[1] Partnership agreements will typically mandate general partners to notify them when a key person event occurs. Such notices will typically trigger an automatic suspension or a suspension based on votes.
