Key person clause

A key person clause gives investors special when crucial investment professionals leave a hedge fund. These provisions recognize that many investors commit money based on specific individuals managing their investments, not just the broader team.

Hedge fund managers often market their funds by highlighting star portfolio managers or founding partners. When investors choose these funds, they expect those specific people to make investment decisions. If a key person leaves, investors may lose confidence in the fund's ability to generate returns. The key person clause gives these investors an escape route.

These clauses become essential for smaller, entrepreneurial where success depends heavily on one or two individuals. Without such provisions, investors might feel trapped if their chosen manager departs unexpectedly.

Key person clauses activate when specific events affect designated investment professionals. The management company must notify investors when covered professionals experience certain qualifying events.

Common triggering events include death, permanent disability that prevents work performance, resignation, termination, extended absence from duties, and significant reduction in time commitment or responsibilities. Each fund defines these events differently, but they generally capture situations where a key person can no longer effectively manage investments.

The fund documents must clearly specify which investment professionals qualify as "key persons." Typically, this includes founding partners, lead portfolio managers, and other senior professionals whose departure would materially affect the fund's investment approach.

Many fund documents use vague language about when someone becomes "unable to perform responsibilities" or "ceases active involvement." This ambiguity creates problems because investors and managers may disagree about whether the clause has been triggered.

Fund managers should establish objective criteria to eliminate confusion. For example, a clause might specify that a key person becomes unavailable if they cannot perform their functions for sixty or ninety consecutive days. This approach provides clear benchmarks that both parties can measure.

Without objective standards, disputes arise over subjective determinations. Questions like whether someone remains "actively involved" or has suffered sufficient incapacity to trigger the provision become difficult to resolve.

When a key person event occurs, the fund follows a structured process to handle investor responses. After receiving notice, investors typically receive a specified period to decide whether to exercise their special redemption right.

During this decision period, funds commonly suspend ordinary redemptions so that all redemption requests receive equal treatment. This prevents early responders from gaining priority over others who need more time to consider their options. The fund processes all key person redemptions simultaneously rather than on a first-come, first-served basis.

Redemption proceeds follow the fund's normal distribution procedures, including timing and payment mechanisms. The special nature of the triggering event does not change how investors actually receive their money.

Consider a fund with three key investment professionals covered by the key person clause. When one decides to retire from day-to-day management, the remaining principals believe they can continue successfully managing the fund with their established investment team.

Rather than shutting down the fund, management notifies all investors about the retirement and activates the key person redemption right. This allows concerned investors to withdraw while enabling confident investors to remain with the continuing management team.

The fund sends prompt notification after learning of the principal's retirement plans. The notice explains the situation and outlines investors' options under the key person provision.

Following a key person event, the fund implements specific notification and suspension procedures to ensure orderly processing. Investors receive detailed written notice explaining the triggering event and their redemption options.

The notification typically includes a suspension period during which regular redemptions cannot occur. For example, the fund might suspend redemptions for ninety days while processing key person redemption requests. Investors who want to redeem must provide written notice at least thirty days before the suspension period expires.

All redemptions become effective at the end of the suspension period. The fund then distributes proceeds according to normal payout procedures. This coordinated approach ensures fair treatment for all investors during a potentially disruptive period.

Different funds adopt varying approaches to key person provisions based on their investment strategies and investor preferences. Some funds establish specific notice and suspension periods with fixed redemption dates, while others maintain more flexible arrangements.

Alternative approaches allow funds to liquidate portfolio positions in a commercially reasonable manner without committing to specific redemption dates. This flexibility helps funds avoid forced sales that might harm non-redeeming investors.

Until redemption requests are satisfied, redeeming investors remain subject to the fund's portfolio risks. This continued exposure reflects the practical reality that complex investment positions cannot be liquidated instantly without potential losses.

Investors often negotiate key person provisions through when such clauses do not appear in standard fund documents. These private agreements allow investors to secure personalized protections based on their specific concerns about key personnel.

Side letter negotiations reflect investor recognition that they are backing particular individuals rather than just institutional investment processes. When investors lack confidence in remaining team members, they want the ability to withdraw if key persons depart.

Funds without built-in key person redemption rights may accommodate significant investors through customized side letter provisions. This approach allows funds to maintain standard terms while addressing specific investor concerns.

Some hedge fund sponsors prefer limiting investor requests to notification rights rather than full redemption rights. Under this approach, investors receive notice of key person events but do not automatically gain special withdrawal privileges.

Managers who grant notice rights through side letters should consider by voluntarily providing such notifications to all investors. Selective disclosure to only certain investors may create unfair advantages and potential legal issues.

This alternative balances investor information needs with fund stability concerns by keeping investors informed without automatically triggering mass redemptions.

Many hedge funds include automatic suspension mechanisms that activate immediately when key person events occur. These provisions typically suspend redemptions for a specified period, such as ninety days, giving the fund time to assess the situation and communicate with investors.

After the automatic suspension period expires, the fund typically offers redemption rights to all investors while lifting any remaining . This approach provides structured transition periods that benefit both departing key persons and remaining investors.

Automatic suspensions prevent panic redemptions while ensuring that all investors eventually receive equal redemption opportunities. The predetermined nature of these mechanisms reduces ambiguity about how key person events will be handled.

Key person clauses serve multiple purposes beyond investor protection. They help emerging managers demonstrate commitment to investors by acknowledging the importance of specific individuals to the fund's success. These provisions can provide stability during transition periods by creating structured processes for handling departures.

The clauses also create incentives for key personnel to remain with the fund, since their departure triggers investor redemption rights that could destabilize the fund. However, these provisions also constrain fund operations and may limit management flexibility during organizational changes.

Fund sponsors must balance investor protection against operational flexibility when drafting key person provisions. The goal is providing appropriate safeguards while maintaining the ability to adapt to changing circumstances and personnel decisions.

The scope of key person provisions varies significantly across funds based on several factors. Some funds cover only the most senior investment professionals, while others extend coverage to broader categories of personnel.

Factors influencing coverage scope include the complexity of the fund's investment strategy, the depth of the investment team, how concentrated decision-making authority is, and investor preferences. More established funds with deeper teams may limit key person provisions to senior managing partners.

Emerging funds often need broader coverage to satisfy investor requirements, since these funds typically have fewer personnel and more concentrated expertise. The appropriate scope depends on honest assessment of which departures would materially affect the fund's ability to execute its investment strategy successfully.