What is more important to limited partners than the stability of a private equity team?
In recent conversations, I’ve discovered that some LPs believe, when backing an ancillary product which is part of a much larger firm, that individual heads of those funds are not as important as the broader organization.
This relates to a story I wrote recently on some Vista Equity LPs concerned about abrupt changes atop the firm’s mid-market funds earlier this year. The co-heads of both funds stepped back into advisory roles, which did not trigger key-person protections. Read more here.
Key-person provisions are in place to ensure that the leadership that raises the fund remains through the life of the pool. When departures trigger a key-person provision, LPs generally have the ability to halt the fund’s ability to make new investments and decide if they want to restart the fund. This usually leads to negotiations between LPs and GPs about installing new leadership to run the fund into the future.
For some LPs, the changes at Vista were frustrating in that both mid-market teams recently closed new funds. Those LPs put their money behind individuals they trusted to run the funds and stick it out through the life of the pools. When those folks leave early on, that can be quite a blow to the LPs’ confidence in the future of the fund.
However, there’s a catch, from what I heard in recent conversations, at least for some LPs. Other investors reasoned that the commitments they made to the funds were more of a platform bet on Vista as an organization, rather than on simply backing talented individuals.
In cases like this, large organizations that can attract talent easier than independent firms, the loss of a fund head might be less traumatic. In other words, when the co-head of a fund leaves a two- or three-person shop, that is a potentially devastating situation. When leaders leave smaller funds within broader organizations, that likely doesn’t have the same kind of impact.
In Vista’s case, on its small-cap Endeavor fund, the firm promoted a veteran operating partner, Rachel Arnold, into the co-head spot alongside René Yang Stewart, who has led the fund since inception. Arnold got nothing but glowing reports from LPs I spoke to, with the one area of concern being a lack of raw investment experience (as opposed to operational work).
In general, key-person negotiations have become an area of frustration for LPs, as these provisions have become diluted and very hard to trigger, sources have told me in recent conversations. We’ll be exploring this issue going forward.
For many LPs, it comes down to a decision: do you want access to a fund from a manager you want to work with, and is a weak key-person rule material enough for you to walk away? In today’s bullish fundraising environment, the answer is frequently for LPs to hold their noses and commit to the fund, with fingers crossed that the key-person scenario never arises.