Why are key-person protections so contentious in fund term negotiations?

Happy Friday LP community!

I spent a day at PEI’s Investor Relations, Marketing & Communications Forum, listening to tales of the challenging fundraising trail and how firms are working to up their game in LP relations. It’s an interesting time to be in IR …

Some interesting findings – the most contentious term that comes up in negotiations, according to findings from PEI’s LP Perspectives 2024 survey – the focus of a panel discussion at the event – involved key-person provisions, which a few sources found surprising.

According to PEI’s LP Perspectives 2024 Study, 46 percent of respondents said unsatisfactory or a lack of key person clauses were a point of contention when reviewing fund terms – 5 percentage points higher than in the 2023 study.

“If LPs see sufficient involvement from a key person, they may accept key-personhood. For example, when there is a large GP commitment or no reduction in time spent on deals or with LPs,” Vish Ramaswami, a managing director and head of Asia-Pacific private investments at Cambridge Associates, told PEI in an interview last year.

Over the years, I’ve talked to LPs who feel that key-person provisions have become diluted as they are spread across ever-larger groups of partners, rather than one or two main individuals, in their minds de-fanging such protections.

Key-person provisions are meant to ensure that executives that LPs back in a new fund stay put through the life of the fund. If a key-person provision is triggered, LPs generally have the ability to end the investment period, preventing the fund from making new investments. It’s a statement from LPs that the fund should not continue if it’s not being run by the individiuals we trusted up front to manage our money.

If the protections are tied to a group of several individuals, rather than one or two, they are unlikely to be triggered even if the most important executive leaves.

As well, LPs at times have concerns that the true work horses of a firm are professionals in the mid-tier ranks, rather than those whose names are on the door, and the key person protections are focused on the wrong people.

Still, the findings that key-person provisions were the most highly contested term was surprising to some attendees at the event. Every fund is different and every negotiation its own journey, but a few sources seemed to think key-person terms were far from the thorniest issue.

Following closely behind were economic terms and carried interest distribution structures. The majority of funds in the US distribute carried interest (after hitting a preferred return) after each deal, as opposed to in aggregate at the end of the fund’s life, known as an European-style waterfall.

While LPs like to see carry distributed Euro-style, firms are reluctant to make the switch, because as one delegate said, once you make the switch, you’re never going back.

Euro-style waterfalls is always an ask by LPs, but the structure comes with its own challenges, including how to incentivize more junior members of the team who won’t be expecting carry for years.

Face-to-face meetings preferred

Another interesting dynamic in today’s market is a major shift from the remote fundraising days in the pandemic years. While GPs and LPs got used to meeting remotely, today’s LPs want in-person meetings. That includes LP institutions around the world, making it even more imperative for IR professionals to target the right potential sources of capital, justifying the time and expense of global travel.

Also, the sentiment at the event seemed to be that LPs would prefer less extravagant annual meetings, especially those held at resorts. Better to have them at major cities rather than places like Phoenix or Boulder (unless the firm is actually based there).

What do you think? Hit me up at christopher.w@pei.group or find me on LinkedIn. Have a great weekend!