Drafting Effective Key Person Provisions for Hedge Funds (Part One of Two)

Although hedge funds vary widely in terms of size, profile and investment strategy, it is not uncommon for a single individual at a fund to wield vast authority and oversee most or all trading and investments. Often, that same person – who may be the founder, managing partner or head portfolio manager, for example – conducts outreach, brings new investors on board, builds relationships and commands the trust and respect of investors, who may not want to grant oversight of their money to anyone else. If someone wielding so much responsibility were to die suddenly, fall chronically ill, quit, retire or otherwise cease to be part of the fund’s operations, the consequences could be dramatic. Some investors may seek to redeem their shares as fast as possible and exit the fund, while others may wish to stay on under new leadership, necessitating careful succession planning. Thus, it is imperative for hedge funds to have the right key person provisions in their governing documents. This article, the first in a two-part series, explains what key person provisions are and in which documents they typically appear; the terms of such provisions, including which personnel they cover, what scenarios could trigger them and investor rights if they are triggered; why they are vitally important in the SEC’s eyes; and how they relate to succession planning. The second article will delve into the operational logistics of what happens when a key person event occurs. See our two-part series on succession planning: “A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders” (Nov. 21, 2013); and “Selling a Hedge Fund Founder’s Interest to an Outside Investor” (Jan. 16, 2014).

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