The key-man provision in companies
Mutual funds, hedge funds, private equity, venture capital firms deal with large amounts of their client’s money, and wrong decisions can lead to great losses to the clients who invest their money. Hence many investors insist that the financial firms have a Keyman provision to ensure that their money is invested by having the necessary skills, knowledge, and experience to ensure that the right decisions are taken.
What is a key man clause?
The key man clause in the contract prohibits the fund manager or investment firm from making new investments if one or more key employees are not available to spend sufficient time managing the investment.
Key man clause private equity explanation.
The key man is an executive or employee whose presence is important for the organization’s proper functioning. The death, disability, or absence of the key man can adversely affect the investment firm, so if the key man is not present, the investment firm will stop investing more money. It will resume investing only after the key man has been replaced and the investors approve the replacement. However, if any investments were made before the key-man clause was implemented, these investments will remain. The key-man clause is often found in smaller firms, where they are only a few experienced employees.
Importance of the clause
Investors want to be sure that their funds are being invested in well-run companies and the right decisions are being taken. Most large investment firms have major decisions approved by experienced, skilled staff to ensure that the investors’ money is properly invested. Investors make decisions based on the investment firm’s track record, and this key-man provision ensures that there is no major change in the firm’s approach towards investment. Usually, the firm will invest in a business for many years, and this clause ensures that the key man will ensure that the firm gets the best possible returns.
This clause ensures that the firm will quickly replace the key top executive who leaves the firm in larger investment firms. The business can also purchase key man insurance, which compensates the business for any financial losses caused by the death or absence of the key man. Only a fixed amount specified in the insurance policy is provided to the business, which can help cover the loss caused due to the loss of specialized skills, experience, and profits from investment. Insurance compensation can help in recruiting new staff and also paying others.
How to implement a key-man clause
Though it is not mandatory, increasingly, businesses are incorporating a key man (KM) clause to protect themselves if important executives leave. This protects the business’s interests and helps to reassure investors in the company.
Creating a clause
First, the business should identify all the important decision-makers for the business, whose exit could cause a business loss.
Create a replacement plan.
In case the key man is absent for a longer period, the company should create a plan for recruiting and training a replacement and who will take over the responsibilities in the absence of the key man.
The company may also purchase key-man insurance so that the company is compensated financially if they leave unexpectedly.