Updated July 12, 2023
What is a Key Man Clause?
The key man clause is a condition that restricts a firm from making any new investments or new decisions in the absence of key persons. Key persons are in charge of the money handled by the firm.
It triggers when executives cannot devote sufficient time to manage the firm’s investment. The clause keeps the major decisions on hold until the resumption of the key person.
How to Implement?
There are various steps for the implementation of a Key Man Clause:
- This should be comprehensive, holistic, and efficient enough to cover all factors affecting its implementation. Thus, the first step of creating the key man clause is to identify the key men of the entity.
- In the case of the replacement of key men, it may not be quick for a small or medium-scale entity to replace them. Thus, it is suggested that such entities should go for key man insurance. In such a case, the insurance company will compensate the entity in the event of the loss of key men or cessation of work for any reason.
- The replacement plan is the final step for implementing the Key Man clause. The replacement plan ensures that investment decisions are held until a replacement is done.
Example of Key Man Clause
A sample key man clause can read as follows:
Mr. John Mitchell considers an integral part of the investments and operations of the firm (“Key Man”). If Mr. Mitchell plans to leave the firm or in case of untimely death or unfortunate disability with permanent nature arises, the management of the funds could be materially affected. In such a scenario of the absence of the Key Man, the members shall have the right to approve a replacement of the Key Man within six months from the date of non-availability of the Key Man. The same shall be done by a majority of votes cast in favor. In case of non-appointment of Key Man within the said time frame, the fund will cease to make new investments and shall proceed for liquidation.
Triggers for Key Man Clause
Trigger means what enables the implementation of the key man clause. The following are the factors that may trigger the implementation of the Key Man Clause:
- The usual case of absence of a key man is when the firm has fired him without proper replacement or the key man has resigned from his post.
- There are changes in the investment industry on a global level. Hence, the current key man may become unfit for the job.
- Death of the key man
- A situation where the key man is bedridden and suffering from long-term disability.
- Investment needs churning as per the risk profile of the investors. Hence, the key man needs to devote time to decision-making. However, the key person may be unable to provide attention to the company’s business.
- The key man may have lost interest in the investment industry. As a result, it may delay the implementation of the investment strategies for the investments held by the firm.
- A situation where the key man is convicted of the crime.
Importance of Key Man Clause
- Investment firms handle people’s money, i.e., the riskiest inventory globally. You got to be on your toes every time to grab the opportunities. You should be able to generate returns per the risk and return profile of the investors or group of investors. Thus, investment strategies are key to any investment firm. Such a strategy may become redundant in the absence of principal officers of the entity. It is where the key man clause gains its importance.
- Since the firm handles the riskiest assets, investors want strong assurance that the investment will be made wisely and with proprietary responsibility. Proprietary responsibility refers to dealing with something as if you own it. Further, they need assurance that the firm is a going concern. When people invest in some firm, they see the people behind it rather than the firm. Thus, the exit or absence of key managerial personnel affects the interest of the investors.
- Therefore, a key man clause provides reassurance that the firm’s investment approach will not change without the presence of a stalwart for its money. Thus, it guarantees that only the most efficient and qualified senior executives will make important decisions to provide the highest possible returns.
- The exit of the key man from the firm or his exclusion from critical decision-making raises eyebrows among investors. However, with the help of this, the firm can quickly provide an effective replacement to safeguard the interest.
- The insurance agreement compensates the business in the absence or death of key decision-makers. The insurer will not make good the actual loss but will provide fixed monetary compensation as agreed in the insurance policy. It facilitates business continuity since the compensation offsets any loss of income due to the extension of any business projects or delays in the project. Also, the entity can search for new talents using compensation for recruitment expenses.
- It is widely used in limited partnership companies, mutual funds, and venture capital. Thus, it is usually applied for smaller funds where the exit of a key man can affect the fund’s existence shortly. On the contrary, large investment firms usually have replacements ready and trained to mitigate the risk of losing the present key man. Further, the key man clause is also helpful if the fund managers leave the firm amid the fund cycle.
Key Takeaways for Key Man Clause
- The key man clause is a condition that restricts a firm from making any new investments or new decisions in the absence of key persons.
- This should be comprehensive, holistic, and efficient enough to cover all factors affecting its implementation.
- The triggers for the key man clause can be sudden death, the conviction of a crime, being fired from a job or resigned, being unfit for the firm, suffering from long-term disability, and others.
- Since the firm handles the riskiest assets, investors want strong assurance that the investment will be made wisely and with proprietary responsibility.
- When people invest in some firm, they see the people behind it rather than the firm. Thus, the exit or absence of key managerial personnel affects the interest of the investors.
- Therefore, a key man clause provides reassurance that the firm’s investment approach will not change without the presence of a stalwart for its money.
Conclusion
Though the key man clause is not mandatory for investment firms, many companies are adopting it as an ethical practice for people’s money. It further enhances the firm’s goodwill and provides mental satisfaction to the investors.
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