Understanding Key Person Risk in the US Alternative Investment Industry

You’re a newer or emerging manager in the U.S. alternative investment industry, and you have just come back from Miami where you’ve had what seems like a year’s worth of investor meetings in just two weeks.

Hopefully, you have some potentially good leads for future follow ups. And in these meetings, investors will really start to dig into your strategy, operation and firm.

One of the things they will examine in great detail is key person risk; the success of private debt, private equity, hedge funds, venture capital, and other alternative investment vehicles often hinges on the expertise, decision-making, and leadership of a few key individuals and if one or more of these individuals were to leave, become incapacitated, or otherwise be unable to fulfil their roles, the financial and operational consequences could be severe.

What Is Key Person Risk?

Key person risk refers to the potential negative impact that the departure or unavailability of a crucial individual (or small group of individuals) can have on a firm or investment vehicle. In the context of private funds, this typically means the fund manager, general partner, or key investment professionals who are responsible for the fund’s strategy, execution, and overall success.

Private funds often rely on specific individuals’ track records, industry connections, and specialized knowledge. Investors allocate capital based on their confidence in these professionals’ abilities. When such individuals leave, it can trigger disruptions that impact performance, investor confidence, and even the fund’s long-term viability.

Situations That Pose Key Person Risk for Investors

Investors consider several scenarios that can give rise to key person risk when conducting their due diligence efforts on potential (and existing) fund managers.

1. Departure of a Key Investment Professional

If a fund’s lead portfolio manager or chief investment officer (CIO) resigns, it can raise concerns about the fund’s future direction. Investors may question whether the remaining team can sustain performance and adhere to the established strategy.

2. Death or Incapacitation

Private funds are often led by seasoned professionals who have built their careers over decades. The sudden loss of a fund manager due to illness, accident, or other unforeseen circumstances can create uncertainty and force the firm to find a replacement quickly—sometimes with suboptimal results.

3. Disputes Among Founders or Partners

Internal conflicts among a firm’s leadership can lead to resignations, disruptions in decision-making, or even legal battles. Such conflicts can destabilize operations and erode investor trust.

4. Regulatory or Legal Issues

If a key person becomes embroiled in regulatory investigations or legal troubles, it can damage the firm’s reputation and lead to investor withdrawals. Regulatory scrutiny can also result in operational changes that affect fund performance.

5. Succession Planning Failures

Many asset managers fail to implement a robust succession plan. If a key individual exits without a clear successor in place, the firm may struggle to maintain continuity, leading to performance declines and investor unease.

How Investors Mitigate Key Person Risk

Given the potential for disruption, investors and fund managers take several steps to mitigate key person risk. While many of these provisions are now considered ‘the norm’ in investor contracts, it is worth ensuring that you have all of these points covered off.

1. Key Person Provisions in Fund Documents

Many private fund agreements include “key person provisions” that outline what happens if a critical individual leaves. These provisions often give investors the right to suspend new investments or even withdraw capital if key persons are no longer involved.

2. Strong Investment Teams and Institutionalized Processes

Funds that build deep, experienced teams rather than relying on a single star manager are better equipped to handle leadership changes. Institutionalizing investment processes can also help maintain consistency.

3. Succession Planning

Firms that prioritize long-term succession planning are better positioned to transition leadership smoothly. Investors often look for firms with well-defined plans for leadership changes.

4. Insurance Policies

Some firms purchase key person insurance, which provides financial support in case of an unexpected loss of a crucial individual. While this does not fully mitigate the risk, it helps manage short-term financial challenges.

5. Diversified Fund Management Structures

Some private funds operate under co-CIO or co-manager models to reduce reliance on a single individual. This structure can distribute decision-making responsibilities and lower key person risk.

Key person risk is a significant consideration for investors in the U.S. private fund industry. While fund managers and investors can take steps to mitigate this risk, it remains an inherent challenge in an industry driven by expertise and leadership. Investors carefully evaluate fund governance, key person provisions, and succession plans when committing capital to ensure their interests remain protected, and managers that acknowledge and take steps to mitigate this risk will have an advantage over their peers that don’t.

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Gregory Poapst is a Managing Partner at Fundviews Capital. Connect with him on LinkedIn here.

Fundviews Capital is a full-service end-to-end Fund Management Platform.  Our platform provides a complete end-to-end solution for asset managers or wealth managers to structure, launch, operate and grow their professional investment funds. You can launch a fund in a matter of weeks, not months, and with minimal capital outlay – not only reducing the risk of launching a fund but also maximizing your chance of success. Once launched, you will find that a dedicated team of professionals is just a phone call or email away at all times, handling all aspects of the back and middle office for your fund.