Managing Key Person Risk
Explanation
Managing Key Person Risk in Private Equity
Successful private equity investing is fundamentally driven by human capital. The expertise, judgement, and leadership of key individuals within the General Partner (GP) team are often central to a fund’s performance. Consequently, the unexpected loss or departure of one or more of these individuals—known as a “key person event”—can severely impact investor confidence and fund operations.
To mitigate this risk, Limited Partners (LPs) and fund managers typically adopt a combination of structural and operational strategies. Below are three commonly used approaches:
1. Key Person Provisions in the LPA
Many private equity funds include key person clauses within the Limited Partnership Agreement (LPA). These clauses outline what happens if a key individual is no longer actively involved in managing the fund—due to resignation, death, or disability.
Typical safeguards may include:
- Suspension of new investments until LPs vote to continue
- Restrictions on investor redemptions during a key person event
- Triggering of “lock-ups,” “gates,” or mandatory investor notice periods
2. Key Person Insurance
Some funds may take out key person insurance—a life or disability insurance policy that provides financial compensation in the event a critical individual becomes incapacitated or passes away.
Benefits of this insurance include:
- Offsetting financial loss to the fund
- Funding transitional management or restructuring needs
- Providing reassurance to LPs that a contingency plan is in place
3. Written Key Person Contingency Plans
Best practice requires that the GP prepare a formal key person contingency plan. This document outlines the course of action to be taken if a key individual is no longer available, including:
- Who will assume their responsibilities
- Steps for ensuring business continuity and operational oversight
- Communication protocols with LPs and stakeholders
- Potential fund dissolution procedures if necessary
In summary: The presence of key person protections—whether legal, financial, or operational—can significantly reduce risk exposure and increase the resilience of a private equity fund. For LPs, these strategies offer reassurance that the fund will remain stable and effective even in the face of unexpected leadership disruptions.
View More Definitions & Explanations
The Origins and Evolution of Private Equity
Private equity (PE) has grown into a global financial powerhouse, but its beginnings can be traced back to the post-World War II era. The formation of the American Research and Development Corporation (ARDC) in 1946 marked one of the earliest institutional private equity efforts.
ARDC’s mission was to fund companies that could repurpose wartime technologies for commercial use. One of its landmark investments was in Digital Equipment Corporation (DEC). A modest $70,000 investment in DEC eventually turned into $355 million, delivering a return of over 5,000 times the original amount. This staggering success demonstrated the potential of private equity to fuel innovation and drive extraordinary financial outcomes.
The Rise of Leveraged Buyouts in the 1980s
The 1980s became a transformative decade for private equity, largely due to the emergence of leveraged buyouts (LBOs). Pioneering firms such as Kohlberg Kravis Roberts (KKR) led this movement, acquiring companies primarily through borrowed capital, implementing operational improvements, and exiting through strategic sales or IPOs. These deals often resulted in significant returns and played a key role in legitimizing private equity as a powerful tool for value creation.
Private Equity Today: A Global Asset Class
Fast-forward to today, and private equity has evolved into a multi-trillion-dollar global industry. PE firms are actively involved in reshaping key sectors, including technology, healthcare, financial services, energy, and consumer goods. The United States continues to dominate the market, but institutional investors are increasingly turning their attention to opportunities in Europe and Asia where valuations are more attractive and growth potential remains robust.
In recent years, PE has also embraced thematic and impact investing. Many funds are aligning their strategies with ESG (Environmental, Social, and Governance) principles or specific global trends, such as digital transformation, renewable energy, and health innovation. This not only broadens investor appeal but also enhances the sector’s influence on global progress.
The Dominance of Private Companies
One compelling statistic underscores the importance of private markets: approximately 83% of U.S. companies with over $100 million in revenue remain privately held. This highlights the vital role of private equity in financing, developing, and scaling enterprises outside the public markets.
In summary, private equity has evolved from a niche investment strategy to a dominant force in global finance. With its origins in innovation and a future driven by strategic investment, operational excellence, and global diversification, PE is positioned to remain a key player in shaping tomorrow’s economy.
