The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Succession

  • From Vol. 7 No.37 (Oct. 2, 2014)

    Sidley Partners Discuss Trends in Hedge Fund Seed Deals, Governance, Succession, Estate Planning and Tax Structuring (Part Two of Two)

    This is the second article in a two-part series examining the more notable takeaways from the 2014 edition of Sidley Austin’s annual private funds event in New York City.  This article focuses on the discussion during a panel entitled, “Operating a Fund Manager: Opportunities and Pitfalls,” featuring Sidley partners Christian Brause, David R. Sawyier, Kathleen O’Hagan Scallan, Michael J. Schmidtberger and Daniel F. Spies.  The partners discussed capital markets as a source of liquidity for fund managers, evolving trends in seed deals, succession considerations, the challenges of business and personal divorces as they relate to structuring and succession, trust and estate considerations and fund- and management company-level tax developments.  The first article covered evolving fee structures, seed deal terms, single investor hedge funds, risk aggregators, expense allocations and co-investments, among other issues.

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  • From Vol. 7 No.2 (Jan. 16, 2014)

    Succession Planning Series: Selling a Hedge Fund Founder’s Interest to an Outside Investor (Part Two of Two)

    When a veteran hedge fund founder begins to contemplate retirement, he or she has choices to make about the nature of the firm to be left behind.  The previous installment in this two-part series on succession planning explored the issues surrounding one such choice: bequeathing the management firm as an independent entity to be wholly owned and led by a successor generation of firm principals.  This second installment addresses a different decision that a founder nearing retirement might make: selling the founder’s stake in the firm to an outside investor.  More specifically, this article touches on the following topics: reasons for selling a firm, finding a buyer, valuation issues, franchise protection (including strategies for retaining key employees), control rights (including veto rights), future rights to increase or decrease ownership (including exit opportunities for the remaining principals), fund documentation issues, other legal issues and investor relations issues.  In certain respects, these alternative choices have similar consequences and raise similar issues because each path is a way to institutionalize the manager’s business in conjunction with the founder’s exit.  Valuation of the founder’s interest, for example, will be a central concern in each scenario.  Post-closing retention incentives for the manager’s remaining talent is also a common theme, as are investor relations and fund documentation issues.  In other respects, however, a sale transaction differs significantly from an internal succession.  In the sale context, grooming and making visible a new internal leadership generation may not be as important; valuation will be negotiated with a third party and may be AUM-centric; and arrangements regarding post-closing control and ownership rights between the buyer and the remaining principals will loom large.  The authors of this article series are Scott C. Budlong, William Q. Orbe and Kenneth E. Werner, all partners Richards Kibbe & Orbe LLP.

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Succession Planning Series: A Blueprint for Hedge Fund Founders Seeking to Pass Along the Firm to the Next Generation of Leaders (Part One of Two)

    A generation of hedge fund founders is arriving at a crossroads.  By one estimate, around $600 billion of the industry’s assets are managed by firms whose founding principals will reach at least their sixties in the next decade.  As they begin to contemplate retirement or devoting time to other projects, founders are considering a fundamental question: Do I want the firm to continue after I leave the stage?  Some founders will choose to wind up the firm.  Others, however, will want to leave behind an institutionalized business.  One way to do that is to sell a significant stake in the firm to an outside investor.  Alternatively, the founder may decide to groom a successor generation of leadership and make operational adjustments designed to let the firm thrive as an independent organization after the founder’s departure.  This guest article is about the latter approach to institutionalization – preparing to bequeath a free-standing franchise to the manager’s remaining principals and employees.  More specifically, this article addresses the imperative of advance planning for leadership transitions; choosing new leaders; the treatment of the founder’s economic interest in the firm; retaining and motivating key talent; and a variety of issues concerning succession execution, including investor communications, consent issues and key-man provisions in partnership agreements.  The authors of this article are Scott C. Budlong, William Q. Orbe and Kenneth E. Werner, all partners Richards Kibbe & Orbe LLP.  In a subsequent companion article, Budlong, Orbe and Werner will explore the possibility of selling an interest in the manager to a third party, where, in a different context, the institutionalization process is also important.  For more on succession planning, see “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two),” The Hedge Fund Law Report, Vol. 5, No. 8 (Feb. 23, 2012).

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  • From Vol. 5 No.11 (Mar. 16, 2012)

    Ernst & Young’s Arthur Tully Talks in Depth with The Hedge Fund Law Report About Hedge Fund Governance, Succession Planning, Valuation, Form PF and Administrator Shadowing

    Ernst & Young’s (E&Y) recently published “Coming of Age: Global Hedge Fund Survey 2011” (Survey) highlighted a host of operational issues that hedge fund managers have recently grappled with, including issues related to corporate governance, succession planning and shadowing of fund administrators.  See “Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence,” The Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  We recently interviewed Arthur Tully, the Co-Leader of E&Y’s Global Hedge Fund practice, on various topics covered by the Survey, including: issues related to valuation of investments; independent reconciliation of investment positions; reconciliation and documentation of differences in NAV calculations; independent administration considerations for UCITS funds; and how to gather the data necessary to complete Form PF.  See “Hedge Fund Valuation Pitfalls and Best Practices: An Interview with Arthur Tully, Co-Leader of Ernst & Young’s Global Hedge Fund Practice,” The Hedge Fund Law Report, Vol. 5, No. 2 (Jan. 12, 2012).  In this follow-up interview, Tully shares his insight and experience on additional topics of pressing importance to hedge fund managers, including best practices for hedge fund corporate governance; compensation structures for effective succession planning; valuation issues (including a discussion of the biggest mistakes made in valuing assets); project management in the Form PF context; and administrator shadowing (including common functions shadowed by hedge fund managers).  This article contains the full text of our second interview with Tully.  Tully is expected to expand on these and related topics during a session focusing on hedge fund governance at the Regulatory Compliance Association’s Spring 2012 Regulation & Risk Thought Leadership Symposium.  That Symposium will be held on April 16, 2012 at the Pierre Hotel in New York.  For more information, click here.  To register, click here.  (Subscribers to The Hedge Fund Law Report are eligible for discounted registration.)

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  • From Vol. 5 No.8 (Feb. 23, 2012)

    Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two)

    The death, disability or departure of a founder or key employee of a hedge fund manager (succession event) creates a business risk that the manager must proactively address to ensure the long-term viability of the enterprise, to respond to investor concerns and to meet the firm’s regulatory obligations.  A firm must anticipate and address not only personnel considerations, but also the impact of a succession event on ownership, compensation and other legal and operational issues.  This is the second article in a two-part series analyzing key considerations for hedge fund managers aiming to adopt and implement an effective succession plan.  The first article in this series discussed: why succession planning is an imperative for hedge fund managers looking to raise institutional capital and create long-term enterprise value; applicable regulatory requirements; the imperative of commencing succession planning today rather than deferring difficult decisions; examples of prominent hedge fund managers that have implemented succession plans; what types of succession events a succession plan should cover; people decisions, including how to identify roles to be filled and how to identify, incentivize and train successors; and the role of management committees in succession planning.  See “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 7 (Feb. 16, 2012).  This article discusses: potential changes in a firm’s ownership and compensation structure designed to incentivize prospective successors to stay with the firm and to address the economics of departing founders or key employees; how to document a succession plan; how to test a succession plan; and how to communicate information about a succession plan with investors.

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  • From Vol. 5 No.7 (Feb. 16, 2012)

    Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part One of Two)

    Many hedge fund managers may be surprised to learn that they are mortal.  But managers are being reminded of this unpleasant fact with increasing frequency by institutional investors requesting robust succession plans.  In one view, succession planning is part and parcel of the frequently cited “institutionalization” of the hedge fund industry.  By definition, institutions are not about any one person.  They may have a charismatic founder – a Sam Walton or a Ross Perot – but they can survive the death, disability or departure of that founder, and even thrive following such an event.  But more fundamentally, succession planning is about going from good to great.  A good hedge fund manager can generate consistent returns over an extended period.  A great hedge fund manager can create an institution that generates consistent returns over an extended period.  In other words, a good hedge fund manager is a good investor, but a great hedge fund manager is a good investor and a good businessperson.  Paradoxically, greatness in the hedge fund business – as in any business – requires the ability to render yourself somewhat irrelevant.  Service partnerships like hedge fund managers are inherently fragile because their primary asset is their talent and talent can be fickle, fleeting and, absent contractual restrictions, mobile.  See “Schulte Roth & Zabel Partners Discuss Non-Competition and Non-Solicitation Provisions and Other Restrictive Covenants in Hedge Fund Manager Employment Agreements,” The Hedge Fund Law Report, Vol. 4, No. 42 (Nov. 23, 2011).  Moreover, talent at the top that is insufficiently diffused throughout the organization can result in a top heavy hedge fund manager, and one that is therefore easily toppled.  Accordingly, investors in hedge funds and acquirers of hedge fund management businesses want concrete evidence that a manager has mitigated the business risk.  A considered, workable and realistic succession plan is the best evidence that a manager has thought ahead.  Reasoning backwards, a succession plan is more than just a defensive document: it offers franchise value to acquirers, predictability to investors and long-term value to the founder and his or her heirs.  See also “Key Person Provisions in Hedge Fund Documents: Structure, Consequences and Demand from Institutional Investors,” The Hedge Fund Law Report, Vol. 2, No. 37 (Sep. 17, 2009).  This is the first article in a two-part series that will outline key considerations for hedge fund managers seeking to develop and implement a succession plan.  This feature-length article discusses: why succession planning is an imperative for hedge fund managers looking to raise institutional capital and create long-term enterprise value; applicable regulatory requirements; the imperative of commencing succession planning today rather than deferring difficult decisions; examples of prominent hedge fund managers that have implemented succession plans; what types of succession events a succession plan should cover; people decisions, including how to identify roles to be filled and how to identify, incentivize and train successors; and the role of management committees in succession planning.  The second article in this series will discuss potential changes in a firm’s ownership and compensation structure designed to incentivize prospective successors to stay with the firm and to address the economics of departing founders or key employees; buyout and sunset provisions and the role of insurance; how to document and test the succession plan; how to communicate information about a manager’s succession plan with investors; and considerations with respect to redemption rights.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Ernst & Young Survey Juxtaposes the Views of Hedge Fund Managers and Investors on Hedge Fund Succession Planning, Governance, Administration, Expense Pass-Throughs and Due Diligence

    Ernst & Young (E&Y) recently released the 2011 edition of its annual hedge fund survey entitled, “Coming of Age: Global Hedge Fund Survey 2011” (Report).  The Report conveys and compares the views of hedge fund managers and investors on topics including succession, independent board oversight, use of administrators, expense pass-throughs and due diligence.  This article summarizes the more salient findings from the Report.  One of the Report’s many interesting insights is that managers frequently receive little in the way of feedback when a potential investor declines an investment.  The Report partially fills this “feedback gap” by offering generalized insight on what matters most to investors.  For example, managers may be surprised to learn that the absence of a robust and reliable succession plan may have played as much or more of a role in a lost investment as performance or even operational issues.  (The HFLR will be covering succession planning for hedge fund managers in an upcoming issue.)  More generally, the depth of the disparity in perception between managers and investors on a range of topics, as found by the Report, is at times startling.  The Report therefore offers a sobering reality check for both managers and investors.  Both sides need one another, albeit for different reasons, and the lifecycle of an investment can be significantly more productive if expectations and assumptions are better aligned.

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  • From Vol. 2 No.37 (Sep. 17, 2009)

    Key Person Provisions in Hedge Fund Documents: Structure, Consequences and Demand from Institutional Investors

    Traditionally, the success of a hedge fund manager and its funds under management flows (or fails to flow) directly from the vision, expertise or acumen of one person, or a small group of people.  That person is often, though not invariably, the founder of the manager, and those people are often fellow founding partners, or key hires made subsequent to founding.  In a word, key people are the people that generate revenue, and investors are rightfully concerned about what may happen if key people die, become disabled or cease (voluntarily or involuntarily) to actively participate in the management of the funds in which investors are invested.  To address and mitigate those concerns, key person provisions are often drafted into various fund or manager documents or into side letters; the current trend is toward inclusion of such provisions in fund operating documents, and away from inclusion of such provisions in side letters.  Such provisions take various forms and establish differing mechanics, but generally provide for notification and redemption rights in the event of designated triggering events.  This article explores the substance of key person provisions – how they are drafted and the mechanics they establish; the documents in which they are located; the differing consequences of locating the provisions in different documents; the consequences of triggering such provisions; the demand by institutional investors for such provisions; and the relationship between key person provisions and succession planning.

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  • From Vol. 1 No.21 (Sep. 22, 2008)

    Rothstein Kass Study Suggests that Hedge Fund Managers are Inadequately Prepared for Succession Challenges

    According to a recently-released study, only a small minority of partners and senior managers at hedge funds have adequately planned for succession in the event of the death, disability or termination of an owner, partner or other key person. At the same time, experts interviewed by The Hedge Fund Law Report suggested that increasing numbers of institutional and high net worth individual investors are beginning to demand succession plans as a condition of an investment in a fund. The study was sponsored by accounting and financial services firm Rothstein Kass, and co-authored by private wealth experts Russ Alan Prince and Hannah Shaw Grove. A key finding: fewer than 30% of the partners surveyed are prepared to deal with the death of one of their management-level colleagues.

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