What is a Key Man Clause?
In an investment context, a key man clause is a contractual clause that prohibits an investment firm from making new investments in certain situations.
For example, a key man clause can prohibit a firm from making new investments if one or more named key individuals aren’t present at the time of the decision. It can also prohibit new investments if a firm cannot dedicate sufficient time to managing the investment.
Usually, the key individuals will either be the investment firm’s fund managers or general partners.
This clause is usually used by venture capital firms, limited partnership companies, private equity firms, and mutual fund companies.
A key man clause is also referred to as a key person clause or key man provision.
What is the purpose of a key man clause?
A key man clause helps to give assurance to investors that their funds will be invested and managed by individuals with an appropriate level of expertise and experience.
It is essentially a contractual guarantee made by an investment firm to its investors that their investments are in safe hands.
Skilled investors usually seek out investment firms with experienced personnel who have a proven track record of success. When they invest, investors will therefore have certain expectations for how the investment firm will manage their investment.
A key man clause is seen as a beneficial contractual provision for investors as it prevents any major changes from being made to how their funds will be managed.
What types of investors seek key man clauses?
Key man clauses are usually sought by investors who have a substantial amount of money at stake.
In addition to savvy individual investors, startups, foundations, and those with endowments may seek, or even demand, an investment fund to include a key man clause in their contract.
What are the implications of key man clauses?
If one of the key individuals named in a key man clause leaves the investment firm, the key man clause will help ensure that they are replaced in a timely manner.
It does this by prohibiting the firm from proceeding with any new investments until the key individuals have been replaced.
In cases where they cannot be replaced, the investments will usually terminate, and the firm will withdraw the funds it invested.
When will it come into effect?
A key man clause will usually come into effect when the key individuals named in it are no longer sufficiently engaged in managing the investment.
There are many reasons this could happen. Some examples include when the key individual:
- Is not devoting enough time to managing the investment.
- Quits the investment firm.
- Is fired.
- Is seriously injured or suffers from a serious illness and is no longer able to work.
- Becomes permanently disabled.
- Is convicted of a crime.
Are there exceptions to the key man clause?
Any investments made before a key man clause has been agreed upon will not be affected by its provisions.
For example, say Investment A is made in July 2021, and a key man clause is agreed upon in August 2021. The key man clause will not apply to Investment A will as it will only affect investments made after the clause was agreed upon.
What other contexts are they used?
While usually associated with investment firms, there are a handful of other contexts where key man clauses are used.
A key man clause can be used more generally to contractually state that if one or more key individuals in the contract do or don’t do a certain action, the contract may be terminated.
For example, key man clauses are often used in record deals. In this context, the clause will designate one or more “key members” who are considered integral to a given musical group. If those key member/s decide to leave, the key man clause will offer the music label legal grounds to claim a breach of contract.
Key man clauses are also used in a type of insurance policy known as key man life insurance.
Key man life insurance, also called key person insurance, is a type of life insurance policy a company obtains in the name of a key executive. If the executive dies or suffers from a serious disability or illness, the key man clause will come in effect to protect the company from any financial loss caused by the key individual’s death, disability, or illness.