What Does Key Man Provision Mean?
A key man provision is a contractual clause that prohibits the fund manager or general partner from making key investments if one or more named key principals fail to devote a specific amount of time to the partnership. The general partner or fund manager can restart investments only after new replacement key executives are appointed and approved by the partners of a limited partnership firm. The only exception to this rule is the investments that have been agreed to before the key man clause took place.
Divestopedia Explains Key Man Provision
A key man clause is mostly seen in limited partnership companies, venture capital organizations and mutual fund companies. In general, it applies to smaller and newer funds where the exit of one person can mean the end of the fund itself. It is not applicable to larger firms because they tend to diversify their risk better, and will not be in a position where any one person will be the key to manage the entire fund or operations of a firm.
In the case of fund managers, they usually leave only at the end of the cycle so that it does not have much impact on the operations of the organization. However, sometimes key personnel do leave during the middle of a fund cycle for various reasons, and in such cases, the key man clause comes into effect.
The key man clause, however, does not apply to the funds that are already invested. So, if money has been invested with a venture capital (VC) firm, the investor does not get the money back when the key man clause comes into effect. Instead, more money will not be used to pay for certain management fees nor for more investments. Future investment funds will be shut down, but existing ones are not affected.
This clause will not cause a firm to dissolve, especially in VC firms, because it is illiquid. Since the investments and illiquid securities of the firm will cease in the event of a dissolution, it will not happen. Instead, negotiations between partners will lead to the termination of the key man clause.