What Is the Key Man Clause?

A key man clause (or key person clause) says that when certain executives of an investment firm are absent, the firm cannot make any new investments until they replace them. Investments need constant watching. Therefore, it's important for investment firms to always have someone in charge.

Key man clauses trigger anytime the executives named by the clause aren't spending enough time managing the firm's investments. This can happen if the executive:

  • Dies
  • Suffers a permanent or long-term disability
  • Spends too much time at another job
  • Quits or is fired
  • Is convicted of a serious crime

Whatever the cause happens to be, if the executive can't do his or her job, the key man clause puts investing on hold at the very least. Sometimes it means the investment firm has to end, depending on how big the firm is and how important the key person was. When this is the case, the key man clause also allows the firm to withdraw all its invested money at once. But if that doesn't happen, any investments already planned out can usually go forward.

Why Is the Key Man Clause Important?

Investing is an important responsibility. Firms handle thousands or even millions of dollars of other people's money. Those people trust the firm to make that money grow by investing it in growing companies. This isn't money they can get back quickly. Therefore, the firms have to be certain they're investing wisely.

The key man clause is a guarantee the investment firm makes, stating the company will only let the best-qualified people make investment decisions. The existing investments still need someone to keep track of them. But the key man clause also lets the firm start looking for a replacement right away.

For the same reasons, insurance companies offer key man insurance policies. These policies pay out when a key man clause triggers. The money helps investment firms make up for lost profits while they search for a replacement.

Why You Should Have a Key Man Clause

Major investors, such as foundations and endowments, will sometimes refuse to use an investment firm without the guarantee that is the key man clause. Firms could get away without having one before, but that's becoming less common. This is because the key man clause also helps the firm. It gives the company a good, clear reason to replace its important executives and to do so quickly. For limited partnership firms, it also gives those limited partners an excuse to look at the remaining general partners and create a new deal with them.

Key man clauses are most common among investment firms. This is because a lot of money is at stake, and even a large company has to rely on a few important decision makers. However, startups in other industries with only have a few executives might want something such as a key man clause, so the firms investing in them will know their money is safe. In fact, the music industry uses key man clauses so artists can leave a label with their managers. This is because the manager-artist relationship is important and based on both of their personalities.

Important Steps to Take

If you own or manage a private equity firm, mutual fund, or other investment business, and if you want to let your investors know their money will be safe, no matter what happens to you or to the managers who make your investment decisions, there are several steps you should take:

  • Create or Insert Key Man Clauses

Take a headcount of everyone in your business who makes final decisions about how you invest your clients' money. Each should have a key person clause in his or her contract that stops the company from investing when he or she can't do the job for any reason. Don't forget to add this clause to the contract of anyone who joins your company later as an investment manager.

  • Buy Key Man Insurance

Not every investment business needs key man insurance. But if you're a small firm without anyone to replace your key managers, or if you have one or two managers you can't hope to replace, then buying an insurance policy to protect the company is probably a wise investment.

  • Create a Written Contingency Plan

A key man clause and insurance are good first steps, but you can do more than that. A contingency plan will lay out what the company should do if something happens to an important investment manager. If your company is big, the plan will say who gets which investments. It also offers a timetable for hiring or promoting a replacement. If your company is small, you may have to figure out whether to hand your investments to other firms or back to your clients. Also, you'll have to decide who will handle shutting down the firm.

Using key man clauses in your investment business isn't required. However, it's a good idea and becoming better all the time. If you are considering creating or revising your clauses, UpCounsel offers plenty of free legal resources, including an employment contract template and a confidentiality agreement template.

If you need help with writing or changing your employment contracts to add a key man clause, UpCounsel can help. You can post your legal need to get free custom quotes from our marketplace which connects companies with some of the best lawyers in the business, including graduates of Yale and Harvard and law firms that have worked with major companies such as Stripe, Twilio, and Google.