Key Takeaways

  • A key man clause suspends new investments if named executives or managers are unavailable due to death, disability, departure, or other disqualifying events.
  • It protects investors by ensuring qualified leaders are actively managing funds, and reassures limited partners of operational stability.
  • The clause is common in private equity, venture capital, hedge funds, and even creative industries like music, where leadership roles are essential.
  • Key man clauses are often paired with key person insurance and a written contingency plan to reduce financial and operational risk.
  • Negotiations typically focus on which individuals trigger the clause, the number of departures required, and the consequences for the fund.

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.

Key Man Clause in Different Industries

While the key man clause is most frequently associated with investment funds, its application extends across multiple industries. In venture capital and private equity, it ensures that named partners remain fully engaged in managing portfolio companies. In the music and entertainment industry, artists and managers often use key man clauses to allow an exit if a manager leaves a label, recognizing the importance of personal trust and guidance. In startups, investors may insist on such clauses to guarantee that founders or lead executives remain actively involved, safeguarding early-stage capital.

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.

How Key Man Clauses Protect Investors

A key man clause protects investors by ensuring that their money is overseen by the individuals they trusted at the time of investment. If those individuals leave or become unavailable, the clause pauses new investments until replacements are identified and approved. This safeguard prevents unexpected strategy shifts or mismanagement during leadership transitions. In addition, it enhances investor confidence, making it easier for funds to raise capital from institutional investors, pension funds, and endowments.

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.

Key Elements in Drafting a Key Man Clause

When drafting a key man clause, parties should carefully consider:

  • Trigger Events: Death, disability, resignation, termination, or criminal conviction.
  • Named Individuals: Clearly list the executives or managers essential to the firm.
  • Time Commitment Thresholds: Define what level of involvement qualifies as “active management.”
  • Suspension Rules: Clarify whether the clause halts all new investments or only restricts specific actions.
  • Cure Periods: Allow time for firms to find replacements or propose alternative arrangements before penalties apply.

By tailoring these components, a clause can balance investor protection with operational flexibility.

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.

Negotiating and Enforcing Key Man Clauses

Negotiation is central to the effectiveness of a key man clause. Limited partners may push for broader coverage, naming multiple executives, while general partners may seek narrower terms. Enforcement typically involves:

  1. Automatic Suspension: Funds must stop making new investments immediately once the clause is triggered.
  2. Investor Approval: Resuming investments often requires consent from a majority of limited partners.
  3. Alternative Solutions: Funds may propose interim managers or reallocate responsibilities to avoid liquidation.

In practice, the clause serves as a balancing tool—protecting investors without paralyzing the firm if one executive leaves unexpectedly.

Frequently Asked Questions

  1. Who typically requires a key man clause?
    Institutional investors, pension funds, and endowments often insist on key man clauses when committing large amounts of capital.
  2. How does a key man clause differ from key person insurance?
    The clause restricts investments if key individuals leave, while insurance provides financial support to offset losses during transitions.
  3. Can startups benefit from a key man clause?
    Yes. Startups may use them to reassure investors that founders or top executives will stay actively involved in operations.
  4. What happens if a key man clause is triggered?
    The fund is generally prohibited from making new investments until replacements are approved by investors or alternative measures are agreed upon.
  5. Are key man clauses legally enforceable?
    Yes, when included in contracts or fund agreements, they are binding provisions that investors can enforce if conditions are met.

If you need help with 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 Menlo Ventures, Airbnb, and Google.