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Understanding key man clauses and what they entail

On Behalf of | Dec 27, 2021 | Risk Management

If you’re starting a private equity, venture capital or other investment business, its success and reputation will be dependent on one or more “key” people to make and manage investments. That’s why it’s wise to include a key man (KM) clause in the contracts of your executives and others who are key to your business. 

This clause prohibits the business or any fund manager from making an investment of the designated key person(s) if they won’t be around or able to devote sufficient time to the investment. This could occur not just through resignation, termination or death. A KM clause might need to be invoked if a person takes a leave of absence or simply no longer has the necessary time to devote to their responsibilities.

The key people named in this clause don’t necessarily have to be partners or other executives with the company. However, they are people whose experience, skills and knowledge in sales, product development and other areas are crucial to the business’s success.

A key man clause helps the business and its clients

Having a KM clause can help reassure potential investors that their money will by the people in whom they’re placing their trust. A KM clause also protects the company if one of their primary decision-makers leaves or cannot devote enough time to the business.

Including the clause is just the first step. You need to detail what the business will do if a key person dies, leaves the company or is otherwise unable to fulfill their responsibilities, such as hiring someone new or training someone to take over. A timeline for this transition needs to be included in the replacement plan.

You may also want to invest in key man insurance. This can compensate the company if you suffer losses because a key individual is no longer there. However, it’s much better to have a contractual clause and replacement plan in place so that you don’t have to deal with losses that can significantly affect the success of your company and cause potential investors to go elsewhere.