While many alternative investment manager founders (“Founders”) opt to wind down their businesses over time, there is an increasing number who instead seek to pass the baton onto the next generation of talent at their firm (the “Successor”). For this latter group of Founders, succession planning requires careful consideration of numerous factors. Set forth below are certain principal steps associated with succession planning for Founders:
- Step #1: Choosing a Successor. Often, the first step to be undertaken is determining who will be the Successor(s) to the Founder. This will require a great deal of soul-searching on the part of the Founder to find a person who has the talent, cultural fit and gravitas to step into his/her shoes. Sometimes the Successor(s) will come from within the organization, while in other instances they may be sourced from outside the firm. Regardless of where the Successor comes from, once the Founder has decided to start the succession process, the firm will be better off the sooner he/she can select the Successor.
- Step #2: Making a Deal with the Successor. From the time that the Founder identifies the Successor, until he/she takes the reins, it may be multiple years. As such, the Founder will need to ensure that the Successor is incentivized to wait patiently in the wings. Part of this process will involve discussions about the Founder’s and Successor’s compensation pre- and post-succession1, the Successor’s evolving duties throughout the process, and the changing role and compensation of the Founder. This may be a complex negotiation and will need to take into account issues such as taxes, conflicts of interest, firm valuation, and the future direction of the organization. Due to the sensitive nature of the negotiation process, this step will need to be kept highly confidential, and will normally involve only those within the Founder’s trusted inner circle. Ultimately, the negotiated deal will also result in extensive revisions to management company, fund and regulatory documentation.
- Step #3: Raising the Profile of the Successor. The timing of the announcement of a Successor is a very delicate process. Oftentimes, the Founder will first look to raise the Successor’s profile within the firm and to key investors and counterparties so that these groups become more comfortable with the individual. Feedback from these constituents will likely have a significant impact on the succession plan’s likelihood of success. If there is positive input, the Founder will typically reveal the succession plan slowly. In many cases, a public relations firm with expertise in these matters will be hired to counsel the Founder and the firm.
- Step #4: Picking the Succession Date. Assuming steps 1-3 have gone well, the Founder, Successor and other key persons will determine when the actual transition may take place. This might be a set date or a soft target date. The date selected may be affected by events impacting the portfolio, the stability of the firm’s personnel and investor base, and the current tax and regulatory environment. In some cases, the Founder will stay on in an advisory, special duties or other bespoke capacity.
- Step #5A: Operational Considerations. As the succession date approaches, the Founder and Successor will want to be in frequent contact with firm personnel, investors and other important third parties to address any final concerns and lay out the Successor’s short-, mid- and long-term agenda initiatives. While this outreach is typically done by phone because of the sensitive nature of the topic, due to selective disclosure concerns, it is best to develop a list of talking points to ensure that everyone receives the same information.
- Step #5B: Regulatory and Contractual Considerations. Changing the management of a firm will implicate many regulations and contractual provisions. From a regulatory standpoint, the change in ownership may be considered a change in control requiring client and possibly investor consent. Related to that, many filings will need to be amended, including Form ADV and blue sky filings. In addition, regulators, boards of directors and clients may be required by law to approve of the transaction. From a contractual standpoint, a change in management could result in, among other things, the triggering of key person clauses in fund governing documents, side letters and seed agreements. Moreover, it could impact clauses in third party contracts such as counterparty agreements and office leases, and may cause auditors and other service providers to conduct updated due diligence of the firm. Lastly, marketing materials will need to be revised to reflect the new management and to review the firm’s past performance record and how it will be presented going forward.
Founder succession planning is a complex process that is intended to have long-term benefits for alternative investment firms, their personnel and investors. However, in order to implement such a change, the Founder must carefully weigh many issues that will impact the success of such an undertaking.