Legit to quit

A GP's departure from a private equity firm isn't as simple as handing in a letter of resignation – carry, non-compete and track record issues can often become sticking points when it's time to move on. By Art Janik, Associate Editor

Private equity and venture capital careers are quite fluid: partners, vice presidents and associates move from one firm to the other with relative ease, provided, of course, they adhere to the provisions of their contracts. The actual process of up and leaving a firm can be complex, dictated by a cornucopia of restrictive covenants that protect the firm's interests as well as the outgoing GP's interests.

Any lawyer will tell you that each quitting scenario is unique and that each contract is different, all of it depending largely on the relationship between the departing professional and the firm. The contract that is negotiated at the beginning of the employee's tenure is obviously tilted in favor of the party that has better reputation and experience. And during the initial negotiations, the typical employee is not discussing what happens should he or she voluntarily quit; rather, he or she is looking to protect himself or herself in case of extreme situations, such as being fired.

Of course, if there's one thing private equity GPs know how to do, it's negotiate, and partners have come to expect certain provisions upfront in their contracts. When a partner quits, therefore, the existing agreement is but the starting point of renegotiations. In the time between a partner's entry into and exit from a firm, many things may have transpired and both parties may want something that is not specified in the contract.

?There are no standards when it comes to quitting,? says Robin Painter, a Boston-based partner for law firm Proskauer Rose. ?Some may say that whatever you received is yours, but really it's hard to generalize. What is important in these situations is that a partner understands the basic economics when negotiating his exit.?

These economics may include what happens to a partner who has a stake in the management company, or what his or her capital contribution obligations will be going forward. Below are several key points partners must keep in mind when saying goodbye.

One of the trickiest parts of quitting a firm before the end of a given fund's life cycle is the issue of owed carry. Even when partners leave, they still have an ongoing relationship with the employer, who may still owe them. As a result, partners should be reluctant to wage any sort of ?war?against their former firms under any circumstances. After all, the life cycle of a private equity fund extends to the exit of the final portfolio company, sometimes a decade or more later. And unlike stock options, carry is centered around the l

?There are no standards when it comes to quitting.?

?The way carry is handled is all over the map,? Painter says. ?The way venture funds tend to do carry is tied to the overall fund portfolio, subject to a vesting schedule. But even that's not always the case. Sometimes it's a different schedule if the partner leaves voluntarily rather than because of death or disability.?

A carry schedule, Painter continues, ultimately depends on a partner's seniority with the firm. And from a firm's perspective, there has to be enough carry left to attract someone else to take on the outgoing partner's place. ?If a firm is in a position where too much carry is vested, there's not enough of it to offer to whomever takes over that responsibility.?

The carry schedule, of course, is negotiated at the beginning of the fund before anything happens. According to Jeff Tabak, a New York-based partner for law firm Weil, Gotshal & Manges, in order to incentivize people running the fund to stay as long as possible, firms impose a timeline so that they only share a certain percentage of the proceeds over a period of time. Only in cases of death or termination without cause would those schedules be accelerated. Often, a partner will have to forfeit what he's not vested in.

Tabak adds that some partner contracts may include a provision in which the rest of the firm can buy back a portion of what a partner is vested in at a certain price.

Another common provision is the non-compete clause, which prohibits the departing partner from competing with his former firm for a specified period of time, and, in most cases, in certain geographical areas. Mike Crossan, a London-based partner at law firm Clifford Chance, says a non-compete clause may be a legitimate protection for a business in cases where individuals have access to trade connections, business secrets, or confidential information that may be used to gain an unfair advantage against their former employers. Carry and other incentive plans are sometimes linked to these restrictive covenants.

The covenants may also prevent the partner from soliciting business from or dealing with certain of the firm's customers. According to David Walker, also a partner at London's Clifford Chance, for private equity managers, preventing any dealings with former customers is difficult to enforce.

?It's unlikely you'll stop someone from working at all so the covenants need to be targeted and reasonable,?Walker continues. ?Often, there's a limited period of garden leave-if there is an express clause-to keep partners out of the market. You can keep someone away from the office during that period to restrict them from joining the competitor. It's difficult to control them outside the office during garden leave? [and] to keep them from working in the general profession, [though a restrictive covenant] may be enforceable and restrict activities to a certain extent if properly targeted.?

Whether or not a firm elects to enforce a non-compete clause may depend on how controversial the departing partner's new plans are and how cooperative they are, Crossan says. ?If they don't have a direct material impact on the partnership, it may be better to plan a departure in conjunction with the firm the individual is with at present. They may be able to negotiate an early exit if it's in the best interests of all for them to leave early.?

Ultimately, of course the courts may have to decide a breach of a non-compete provision if the situation gets heated, Crossan adds. ?It's up to the court to interpret the reasonableness of the clause? This should be a legal and factual test, but in reality the circumstances of the departure and behavior of each party could color a court's view if the enforceability of the clause is in the balance.?

Sometimes, at the time of departure, partners negotiate for the right to use their track records, particularly if they plan to spearhead or join a new fundraising effort.

?If someone is going to quit, but remain in the private equity business, it's an issue of distinguishing what their track record is versus what the fund's collective track record is,?says Painter. ?It comes down to what they can say and what they can't. If they're going to raise a new fund, depending on the structure of the former firm, it's not always that easy to determine whose deals are whose.?

Tabak says that legally, departing partners cannot just take credit for certain deals when they go to a new firm that is planning on fundraising. ?You sell interests through a memorandum and put that [track record] information in an offering memo, but you can't take credit unless under law you are responsible for those results. You need to prove what you're responsible for, whether it's identifying the deal, monitoring it and/or exiting it.?

He adds that if the partner is keen on starting his or her own firm, and wants to get certain credits to his track record, he or she may have to give up other things to the former employer.

Since most private equity contracts have built-in carry disbursement timelines, finding the appropriate time to leave means being ready to make certain financial sacrifices if need be.

?The worst time to quit, from an employer's perspective, is during fundraising,?Tabak says. ?When the fundraising road show begins, the offering memorandum has already been printed and bios of the investment team are already included. If the following week the firm has to reprint supplements to it because one of the partners just quit, the firm wouldn't be too happy.?

Therefore, the ideal time to quit? the natural break point?seems to be after the investment period of the current fund and right before the fundraising of the new fund. However, a partner's responsibilities may still extend beyond the departure from the firm. Barry Wolf, a New York-based partner atWeil, Gotshal & Manges, says that particularly if a person leaves on good terms, the firm may want the person to stay on certain boards of portfolio companies to help on certain matters.? The individual may negotiate for some kind of severance. A lot of GPs get compensated with a small salary and a substantial bonus in addition to their share of the carry.?

Tabak adds that if a partner agrees to stay on a board, sometimes the employer may give relief on the non-compete clause or may choose not to forfeit a bonus.

The private equity industry is inherently relationship-based, a small market with large amounts of money. Since many people-GPs, LPs and advisors-know each other and talk to each other, maintaining a good reputation is extremely important to a successful career, particularly if it involves raising a fund of one's own.

?The investment committees of the LPs know each other pretty well,? says Wolf. ?If you work on a fund and you leave on bad terms, and then come around knocking on their door after walking out on the previous fund, it's going to be a hard sell.?

Crossan says partners should adhere to their duties of trust and confidence. ?Partners should be mindful of their implied and expressed contractual obligations as well as the impact of their conduct in the market. This is a market with a limited number of players and the impact on reputation could be significant.?

Nevertheless, Proskauer's Painter maintains that the vast majority of departures work out well. ?It's rare that the situation escalates, but, as with anything in life, you can never predict it.?