Most private equity shops employ small groups of people. The hours and nature of the work fosters a real sense of camaraderie, which makes the prospect of firing anyone especially unpleasant. But there are ways to limit the potential for lawsuits, nervous LPs, media attention and the inevitable water-cooler gossip.
First, the GP should raise any concerns about performance with the employee, give them a chance to improve and document that effort. Prior to a termination, they should consult legal counsel, check all relevant employment contracts and, if applicable, draft severance paperwork that addresses any issues not covered in previous agreements. When firing senior executives, a communications plan should also be devised to address all the relevant constituents. And when the termination takes place, it should be done quickly and without debate. In the case of veteran or key investment personnel, it shouldn’t be delegated.
Terminations are particularly awkward for private equity houses because they are so rare at the firm level. “There’s a lot of self-selection, where people end up leaving after receiving, for example, a lower than anticipated bonus,” says Lauren Leyden of the law firm Akin Gump. “So few firms have extensive experience with terminations and the process.”
And without an established process, there’s room for error and misunderstanding. As well as a terminations process, a firm should establish a methodology for measuring performance, no matter how difficult a conversation it may create. One lawyer admitted that they have seen the toughest GPs wimp out when gauging the performance of their own administrative staff, since no one wants to be hated by their secretary.
There are real dangers in waiting to address performance concerns. Several employment attorneys cite instances of an employee sensing they are about to be let go and lodging a complaint. This can make the termination seem retaliatory in court, and is particularly damaging in the case of any protected class, such as a minority or the disabled. “They have statutory protections that force you to refute that this was due to discrimination,” says partner Jeff London of the law firm Kaye Scholer. But it can happen with senior professionals from unprotected classes as well.
“Private equity executives often aren’t the most sympathetic plaintiffs,” says Andrew Kofsky of the law firm Simpson Thacher & Bartlett. “However, in employment disputes, there’s typically a bias against the employer and in court it can be hard to explain why someone was paid eight figures if they were underperforming.”
For this reason, an employer must document discussions of performance issues. “Documentation is key and can be an employer’s best friend in these situations,” says Leyden.
And timing matters. “By the time I’m alerted to the situation, it’s often too late to effectively document a performance issue,” says Kofsky. “You can’t write them up on Monday and fire them on Friday.”
This documentation doesn’t have to be formal. Most lawyers agree emailing notes about the chat to an office account with a date and time stamp can be sufficient. “If the employee is being told specific goals that need to be met, it might be helpful to email the individual so that they have something to refer to when trying to improve performance,” says Leyden.
Lawyers agree performance issues should be raised at least once, and ideally a minimum 30 days prior to the termination if it’s strictly performance related and not criminal in nature.
Once the termination is inevitable, all the paperwork related to that person’s employment must be examined to understand the legal and contractual implications. In the case of administrative assistants or analysts, it might be merely an offer letter, but further up the ranks, contractual issues get complicated quickly.
“A lot of times there can be so many documents in terms of the various interests that people have, with respect to open funds or closed funds or portfolio companies, that there’s a dizzying array of contractual implications,” says Kofsky.
Lawyers stress portfolio company affiliations are an issue because an executive may sit on several boards, which requires drafting multiple resolutions to disengage all those existing commitments. The documents will also outline what’s contractually owed to an employee, though often firms improve on those terms, either to avoid disagreement or to end the relationship on a more pleasant note.
But lawyers stress the need to devise the severance terms before terminating the employee. “Look to what the firm gave a similar ranking executive with similar tenure and use that as a guideline in devising the severance terms and package,” says London.
He suggests going back five years or so to find relevant examples or, if there are none, going back to the last relevant firing to ensure the severance agreement is in line with that.
For executives at the VP level or higher, there are often non-compete and non-solicitation terms included in the severance agreement that can influence the package. “With a non-compete clause, you have to ask how much you’re willing to offer that executive to stay ‘on the beach,’” says London.
Younger executives will often ask to waive limitations on working for another private equity firm, and the firm should consider how willing they are to try to enforce that non-compete clause with a lawsuit.
Senior executives often require the most complex and thoughtful severance agreements.
“In the case of managing directors, they may be contractually obligated to receive carry, they may be an investor in the existing funds, and they may have close ties with major investors,” says London. So lawyers stress the need for a diplomatic and perhaps gradual unraveling of their ties to the firm, if possible. But the consensus is that a broad outline of terms should be worked out prior to any termination meeting.
These agreements can still vary greatly with each employee’s situation. “If an employee rose up through the ranks, the initial employment contract may not include non-compete and non-solicitation terms that firms may have negotiated with executives that were brought aboard at a senior level,” says Leyden. “Ideally, you have increased protections as someone gets promoted, but, if that hasn’t happened, you may need to address it at termination.”
Lawyers argue one of the most crucial elements to include in severance agreements is a clause that requires arbitration for any disputes, barring legal exceptions that may be required. The clause may relinquish a GP’s ability to file a motion to dismiss, but the privacy of arbitration allows GPs to discuss any issue with an LP first, rather than risking having an investor read about the situation from a Google search.
Non-disparagement clauses are also key. “It’s a critical mechanism to ensure that investors don’t hear one message from you, and another from the former employee,” says Chuck Dohrenwend of the communications advisory firm Abernathy MacGregor. “And be certain to include language about social media, so that the message is consistent across all public communication channels including an employee’s personal Facebook page.”
Such terms would be better worked out at the time of hiring, but the severance agreement should include them.
For senior investment professionals, the GP should have a communications plan in hand, identifying all relevant audiences and crafting a message for each, even if the termination is unlikely to attract the attention of The Wall Street Journal.
“So many times, a reporter will notice when an executive changes their LinkedIn profile, or when someone is no longer listed on a firm’s website,” says Dohrenwend. Most lawyers recommend tapping a communication advisor to help with the project, though one attorney cautioned it’s important to be discrete in the early stages. Closed door meetings with a PR firm may raise more questions than they answer, especially among internal staff.
The consensus is to make a brief internal announcement as soon as possible after the employee is terminated. There’s value in being discrete about the reasons behind the dismissal, as other employees want to know that senior management wouldn’t bad mouth them should they be fired.
“We find people are less likely to gossip or that gossip ends quickly when the message from management is simply that the person is no longer an employee and we wish them the best,” says Leyden.
By far the most important audience is LPs. The more senior the executive, the more important it is to reach out quickly. In the case of an official “key man” as determined in the LPA, they may be required to disclose the termination, but if that person has any profile among investors, lawyers and PR counsel caution it’s a mistake to stay silent.
A partner’s contribution shouldn’t be downplayed following their departure. “I’ve had GPs tell me, ‘They didn’t do that much,’ and then we’ll pull up our notes from the last fund we underwrote and they’ll have attributed a bunch of deals to that person,” says Karen Rode of Aon Hewitt Investment Consulting. “So which is it?”
She recommends the firm admit what the partner contributed, and explain how the firm will move forward. If that individual had sector expertise perhaps the firm will be more conservative or even inactive in that sector, or they can explain how more junior executives may step up.
“Private equity firms would do well to promote the full breadth of talent they have,” says Dohrenwend. “Maybe the younger professionals present at the annual meeting or meet with a few select investors in an informal setting.”
This way, even when senior investment professionals leave the firm, LPs will be aware of the talent that remains.
In the case of termination over issues such as sexual harassment allegations or accounting improprieties, the GP should be as candid as legally possible. “Don’t sugarcoat it,” says Rode. “Explain that there’s a situation and give us regular updates. The very worst thing you can do is fall into an abyss.”
The last audience may be the management of relevant portfolio companies, and if the employee in question sits on the board of a publicly listed portfolio company, there may be a set of disclosure requirements to meet.
Having the conversation
Once it’s time to notify the employee, every lawyer stressed the importance of making it quick. “You want to keep the meeting short,” says Leyden. “It’s not a time to rehash performance issues, but if the employee tries to do so, we find it helpful to let them know the decision is final.”
The sooner management can begin discussing the severance package, the better. “It can act as a turning point in the conversation.”
While the meeting is taking place, IT staff should end the employee’s access to company email or technology. “Have them relinquish any iPhones or company property at that meeting,” says Kofsky. If they have any personal photos or information on a hard drive or laptop, the firm can offer to have any of that forwarded to them. This removes the temptation for the employee to send a disgruntled email or do anything else they may regret later.
Lastly, there is the desire to skip the meeting altogether. “Many firms delegate it to their HR department, but if it’s a partner, the senior guys need to be involved,” says London. “One of our clients has a partner supervise all HR activities, so there’s senior involvement in all these matters.”
However difficult it may be, the consensus is employees would rather hear the bad news from the same people they worked alongside.
In the case of criminal misconduct or other “bad acts,” GPs don’t have the luxury of more than a day or two to get their ducks in a row. They will have to start with the termination meeting, and work backward to address the communication strategy and other legal matters involved.
Barring those worst-case scenarios, most risks can be mitigated with the right preparation and the willingness to have some frank, if uncomfortable conversations. It sounds simple, but simple isn’t the same as easy.