As the baby boomer generation nears full retirement age, many are left to wonder what is next and what they can do to enable a well-organized transition and exit from a company where they have spent building their careers. Among this cohort are the founders of many hedge fund, private equity, venture capital and real estate investment firms who know a successful transition is paramount to preserving capital and maintaining a lifetime of relationships.
“As important as performance and strategy are to the alternative investment industry, relationships with investors play a significant role in building and maintaining a sustainable capital base,” Mary Rizzuti, partner in EisnerAmper’s Compensation Resources, explained. “Preparing a company for talent transition is something that should begin long before the departure takes place. Many times, departures happen unexpectedly, and without a plan in place, the unexpected departures cause significant disruption in the business.”
As the general partner (GP) or founder looks to pass the torch to the next generation, they also want to maintain the relationships that were built with investors over the years in ways that benefit everyone.
Succession planning can be an important tactic as it is the process of identifying key positions within a business or organization and developing a plan of action for individuals to assume those key positions.
The Importance of Developing a Succession Plan
Unfortunately, the absence of an effective, well-thought-out succession plan can cause unwanted attention internally and externally. A recent Wall Street Journal article covered outlined how a feud between the co-founders of hedge fund titan Two Sigma Investments has reached the point where the firm cited the ongoing rift as a material risk to the organization in a Q1 2023 regulatory filing. According to the filing, the co-founders have failed to agree on a succession plan and defining roles and responsibilities for C-level executives and investment management professionals.
An event like this can cause internal turmoil among employees and cause investors to wonder about their prospects, as the organization has not seemed to adequately prepare them for the future.
Although there is no current regulatory requirement for a succession plan, the Securities and Exchange Commission (SEC) proposed a rule in late June of 2016 that would require registered investment advisers to adopt and implement written business continuity and transition plans.
This proposed rule was designed to ensure that investment advisors have plans in place to address any operational risks that could cause a significant disruption in their business so that they are able to minimize any potential investor harm. Although the SEC has not adopted this rule, it has become a standard with many in the industry seeing it as best practice.
What to Consider During Succession Planning
The obvious first step in the implementation of a succession plan is to identify key leadership positions and then identify a list of successors or potential successors for those roles.
For larger organizations, it’s important to have the advisory board or the board of directors along with the human resources group and general counsel participate in this process.
For founder-led or smaller organizations, a succession plan is essential to avoid “key person risk.” Key person risk is the risk that arises from an organization’s sole reliance on one or two individuals for all knowledge, skills and relationships that are crucial to the performance of that business.
A good succession plan can identify and address the risks to put investors at ease and help foster a long-term future for the organization.
Below are a few areas of importance to investors that an organization may wish to consider when developing a succession plan:
- Identifying and defining key roles and responsibilities that will be covered by the plan.
- A list of potential successors (and whether the organization will look internally or externally).
- Potential impact on investment strategy and/or investment allocations.
- If a departure or event is known ahead of time; and whether there is a time frame for stepping down or a plan for any continuing involvement within the organization.
- Compensation: How will it be determined? Will the founder or GP completely divest? If significant, will their interest in the fund look to be sold to an outside firm?
It is important to note that a plan should be put in place before a situation arises, as it can take years to develop the next successor. Additionally, it is often beneficial to identify the successor publicly before a planned departure so relationships with investors may be maintained.
A carefully planned transition can strengthen employee morale and help develop an organization’s culture. With an increasing number of retirees expected within the next decade, a well-designed succession plan can put an organization on a continued path of success well after a key event or departure. As famous business professional Jim Moran once shared, “The future belongs to those who prepare for it.”