By Gerelyn Terzo – July 17, 2009 – When Jean-Pierre Aguilar, the co-founder and chief executive of Capital Fund Management, France’s largest hedge fund, was killed in a gliding accident earlier this month, there was little delay before the company announced plans for its future — business would go on.

It wouldn’t work that way at many other hedge funds, where succession plans often aren’t even an afterthought.
The team that Aguilar had assembled will run CFM, with no one person, Aguilar included, deemed vital to the continuation of the firm. CFM was fortunate in that it adheres to a quantitative trading strategy that is inherently dependent on computer systems. That was, at least in part, Aguilar’s succession plan — no matter how well known he may have been, CFM would survive even in his absence.

But CFM is an anomaly in the hedge fund world. Unlike in corporate America, where equity ownership is largely shared among investors and management alike and where there is a board of directors to vote on succession choices, hedge funds remain largely private entities whereby equity ownership is often times controlled by one or a few key people. Daniel Loeb, founder of Third Point LLC, for example, holds at least a 75% equity stake in his firm with very few equity partners, according to an SEC filing. Every manager tends to approach their legacy differently, in some cases by not dealing with it at all.

"No one likes to deal with their own mortality. In the hedge fund business, you’ve grown the business and sold investors on the cult of personality. It’s difficult for managers to consciously recognize the need to build out a team and infrastructure to maintain the institutional nature of the firm," says Rob Picard, senior restructuring advisor at Navigant Capital Advisors. And this holds true for emerging managers, too — those who have made the decision to grow their firms into much larger and broader shops, versus one fund and one or two key people. "Succession planning is most relevant for those firms looking not only to survive but to emerge as leaders," says Edward Casas, head of Navigant Capital Advisors.

According to a recent survey of compensation practices in the hedge fund industry, which was a collaboration between Grahall Partners LLC, Kleinberg, Kaplan, Wolff & Cohen and UBS Prime Brokerage Services, most hedge fund managers have no succession plan in place. "We found that from the responses of the participants in our survey, 61% did not have succession plans, which somewhat surprised us. We feel that it is a major issue that firms should address now. In an era of heightened due diligence by investors, succession planning is something that fund managers will have to be more focused on going forward," says Jason Grunfeld, an attorney with Kleinberg, Kaplan, Wolff & Cohen. Of those firms with succession plans in place, 77% of them oversee $2 billion or more in assets under management. Additionally, about 12% of hedge fund managers believe their succession plans are outdated. "We have seen a need to restructure partnership agreements because certain roles have changed, for example either because a partner quits or the hiring of new partners. There is a usually a partnership structure put in place at the founding of the firm. Sometimes this makes it all the way through [the life of a firm]. Often times, it does not," says Tom Roth, a consultant with Grahall Partners.

‘Key Man’ clause
The majority of hedge funds were founded by key members who have demonstrated success in their investment acumen and capital-raising ability, Casas points out. As such, most hedge fund managers include a "key man" clause in their formation documents, or provisions to protect the investor should something happen to the main manager. The clause provides investors with a window of options in the event a key portfolio manager dies or becomes incapacitated, choices they otherwise would not be privy to. These provisions include early redemption rights that loosen lock-up periods and wave withdrawal fees, and sometimes they grant the investor voting rights.

"There is always something listed in the offering documents to ensure that if a key person dies, that 1.) their ownership will get passed to someone else, and 2.) assets are put into receivership and then returned to the investors," says Andrew Schneider, co-founder of HedgeCo Networks.

Daniel Och, at the helm of Och-Ziff Capital Management, one of only a handful of publicly traded hedge funds, is a key person at the firm that bears his name. Och’s importance was addressed in the firm’s S-1 filing with the SEC back in 2007. The filing reads: "Each of our funds has special withdrawal provisions pursuant to which the failure of Daniel Och to be actively involved in the business provides investors with the right to redeem from the funds. The loss of the services of Daniel Och would have a material adverse effect on each of our funds and on us."

John Bender, who ran Amber Arbitrage Fund, a Dublin, Ireland-domiciled hedge fund that had more than $500 million in AUM at its peak in 2000, suffered a brain aneurism while vacationing on his honeymoon. He survived, and weeks later sent a letter to investors, which included George Soros’ Quantum Fund, indicating that he had regained some motor skills — with the exception of speaking — and could follow the markets. "Certain investors gave notice of redemptions while others chose to remain. He felt he wasn’t able to do right by investors and ultimately closed down the fund in September 2000," says Navigant’s Picard, adding that investors still reaped 80% net returns on their investments.

"If there tends to be one guy who is out in front at a firm, then often all of the money is there because of him. Typically, this person can have a larger-than-life personality. When that person is gone, no matter how good the underlying team might be, most investors will shoot first and ask questions later in terms of redemptions," says Greg Dowling, managing principal and director of hedged strategies at Fund Evaluation Group.

In another example, Robert Chapman, an activist hedge fund manager, suffered a surfing accident in 2003 that forced him and the fund to the sidelines for a while. He used the unplanned hiatus for travel, sources say, and when he relaunched the fund three years later, it didn’t fair nearly as well as it had before the accident. Chapman announced on July 2 that he was shifting all of his attention back to Chapman Capital after a brief stint as chief executive for EDCI Holdings, the holding company for Entertainment Distribution Company LLC. He did not return calls.

When renowned investor Julian Robertson, founder of Tiger Management, decided to stop investing clients’ capital at the end of the technology stock boom in 2000, he was 67 years old. During his trading reign, a focus on returns trumped succession planning. "He was chief stock selector and made the decisions. He was focused more on returns for clients than building a sustaining business," says someone who has worked closely with Robertson. Perhaps Robertson would have given more thought to succession if, for instance, his sons were interested in carrying the Tiger Capital torch, but they all pursued other interests. In addition, Robertson’s legacy was tied to his name. "For most, this is a gun-slinging line of work. People like Lee Ainslie, who Julian nurtured, George Soros, and most young managers in their 30s or 40s, they don’t really think in [succession] terms. It’s more about ‘the name on the door is the name you hire.’ It isn’t like corporate America," the source, who declined to be named, says. That’s because hedge fund managers are largely viewed as being more entrepreneurial than any other bunch.

Today, Tiger Capital still exists, although trading is confined to Robertson’s own money. But despite the fact that he is no longer trading alongside other top investment minds, he mentored a crew of prodigies that nearly a decade later are still referred to as "Tiger cubs," including John Griffin, founder of Blue Ridge Capital, Lone Pine Capital’s Steven Mandel and Lee Ainslie of Maverick Capital, among others. "Julian will go down with Soros and Peter Lynch as one of the great investors in history, a legendary investor. He trained some of the most successful people in the hedge fund community," the source says.

Hedging your bets
While the key-man clause is in place to protect the investor, life insurance for hedge fund managers is a part of due diligence that can protect the management company. For those hedge funds where the equity ownership is in fact tied to a few key people, partners should consider the transfer of that ownership in the event of a sudden death. As financial services representative Charles Ross of the Ross Co. points out, implementing buy-sell agreements between partners provides liquidity and a contract that names other key people as the beneficiaries. This allows for the ownership of the firm to remain in the hands of the surviving partners.

"Otherwise, the [deceased's] family could inherit 75% of the company and they may know nothing about managing a hedge fund," Ross says. If the firm’s founder does not make implicit plans ahead of time, there can be significant tax implications and losses. Ross says: "We find that fund managers create so much wealth that they become myopic to the place that they say, 1.) if I die my family will be taken care of; and 2.) there’s enough money in the firm for the business to continue."

(c) 2009 Investment Dealers’ Digest and SourceMedia, Inc. All Rights Reserved.

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