Kirchner Private Capital Group featured in Dow Jones Article:

1 August 2011 – Founder departures in private equity are hardly new and can be traced back to the days of Kohlberg Kravis Roberts & Co. But with a wave of funds approaching the end of their investment periods and the potentially depressed value of some portfolios in the wake of the downturn, the economics of staying on as a founder may not be as compelling today as they had once been.

In recent years, for example, Bruckmann Rosser Sherrill & Co., Code Hennessy & Simmons, Veronis Suhler Stevenson and ICV Partners have all witnessed the departure of their respective co-founders, some of which went on to form new firms.

By most counts, the economics that departing general partners receive – while always heavily negotiated – has come down from what it was 10 years ago. One lawyer specializing in succession planning said that he was no longer doing the “sweetheart deals” the industry used to see for departing founders, where they would continue to receive management fees for a period of time, on top of an extensive cash settlement in the $5 million plus range.

These days, some firms have a penalty vesting provision, where founders lose all or some portion of their existing position in the carry, according to John Ayer, partner at Ropes & Gray LLP. Their forfeited carry will be used to pay whoever takes over his or her role. Sometimes, if the split is amicable and toward the end of the fund, the departing founder typically gets fully vested or nearly fully vested, although only 8.5% of respondents to a 2010 survey conducted by Dow Jones & Co. and Glocap Search LLC said that retirement triggered vesting to accelerate to 100%. But all packages are negotiated and come in myriad forms.

In that same survey, 83.9% of retired partners from buyout and venture capital funds share carried interest from active funds raised prior to retirement. Only 8% share carry from active funds raised after retirement. Even some provisions like a non-compete have become more common, says another lawyer. “The industry never used to have it. Now, I raise it with every new group that I work with as an option,” he said.

Bud Kirchner, who runs merchant bank Kirchner Private Capital Group, devotes part of his practice to GP succession situations, where his firm will help structure a transition and essentially stand in for the departing GP to manage their portfolio companies. Business has been gaining momentum, he says – for several years it was venture capital-focused, but today the buyout side has caught up.

“We have a tremendous wave of funds coming up to the end of their fund life, and that crystallizes these issues: fees fall precipitously, the value of the carry is put into question, and you’re not sure if you’re up for raising another fund,” Kirchner said.

Despite the tightening of fund terms, the consensus seems to be that the current transition processes GPs go through have been, on the whole, fairly smooth. “Our industry is maturing; it’s becoming more institutional, and you have fewer of the blowups that happened in the past,” said one co-founder of a buyout firm that went through a rockier transition period when a founder left. “I’m actually surprised at how natural the evolution has been at many firms – it in general has been done in a thoughtful and organized fashion.”

His firm has been careful about the dispersion of carry – co-founding partners already know what their carry will be in the next fund with an agreement upfront rather than negotiation before a fund-raising period. It’s a testament to the more “mapped out” process GPs go though these days when it comes to succession issues, he said. Whether or not the industry will indeed see a wave of founder retirements remains to be determined.

“It’s a bit of a George Washington problem,” said Ayer. “You want to be fostering a new generation of partners who can continue to successfully run the firm. On the other hand, founders are incredibly valuable. The balance is keeping these highly talented guys for the next generation, but making the transition in a way that’s respectful of what the founders have created.”

Written By: Beina Xu, Dow Jones Reporter