When investment executives leave an alternative investment firm, the big question is whether and how much of their track record can they bring with them.
Track records reflect the net performance of investments that can be attributed to the executive. They are especially important for executives wishing to start a new money management firm because there is no way to market the firm or a fund without a track record, said Debra K. Lussier, Boston-based asset management partner and co-leader of the buyout and growth equity funds team at law firm Ropes & Gray LLP.
"In my experience, the more senior you are, the more likely you can negotiate an agreement" to use the track record, Ms. Lussier said.
More junior executives are less likely to be able to secure those rights, she said.
When an executive does reach a track-record agreement with his or her former employer, there can be limitations, Ms. Lussier said.
Sometimes the former employer will want to review the track record or reserve consent over how it will be presented, she said. Sometimes there are time limits placed on how long the executive can use the track record. In other conditions, executives can use the performance of investments attributed to them as long as they do not go to one of the former employer's competitors, Ms. Lussier said.
Even if the executive's former employer consents to the use of the track record, the executive can only claim the performance of an investment in which he or she played a key role, she said.
Such contracts are written narrowly so that an executive can't claim credit for the return on an entire fund. The investment executive can only use the portion of the investment attributable to him or her, Ms. Lussier explained.
This makes it very difficult for anyone to demonstrate their abilities if they haven't played a material role in investment decisions or is senior enough to be on the investment committee, she said.
For senior-level executives, both parties are "motivated to reach an agreement," Ms. Lussier said.
Investment executives wishing to start a firm not only have to gain access to a portion of the track record but also abide by certain restrictive covenants and other portions of their employment contracts or offer letter, said Jennifer Cormier, a partner at Ropes & Gray. Offer letter are less comprehensive than an employment contract but can still include such covenants as a confidentiality agreement, she said.
Separate from the track-record issue, these contracts can also contain non-compete provisions and/or non-solicitation clauses, confidentiality agreements and mandatory arbitration clauses, she said.
A non-solicitation clause can bar the executives from soliciting colleagues to join them at their new venture, marketing to the firm's limited partners or setting up a competing firm, Ms. Lussier said. If there were deals in the pipeline, the departed executive cannot go after that transaction, she added.
Some employment contracts have mandatory arbitration clauses that require both parties to arbitrate disputes, barring them from filing a lawsuit in court.
"There are pros and cons to arbitration clauses, Ms. Cormier said.
Arbitration is less costly, it's faster and it's "more likely to lead to a comprehensive decision, which in a lot of ways can benefit the individual and not the sponsor," she said.
What's more, arbitration is confidential, Ms. Cormier said.
"A dispute is a career killer," she said.
There may also be situations where there are reputational concerns on both sides and both parties are hesitant to have their dispute aired in public, Ms. Cormier said.
Some executives manage to launch a new firm without using their track record when they have support of their old firm partners or are well-known to consultants and/or limited partners, industry executives said.
One example is Sole Source Capital LLC, a Santa Monica, Calif.-based private equity firm founded in 2016 by David Fredston, a former principal in merger and acquisitions at Los Angeles-based private equity firm The Gores Group LLC. This is Mr. Fredston's second firm. He founded hedge fund Long Green Capital Management in 2007.
"When we started Sole Source, we didn't use our track record because we were not members of the investment committee at The Gores Group," said Mr. Fredston, who is CEO. "Instead, Alec Gores (chairman and CEO) invested in our firm as a regular LP and has been a tremendous resource for us."
Mr. Fredston added that he and other Sole Source executives who had worked at The Gores Group took a year of garden leave to set up the firm. John Pierucci, principal, M&A at Sole Source had been an associate at The Gores Group, and Dewey Turner III, Sole Source president of operations, had been a senior vice president at The Gores Group before joining Clearlake Capital Group LP as principal of portfolio operations. Mr. Turner joined Sole Source in 2017.
"He (Mr. Gores) was pleased that John and Dewey joined Sole Source with his blessing," Mr. Fredston said.
And Sole Source is not competing with The Gores Group, he said.
"Alec has migrated to SPACs (special purpose acquisition companies) and we are addressing the need for professional management and capital in the lower middle market," said Mr. Fredston, who is also married to Mr. Gores' daughter, Rochelle Gores.
He said the team's experience at Gores Group has paid off.
"John and I worked on a lot of carve-outs, complex transactions … that experience with integration has enabled us to build businesses at high speed," he said.
