Negotiating a Lift-Out

Expect some tough issues and complex solutions

Whether it’s because of the Volker Rule, deflated bonuses or industry consolidation, lift-outs of proprietary trading units and hedge fund management teams are in the air. They are certainly cheaper, faster and more surgical ways of acquiring top talent than full-blown mergers or acquisitions.

If you’re inclined to lure an entire investment team from a competitor, however, be prepared for some intense negotiations. Highly successful portfolio managers and prop traders are not known for their reticence.

Any investment team open to a lift-out is looking for better economics and at least as much autonomy as it enjoys in its current home. You, on the other hand, are seeking to maximize the team’s financial contribution to your business and to minimize the investment, operational and cultural risks it presents. That disparity will generate a lot of intricate and difficult horse-trading over such issues as where the team is to work; its access to senior management; its middle and back office support requirements; the size and composition of its operating budget; the sharing of its management and performance fees; its base, bonus and deferred compensation terms (including any clawbacks); and its hiring and firing decisions.

A similarly edgy issue in your negotiations will be over the parting of ways. You will want to retain the team for as long as it produces the hoped-for investment and marketing results (probably by way of deferred compensation), but the better it performs the more likely the team will want to set off on its own. As a result, the team will demand future buy-out provisions from you and you in turn will need to specify the circumstances under which you can withdraw your seed capital and discharge any or all of the team’s members.

In addition to key business terms, there are a number of legal issues that could further complicate the negotiations such as the ownership and ultimate portability of the team’s track record; the added compliance responsibilities associated with the team’s strategy and investment products (including SEC, NFA, state and foreign registrations); indemnities for contract breaches running in both directions; the duration of the no-shop period for the team while negotiations are ongoing; and the application of non-competition and non-solicitation restrictions to departing team members (especially those who leave prematurely or otherwise violate their employment agreements).

Though it may seem obvious in pursuing a lift-out, you should begin the process by making sure that the key members of the targeted team are not off-limits altogether due to non-competes or non-solicits in their existing employment agreements. You should also assure yourself that the team will not be spiriting away any clients, trade secrets or investment performance records to which it is not legally entitled.

The last thing you want is a lawsuit in lieu of a lift-out.