Looking for American vs European waterfall example

Hi everyone,

Does anyone have a worked example to show the difference between American vs European waterfall calculations?

I do understand the concept but would like to see an example on it. Managed to find this article online but have no clue how the figures came about (http://www.slideshare.net/adnantapia/waterfall-am…). For example, for the Pref figure on Slide 6, why would it be different between an American waterfall ($48,400 + $34,118) and European one ($96,800).

Thank you.

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Best Response

The difference is because the second investment in the American waterfall essentially "failed." The investment did not meet the return threshold to pay out carry. In the American waterfall example, the first investment pays out the 80/20 carried interest split and the second investment pays out no carry. The two are calculated independently.

In a European waterfall, because the second investment failed, proceeds from the first investment are used to compensate for the shortfall. Basically, the proceeds are distributed in the aggregate and the second investment "losses" are deducted from the first investment "gains."

Probably not the best worded explanation, but hope this helps.

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CompBanker:

The difference is because the second investment in the American waterfall essentially "failed." The investment did not meet the return threshold to pay out carry. In the American waterfall example, the first investment pays out the 80/20 carried interest split and the second investment pays out no carry. The two are calculated independently.

In a European waterfall, because the second investment failed, proceeds from the first investment are used to compensate for the shortfall. Basically, the proceeds are distributed in the aggregate and the second investment "losses" are deducted from the first investment "gains."

Probably not the best worded explanation, but hope this helps.

Hi CompBanker,

Many thanks for the replies. But would you mind explaining to me how the preferred returns of $48,400 (Project A) is determined under the American Model as well as the preferred returns of $96,800 (Project A and B) under the European Model?

I can't seem to figure it out. Given that it indicates that preferred return is 10% (slide 6), so I was guessing that it should be 10% on the cost that equity holders put in? So for the preferred returns under the American model, it should be: Project A = $40,000 * 10% = $4,000 (ie. $44,000) Project B = Not applicable since failed to return capital.

And for the European Model, it should be the combined sum multiplied by 10%: Project A + Project B = $80,000 * 10% = $8,000 (ie. $88,000)

Thank you for your help.

 

Based on my review, the preferred is split 90% to the LPs and 10% to the GPs. This is probably because the GPs invested hard dollars equal to 10% of the total investment, while LPs invested hard dollars equal to 90% of the total investment. The document is confusing in that it appears to have a preferred PIK of 10%. The calculation of the PIK is not actually used in the analysis, only the final amount of preferred is shown.

What is also not shown is the fact that the distribution is below the preferred return threshold. It is implied because there is no value in "remaining cash." This is also confusing unless you already know how the securities work, so don't be surprised if you didn't get it at first.

CompBanker’s Career Guidance Services: https://www.rossettiadvisors.com/
 
CompBanker:

Based on my review, the preferred is split 90% to the LPs and 10% to the GPs. This is probably because the GPs invested hard dollars equal to 10% of the total investment, while LPs invested hard dollars equal to 90% of the total investment. The document is confusing in that it appears to have a preferred PIK of 10%. The calculation of the PIK is not actually used in the analysis, only the final amount of preferred is shown.

What is also not shown is the fact that the distribution is below the preferred return threshold. It is implied because there is no value in "remaining cash." This is also confusing unless you already know how the securities work, so don't be surprised if you didn't get it at first.

Hi CompBanker,

Many thanks for your inputs. Do you know where I can find a good example to understand how American vs European waterfalls work in practice? I haven't been successful in locating an example.

Thanks once again.

 

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CompBanker’s Career Guidance Services: https://www.rossettiadvisors.com/

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