Excel Model - Carried Interest Waterfall

I've built out the model (obviously watered it down for confidentiality purposes), but I was wondering if any of you guys knew how to incorporate both a year and a quarter from multiple drop-down lists in order to determine the income for any time period (ie. 2014 q2, 2016 q1). I used choose,match and vlookup commands for the year but that's about as far as I could get. Silver bananas for anyone who can help!!

Attachment Size
Vlookup formula for multiple Data Validations.xls 1.53 MB 1.53 MB
 
dipset1011:
Are you talking in terms of a traditional waterfall or the alternative structure?......traditionally they follow a 80/20 rule. 20% of profits after hurdle rate goes to sponsor the rest goes to money. Sponsor also has a % in the money and its profits are distributed by wieghts the LP's have in the fund.

Dipset, nice trying of you to inject some garbage. There is no such thing as "traditional waterfall structure". Besides, his question has nothing to do with distribution percentage.

 

Thanks No Leverage for the confirmation

dipset... Not sure why you talked about the 80/20 rule...

For a numerical example, lets say that

1) the hurdle rate is 7% 2) PE Fund total committed capital is 100M 3) the only capital drawn down is 50M at time 0 ( to keep things simple) 4) There is only a distribution in year 4, year 1 - 3 has no distributions at all.

Before carried interest kicks in for year 4, the amount needed to be returned to LPs is

a) 100*((1.07)^4) or b) 50 *((1.07)^4)

Does what I'm typing make sense?

 

Typically what shops will do is take carry on distributions as they are returned to LPs. What they'll do is have a reserve in which every partner or vested employee will contribute a certain percentage of their carry which is then used to insure themselves against any clawback the LPs may have for the minimum hurdle rate. Believe me, alot of PE funds are eyeing that hurdle rate very carefully these days.

But to answer your question, carried interest is returned to the GP as capital is returned to the LPs - you do not need to have put the entire fund to work before carried interest is taken.

 
ibleedexcel:
Nobody has yet answered the OP's question. The answer is the hurdle rate only applies to called capital. There is no ticking hurdle on uncalled capital.

Hi,

I do not agreed with you. Any way, your ideal make me thinking about some thing for my project.

Apart from that, this link below may be useful: Distribution interview questions Please try to keep posting. Tks and best regards

 

Market preferred return terms will vary over time, but are almost always based on unreturned contributed (not committed) capital. ibleedexcel is correct.

When GPs have leverage, the next step in the waterfall is to have a catchup that - for a high enough return - moves the effective profit share from, say, 80/20 after preferred (a "hard" preferred) to 80/20 period (a "soft" preferred).

Other GP-favorable terms that occasionally fly are simple preferred rather than compound and preferred return on capital only (not fees/expenses).

It's not my fault.
 

Ok, here's my question (it's from an article on fund terms). Please could you explain to me each of the numbered sentences:

"Whether reinvestments should increase unfunded commitments presents a difficult issue. (1) Once possibility is for reinvestment proceeds to be treated as a distribution and a recall, which does not increase unfunded commitments. This allows the general partner to take a carried interest. (2) Another possibility is to treat the reinvestment as an additional capital call, without an offsetting distribution, particularly if the reinvestment occurs a short period of time after the initial investment (such as less than six months thereafter). In such event, the general partner is often able to take carried interest by deeming the reinvested amount distributed. This saves the general partner from having to distribute and recall reinvestment proceeds".

There is then the following extract from another article:

"Sometimes fund sponsors provide that reinvested proceeds will be withheld from distributable funds. The general partner may nonetheless want to receive carried interest on such amounts. Reinvested amounts may be deemed distributed and recalled per the reinvestment provision and can be deemed run through the waterfall. As a result, the profit portions that do not constitute a return of capital or preferred return may be distributed in part as carried interest, which would result in the GP receiving profits on a previously disposed asset even though the investors did not actually receive their return of capital plus preferred return. This could result in a leaky bucket."

Now, I generally understand how a waterfall distribution provision works; but, not quite sure how the GP can get carry in recycling/reinvestment situations where, for example, the GP deems the reinvested amount distributed, but which the LPs don't actually receive. Could you explain, if possible in 'baby-language', the above two article extracts? This would be much appreciated.

Many thanks

Quite Confused.

 
Best Response
Quite Confused:

"Whether reinvestments should increase unfunded commitments presents a difficult issue. (1) One possibility is for reinvestment proceeds to be treated as a distribution and a recall, which does not increase unfunded commitments. This allows the general partner to take a carried interest.

There is then the following extract from another article:

"Sometimes fund sponsors provide that reinvested proceeds will be withheld from distributable funds. The general partner may nonetheless want to receive carried interest on such amounts. Reinvested amounts may be deemed distributed and recalled per the reinvestment provision and can be deemed run through the waterfall. As a result, the profit portions that do not constitute a return of capital or preferred return may be distributed in part as carried interest, which would result in the GP receiving profits on a previously disposed asset even though the investors did not actually receive their return of capital plus preferred return. This could result in a leaky bucket."

Now, I generally understand how a waterfall distribution provision works; but, not quite sure how the GP can get carry in recycling/reinvestment situations where, for example, the GP deems the reinvested amount distributed, but which the LPs don't actually receive. Could you explain, if possible in 'baby-language', the above two article extracts? This would be much appreciated.

Many thanks

Quite Confused.

Reinvestment means that after the PE fund has exited certain positions (with profits presumably) it can then re-invest the proceeds in other deals before the end of fund life cycle. This is easy to do if the GP puts the same money into another deal right away while it is still in the fund. It becomes trickier if the profit has already been distributed back to the LP, presumably in accordance with fund terms and then the GP wants to "recall" it back to invest in other deals.

GPs have incentives to do this because every time they exit an investment at profits they get to charge performance fee/carried interests off the deal. So the more often they can "recycle" the same capital to make money from multiple deals over and over again, the more carried interests they get from the same source of capital. Hmm... this sounds like a pretty sweet way to get really rich very quick if you can pull it off. I wonder what is the record of the number of times a PE fund can profitably recycle the same capital.

On the other hand, many LPs don't like this as this can potentially dilute their returns/turn their profits into losses if subsequent investment dont work out. Hence the contention of under what circumstance are GPs allowed to do this.

This is the nutshell of the contention described here. Exactly how this may turn out in practice is entirely contingent upon the way the fund is structured and certain crucial terms are defined, e.g. what exactly is stated in the reinvestment provision clause under P.E fund formation document.

I assume the fund in questions uses U.S style waterfall (as opposed to European)distribution as it appears to give out carried interest on a deal by deal basis with clawback provision. The exact sequence of distribution under the waterfall and how does the clawback provision work in case of a succession of deals done using the same capital drawn down is again, entirely a function of the way the key terms are defined for this specific fund and cannot be generalized.

Too late for second-guessing Too late to go back to sleep.
 

I believe this is not an issue of the amount of GP carry. If the manager can flip a deal after a deal, what is wrong with calculating the carry on each deal vs. once and for all at the end? I believe the total amount should be the same at the end (ignoring time value of money). Also, a subsequent loss should result in a clawback.

I believe the issue to be an issue of timing and of whose money can be recalled. On sale of first deal, both GP and LPs have profits that they could take. Regardless of whether capital is actually distributed and then recalled soon, or never distributed, there is the situation that the GP asks for his carry. But the recalled capital comes from the net distributions only. The carry itself is not "recalled" and reinvested. So the GP gets his money (meaning carry) soon, while the LPs are at the mercy of the GP and future investments--although the GP is supposed to be paid only after the LPs truly get at least their capital and preferred return back.

It is like "I get my money now, but you get yours later" - I think?

 

brandon st randy's answer is a good one. Essentially, the fund documents stipulate the terms in which capital can be recycled. There may be a limit on the amount of recycling (can only recall 10% of distributed capital) or a time limit (can only recall capital distributed within six months of distribution). brandon st randy commented on one of the reasons why this can be beneficial to the general partners. Another reason is that there is usually a return hurdle the fund needs to hit before they can start distributing carried interest, typically 8%. If the original capital is deemed to have been returned to the L.P.s, this improves your IRR. Similar to the reason why a fund may do a dividend recap on one of their investments --- it get the original capital back to the L.P.s as soon as possible.

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

It usually means you have $500k at work under the assumption the fund is a double. Might be in multiple funds, not sure your situation. Say it's one $100mm fund and 2/20. Assuming a double when all is said and done, or $100mm of gain, 20% to the GP would be $20mm and you would get $500k of that.

I would definitely focus on the % of the GP you're committing to and what the current performance of the fund looks like. If the fund is below the hurdle and already invested, that $500k could mean nothing.

 

It can also be your phantom equity $s relative to the overall GP commitment. For instance, if the GP commitment in the fund is $5 million, then you have a $500K cost basis in the $5 million GP commitment. In this instance, you would get 10% of the carry dollars made available to the partnership. In this case, if you are a $100MM fund with a 20% carry structure and the fund doubles, you would get $2 million. (10% of the $20 million in carry). The way that carry is described varies greatly between funds and the way they are structured also vary greatly, which has significant tax implications.

You may also literally have a $500K commitment over the life of the fund, if it isn't under a forgivable loan or phantom equity structure. You really need to ask them how the math works.

 

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