How are PE deals structured on the LP side
Quick question regarding the returns provided to LP's from the PE GP's. Do PE firms stipulate a maximum x% return in the contract somewhere or are the LP returns strictly proportional to how much the firm is bringing in?
For example, assume a PE firm buys a company for 10m, with 8m debt (0% interest) & 2 mil equity (mix of investor equity and firm equity 1m each), and sells it for 15m, would the investors typically receive a flat percentage of the profit? As in maybe 20%*(15-8m), or would it be split evenly due to a fifty percent stake?
What I'm trying to get at is is there a way for PE firms to double lever in terms of treating LP equity like debt? Or at that point is it pretty much a family office?
Hm, not certain I understand your question, but here's my take:
In a typical LBO, a private equity firm invests out of its fund in a single equity "tranche". So in your example above, you would simply have $2mm of "sponsor equity" at entry. You have both LPs and GPs investing into the broader fund, and then this fund is allocated to individual deals on a pro rata basis. So say you have a $100mm fund with 4 LPs who each put up $24mm, and GP coinvest of $4mm. When you do your above proposed deal, that $2mm equity is going to be $1.92mm LP equity ($0.48 from each LP) and $0.08mm GP equity. When you exit, the return will be allocated based on these entry equity weights.
As far as fund profit rights, it gets more complex. On the LP return on this deal of $6.72mm (96% of the $7mm equity at exit), the LP gets 100% of the return up to a certain IRR (usually 8%), beyond which the PE firm takes 20% of the incremental return. You can easily see how this structure protects the LP's baseline return (their promised Gross IRR of 8%), and aligns the PE firm to earn their LPs even more, because the PE firm really only gets to participate in the returns above the 8% hurdle rate.
Tell me if I'm missing the point of your question, because I'm not sure what you mean by double-levering in this context.
FWIW, The structure you laid out is quite unlikely in traditional buyout PE for a couple reasons - you really can't get debt investors to make up 80% of the purchase price, and obviously never ever for free (0% interest).
No what you said is right in terms of LP's making a guaranteed 8% and the GP's keeping the excess return, that's what I was getting at. Just wasn't sure if LP's got all excess returns or not.
Thanks.
GPs keep 20% of the excess profits after a hurdle rate (8% standard)
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