Interest equalization in a fund, how to calculate.
I am dealing with a calculation of the interest equalisations to be paid in a hypothetical investment fund. The situation is as follows (with simplified terms):
The first group of investors (investors 1 and 2) join the fund on 1.1.2020, with both committing $100 ($200 in total) into the fund. On 1.10.2020 the fund calls $40 in total from the investors (call 1), on 6.6.2020 the fund makes another call of $60. A second group of investors (investors 3 and 4) join the fund on 1.1.2021, with both committing $50. On 6.6.2021 there is a capital call of $50. On 1.1.2022 a third and final group of investors (investors 5 and 6) join, both committing $60. The investors participating in subsequent closings are required to pay interest at a rate of 5% per annum to existing investors, calculated on previously called capital, as compensation for earlier entry.
How should the equalisation between investors be calculated? Specifically the issue I am having is trying to figure out, how does the third group of investors compensate the second group regarding capital calls 1 and 2. Should the second group be compensated by the third group for the capital they contributed upon joining the fund, or only for the calls that were made after the second group had already joined?
Based on the most helpful WSO content, here's how you can approach the interest equalization calculation for your hypothetical investment fund:
Understand the Equalization Concept:
Key Details in Your Scenario:
Interest Equalization for the Third Group:
Interest Rate Application:
Calculation Example:
Compensation Between Second and Third Groups:
Final Steps:
This approach ensures that all earlier investors are fairly compensated for the time value of their money, and the calculations align with standard fund equalization practices.
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it obviously varies according to your LPA, but at least in our case the investors from the second closing should only be compensated by the investors from the third closing for the capital calls that happened between those closings, not for the earlier capital calls (since those where funded with funds from the first set of investors). the first set of LPs basically loaned funds to the rest of the LPs to fund the investments made with the funds from the first call, and the interest equalization payment is the interest for that loan.
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