Quick question about the 2/20 rule... Question first and then background of why I'm asking.
Q: it seems as though waterfalls do not exist in PE, is this correct? why is this structure preferred?
I understand the concept of the 2/20 rule, but coming from a RE background, there's something i can't wrap my head around. In real estate, there are hurdles to meet and cash flows through a 'waterfall'. For example: the GP gets their pro rata share of returns up to 10%, they get 25% of the returns that fall between 10-15% and 50% of the returns greater than 15%. it's called meeting your prefs or meeting your hurdles.
It seems as though the waterfall structure does not exist in PE and the GP gets a straight 20% return of the profits. This can be a double edged sword for the PE firm, but obviously it depends on several inputs and assumptions.
There certainly are waterfalls in PE. Most funds have a standard hurdle + catch-up structure.
Ok, that makes sense. then where does the '20' part of the 2/20 rule come in? is 20% supposed to be like an average return?
A simple example, assuming 8% hurdle and 20% carried interest:
0 - 8%: 100% to LPs 8 - 10%: 100% to GP (catch-up) Now the split is 80:20 for whatever is remaining
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