Equity Waterfall Question!

Based on the most helpful WSO content, here's how the equity waterfall would work for the scenario you provided:

1. Initial Equity Contribution:

   • LP contributes $45M (90% of the equity).
   • GP contributes $5M (10% of the equity).

2. First Distribution - 5% Noncumulative Preferred Return to LP:

   • The LP is entitled to a 5% preferred return on their $45M equity contribution.
   • This means the LP must receive $2.25M annually (5% of $45M) before any other distributions occur.

3. Second Distribution - Return of Capital to LP:

   • After the 5% preferred return is satisfied, the LP must receive their full $45M equity contribution back.

4. Third Distribution - 12% Preferred IRR to LP:

   • Once the LP has received their 5% preferred return and their $45M capital back, they are entitled to a 12% IRR on their investment.
   • This means the LP must achieve a 12% annualized return on their $45M investment (including the 5% preferred return and return of capital).

5. Final Distribution - 50/50 Split:

   • After the LP achieves their 12% IRR, any remaining cash flow (both operating cash flow and cash flow from the sale) is split 50/50 between the LP and GP.

Example Breakdown (Simplified for Sale Proceeds):

• Sale Price: $75M
• Initial Equity Contribution: $50M

• Net Proceeds After Sale: $75M - $50M = $25M

  • Step 1: LP gets their 5% preferred return (if unpaid from operating cash flow).
  • Step 2: LP gets their $45M capital back.
  • Step 3: LP achieves their 12% IRR.
  • Step 4: Remaining proceeds are split 50/50 between LP and GP.

If you need a more detailed cash flow breakdown or IRR calculation, let me know!

Sources: Trying to understand the concept of IRR, When does the promote split actually occur?, https://www.wallstreetoasis.com/forum/real-estate/waterfallpromote-nuance?customgpt=1, , An explanation of Limited Partnership Agreement (LPA) in Private Equity