Help with thinking through promote terms with a potential programmatic JV, especially a catch-up

Based on the most helpful WSO content, here are some key points to consider when evaluating promote terms and the inclusion of a catch-up clause in a programmatic JV:

Promote Terms

• Promoted Interest: This is when you receive a larger share of the equity at the terminal event than you originally contributed. For example, if you contribute 5% of the equity but receive 10% of the returns, you have a 5% promote.
• Hurdle Rate: This is the return threshold that must be met before the promote kicks in. A higher hurdle rate means the project needs to perform better before you start receiving your promoted interest.

Catch-Up Clause

• Catch-Up Clause: This clause allows the General Partner (GP) to receive a disproportionate share of the proceeds at a certain stage of the waterfall, after the Limited Partner (LP) has received their preferred return. For example, if the LP has a 12% preferred return, the catch-up clause might allow the GP to receive a larger share of the remaining profits until they "catch up" to a certain level of returns.

Evaluating the Offer

• 50/50 Catch-Up: This means that after the LP has received their preferred return, the remaining profits are split 50/50 between the GP and LP until the GP has caught up to a specified return level. This can be attractive as it allows the GP to receive a significant portion of the profits earlier in the distribution waterfall.
• Comparison with Other Terms: If the other prospective investor is offering better promote terms but without a catch-up clause, you need to weigh the benefits of the catch-up clause against the slightly worse promote terms. The catch-up clause can potentially make the deal more attractive as it reduces the risk for the GP and allows for earlier profit realization.

Decision Factors

• Hurdle Rate: A 1 percentage point higher hurdle rate means the project needs to achieve a higher return before the promote kicks in. This could be a disadvantage if the project is expected to have lower returns.
• Promoted Interest Rate: A slightly lower promoted interest rate means you will receive a smaller share of the profits once the promote kicks in. This could be a disadvantage if the project is expected to be highly profitable.

Conclusion

• Attractiveness of the Catch-Up Clause: The 50/50 catch-up clause can make the deal more attractive as it allows the GP to receive a significant portion of the profits earlier. However, you need to consider whether this benefit outweighs the disadvantages of a higher hurdle rate and a lower promoted interest rate.
• Overall Evaluation: Consider the expected performance of the project and how the different terms will impact your returns. If the project is expected to perform well, the catch-up clause could be beneficial. If the project is expected to have lower returns, the higher hurdle rate and lower promoted interest rate could be a significant disadvantage.

In summary, the 50/50 catch-up clause can make the JV terms more attractive, but you need to carefully evaluate the overall impact of the higher hurdle rate and lower promoted interest rate on your potential returns.

Sources: Promote vs Carried Interest vs Catch up, When does the promote split actually occur?, Promote Structure Alternatives, What is meant by a "pure promote"?, Promote from $500k to literally $0 - what do those who have been through a RE downturn recommend?