When raising a fund as a lender - how do you calculate the returns for the hurdles?
ie. You raise 10 million as a debt fund. Whatever the hurdle is for a return for LPs, ie:
o 10.0% above a 10.0% hurdle and full GP catch-up
o 20.0% above a 20.0% hurdle and full GP catch-up
o 30.0% above a 30.0% hurdle and full GP catch-up
*(What is full GP catch-up??)
The 10 million is going to be put out over a number of deals, sporadically. Each deal will be underwritten individually to see what the IRR is, etc. How do you measure the returns for the fund if each deal will have its own IRR and performance? Do you have to wait until all the capital raised is put out? How do you know what the return or performance is until all the loans are paid back in full? Am I looking at this wrong?
You're asking good questions, but I have a question for you. How is anything you described different than a fund with equity that invests in deals? They have the same issues as funds (different start dates, different returns, cash coming in and out, not knowing the performance of the fund until the end, etc.)? At the end of the day investments in debt or equity will be a stream of cash flows that you can calculate an IRR, waterfall, and distributions out of.
Typically on a fund, they use a "European" waterfall or "Crossed" waterfall which essentially means that the promote of the fund is measured on the aggregate cashflows of all of the deals combined, i.e., it's only paid out at the end of the fund unless your deals knock it out of the park (i.e., pay back all equity + pref with some deals unrealized).
If you're using an "American" or "un-crossed" waterfall the promote is paid out as each individual deal is realized, which typically doesn't happen in a fund, it's a trade off of the stability of the fund vs. early access to promote/getting promote even when some deals don't do well.
GP Catchup - when an outsized portion of the cash flow goes to the sponsor until they reach a certain threshold (usually a total % of profit). Percentages vary, but it's usually 50% or 100% from what I've seen in documents/agreements. In your example at the 10%/20%/30% hurdles the GP gets, likely, 100% of cash flow above a 10% IRR until they are 10% of the profit, after which which then goes 90% LP/10% GP; 100% above the cash flow above a 20% IRR until they are 20% of the profit, after which which it goes 80% LP/20% GP; and 100% of the cash flow above a 30% IRR, after which it goes 70% LP/30% GP.
Hope this helps!
Thank you! Do you mind providing a simple example with numbers? The catch up %s are confusing me, specifically how they're calculated.
Also on GP catchup, from what I've heard it's because the GP has put in very little equity so LP wants to get their returns first for putting up such a large percentage (more than the typical deal).
The only time I've seen a GP catch up was at a very small firm I used to work at. They would do deals in the $10-40mm range and on a $20mm deal (say 60% LTC) out of the $8mm in equity they would put in a combined $1mm maybe less. Just very little equity in deals, doing it for the fees (dev, AM, construction related GC fees) and not caring about how the deal performs because they got their money out.
This wasn't a fund structure, only deal by deal with HNW LPs and a few that would capitalize a deal.
Sure, Let's say I do a deal for 100 (all equity) and a year later it sells for 200 net of transaction costs, etc. (a 100% project level IRR). Note that Pref is most times paid back before Equity, but it usually doesn't matter.
Equity payback: The first 100 go to pay back equity pro rata (at whatever splits the members contributed)
Payback of Pref: the first dollars go to pay back the 10% pref so the members get $10 pro rata
10% catch up - the GP then gets dollars until they are 10% of the profit (in this case they get $1.11 since it's a bit circular)
2nd tier Pref - the split then goes 90% (LP)/10% (GP) until the LP gets a 20% IRR, so the LP gets $10 (this plus the $10 they got before gets them to a 20% IRR) and the GP gets $1.11 again
20% catchup - the GP then gets their catchup to 20% of the profit. Total profit distributed so far was ($10 + $10 + $1.1 + $1.1). The math here is best done in excel, but the GP here gets $2.78 which brings them to 20% of the profit as $1.1 + $1.1 + $2.78 = 5 and total distributions to this point is $25 ($10 + $10 + $5) and $5/$20 = 20%
3rd tier Pref - the GP gets another $10 to get them to a 30% IRR and the GP gets 20%, which is another $2.5 (again, circular, do the math in excel) so at this point the LP has received $30 in profit and the GP has received $7.5 (your check here should be that $7.5 is 20% of $37.5, it is).
30% catch up - The GP now gets 30% of the profit so the GP gets another $5.36 to get them to 30% profit.
The remaining $57.14 is split 70% LP / 30% GP or $40 LP $17.14 GP
If you add all of that up, the GP should get $30 of profit and the LP should get $70 of profit. Catchups are easy if you make it all the way through because you can typically just split the money by the final hurdle and be done, it's more tricky (and generally more likely) when you end up in the middle of a hurdle, which is why these are done in excel.
Also - note that the GP usually has an LP investment as part of the structure, so they'll end up being 1% + of the LP as well.
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