How to model an equity cram down?
Hi, I’m trying to figure out how to value an equity cram down. How do you do this? Any help/insight would be appreciated.
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Lol what is a equity cram down?
You’re a 2nd year associate in REPE and you’ve never heard of an equity cram down?
Asks for a help and proceeds to show attitude as well. Classic post MBA associate here.
Honestly didn’t know! Thought it was a funny term. Don’t tell my IC until my bonus hits plz thx.
Also no idea what an equity cram down is.. dilution of equity % by recapping with additional partners? Idk
I heard this term in REIB but I don’t think it’s used in traditional real estate. Clown question bro
Man… I’m up to my ass in more nuts than a fruitcake.
Isn't an equity cramdown just when an owner/GP is forced to accept unfavorable terms because of one condition or another? If not I have no idea what you're talking about OP, and if so... you would just model it using whatever terms you negotiated?
Yes, that's my understanding of the term. It will probably be pretty situation specific.
To give a corporate example, let's say as a borrower you trip a leverage covenant. The lender might ask (basically force) the borrower to convert a % of the debt to equity (on terms favorable to the lender because the borrower is in default) in order to delever, thus "cramming down" the original equity deeper into the capital stack.
How bout u equity cram deez nuts down ur mouth
You are all going to learn what this is over the next few years!
Easiest explanation is buying equity at a discount.
More typically, it is a debt cram down.
Real world example is what happens to a car loan in a personal chapter 11. You go to the judge and say your loan is $30k and car value is $10k cause you put 500k miles on it. The loan gets “crammed down” to $10k. This is real, but happens all the time in corporate C11 when valuing assets, accrued interest, penalty interest etc.
So run that same concept for equity.
Easiest way to understand an equity cramdown in real estate.
LP Contribution 70%/ GP Contribution 30% (as an example), then there happens to be a capital call. GP does not have sufficient liquidity, so LP contributes more money on a pro-rata basis. Whatever $ amount they contribute, lets just say it is enough that their Contribution is now 85% and GP is crammed down to 15%. So their returns are diluted.
I had to model this 2 years ago, easiest way to model returns from a historical to projection was to have equity cumulative on a monthly basis (like the mechanics of a loan draw), then bifurcate by having equity percentage be a monthly input. That way you can get the total projected return for GP and LP.
Interesting. FWIW I have never heard this called an "equity cram down" before, we just call it "dilution". In our partnership agreements we usually try to negotiate a multiple of dilution (usually 1.5x - 2.0x) on the ownership interest of the nonfunding member.
We call it punitive dilution but I like "Painful Cram Down" a lot more. Will suggest
just people making up new words to sound smart. dilution is the proper way to call it.
I have always done this with manual inputs....Keep GP equity flat and increase LP Equity the month it happens
Also no one calls it that, its just not contributing to a capital call. I think it happened to me in a deal I had ike 5k in bc there are alot of covenants for small investors that you aren't even allowed to fulfill the call
Can someone explain this diluted part further? I understand the LP and GP did not contribute on a pro rata basis thus the LP now has more in the deal than their originally agreed upon split. How does this dilute the GP’s return? Because the GP now has to pay pref on more LP dollars? If yes, isn’t that also beneficial to the GP as it is providing them with further leverage ?
Your capital stack just increased, making your deal level cash on cash return less. How is this accretive to the deal? You are returned based on yes pref(which the GP doesn't pay out, mechanically anyway, the property pays the pref), so GP pays more than proforma to pref(a higher $ amount), less money to be distributed in the hurdles, maybe you don't hit your final hurdle, depending how severe the cost overrun is.
No because now the LP has a greater percentage of the equity (i.e. greater ownership) and shares in more of the cash flows, diluting the cash flow the GP receives on their same dollar investment.
For simplicity, lets say I own I have a 10% ownership share in a property based on a $1M investment (e.g. original equity of $10M) that has $1M of distributable cash flow every year. That means I'm getting $100k annually, or a 10% cash on cash.
If there's a $1M capital call, but I don't have $100k to contribute my 10% share of that and a dilution occurs, the equity stack is now $10M LP/$1M GP, so my ownership share is diluted from 10% to 9.09%. Distributable cash flow hasn't changed, so I'm now entitled to $90,900/year instead of $100k/year based on the new ownership share, reducing my cash on cash from 10% to 9.09% accordingly.
This is before even beginning to consider the implications the changes have on pref and the waterfall structure.
If this is a real deal, read the agreement, it will all be in there. Otherwise make an assumption that it just grosses up ownership.
If GP doesn't contribute for a capital call and LP funds instead, the LP's funding typically has a multiple attached to it for that capital call which by effects dilutes the GP's equity.
Using round numbers let's say prior to capital call there's $1,000 in the deal so far, $900 is the LP and $100 is the GP. A new $100 capital call comes up, supposed to be funded $90 LP / $10 GP. GP doesn't fund their $10 stake so LP does to avoid any issues on costs not being met. LP's funding of the GP stake counts for 2x, so in effect the LP has funded $20 on top of their $90. Now, LP has funded $1,010 and GP has funded $100. LP's is now 90.99% of the equity despite having funded 90.91% of cash to date. If GP had funded their stake, they'd still be 10% of the equity, but they're now 9.01% despite having funded 9.09% of the equity to date. When it comes to distributions at a later point, they're now getting less than their pro-rata cash contribution due to the dilution.
This works in reverse to (i.e. LP diluted if GP meets capital call) but obviously there's far bigger issues to be dealt with if 90% of the equity isn't funding capital calls.
so, to sum up the thread, OP's boss likes to make up terms for something that already has a name to sound smart. OP doesn't understand his boss' made up lingo but instead of asking him wtf this lingo means, he jumps to WSO and asks people how to value made-up lingo. people obviously don't know what it means cause it's not how people generally call it, so they ask OP what it means. OP calls people stupid for not knowing. somebody in the comments eventually guesses that it's just dilution which is easy to calculate for anybody who understands middle school math.
I've heard it called a cramdown before. So I didn't guess.
To be conscious that you are ignorant is a great step to gaining knowledge.
lol, what?
A cram down like in bankruptcy?
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