Approaching a deadline and could use some help. Structure is a 96/4 to a 9% with the first tranche a 70/30 split to a 13%. How do I calculate how much of the 30 in the second tranche is promote vs how much of it is "equity".

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how did you get the 26 of the 30?

Thanks! It matters bec I'm trying to figure out what portion of the 30 is paying down the equity balance. Since the promote portion does not pay down the equity balance.

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If you truly want understand how much of the breakout is lowering your equity basis, you would need to segregate the LP & the promote entity. So you would have 1 LP at 96% equity contribution, 1 LP at 4% equity contribution, & 1 GP that only collects promote.

This is because as an LP you are earning a return on your 4.0% equity contribution at 9%, and again at 13% for the 2nd hurdle. So to just take 26/30 x whatever return you calculate is going to skew how much is actually earned from promote, real promote would be something less.

Technically, the amount that is considered promote ultimately depends on whether the GP equity is diluted like the LP equity (i.e. "promoted"). The first step in calculating the promote % is to take the GP's share of cash flow in the tier (30%) and subtract the GP's equity ownership (4%), which gives you 26%, then divide this by the LP equity % (96%), which gives you 27.08% because the GP is taking 27.08% of the 96% that would be distributed to the LP.

If the GP equity is promoted, then the same 27.08% is taken from the GP's 4% equity share such that the GP's equity share is actually 2.92%. Adding the GP's 27.08% promote share to the GP's 2.92% equity share yields the same 30% cash flow to the GP.

If the GP's equity is non-promoted, then the GP's equity share remains at 4% through the waterfall. Subtracting the 4% from the GP's 30% cash flow distribution means that 26% is promote.

The impact of this distinction is of much more importance when the GP's ownership % of the JV is higher. For example, if the JV equity is structured 50% LP / 50% GP, and the GP gets 75% of the cash flow at a tier, then, if the GP's equity is non-promoted, the promote is 25% (since the 50% GP equity remains the same), whereas the promote is 50% if the GP equity is promoted.

I recognize my comment comes after the fact given the original question was asked with respect to a looming deadline. However, I hope this is beneficial for those with similar questions that look to this thread for the correct answer. H Roark is correct. 26 is not the correct answer, and the thinking behind that is a common misconception. The true promote is 2nd tier GP % less 2nd tier LP % divided by first tier LP % times 1st tier GP %. In this case 30% - (70% / 96% x 4%) .

NYRealEstatePE Sr Assoc:

I recognize my comment comes after the fact given the original question was asked with respect to a looming deadline. However, I hope this is beneficial for those with similar questions that look to this thread for the correct answer. H Roark is correct. 26 is not the correct answer, and the thinking behind that is a common misconception. The true promote is 2nd tier GP % less 2nd tier LP % divided by first tier LP % times 1st tier GP %. In this case 30% - (70% / 96% x 4%) .

Alright, this has been bugging me. The OP asked, "How much of the 30 is promote?"

Or, inversely, "How much of the 30 is 'true' equity?" You're saying less than 4 of that 30 is true equity? And that, therefore, the LP claims more than 96 as true equity?

Best Response

Yes, assuming a common structure in which 100% of the JV equity is invested on a promoted basis and all distributions are made pro rata pari passu, both the LP's and the GP's invested capital gets diluted when cash flow goes towards paying a promote to the GP sponsor.

I think it is easier to understand if you think about it in black and white terms: assume that cash flow distributions are bifurcated between Silo A and Silo B. Silo A represents return on invested capital, while Silo B represents the promote (i.e. performance fee). Distributions into Silo A are shared by the JV members (i.e. LP and GP) based on their relative equity contributions, while the GP sponsor receives 100% of the distributions into Silo B. Until the first hurdle is achieved, 100% of cash flow is distributed into Silo A, while 0% goes into Silo B. Once sufficient cash flow is distributed into Silo A for the LP to reach the first hurdle, some amount less than 100% of available cash flow goes into Silo A and some amount more than 0% goes into Silo B.

Here's an example to better illustrate the concept:

Let's assume the JV is structured such that all of the JV equity contributions are invested on a promoted pari passu basis, with the LP contributing 80% of the JV equity and the GP contributing 20%. Silo A distributions are shared by the JV members pro rata, so the LP receives 80% of Silo A distributions, and the GP gets the remaining 20%.

Assume a simple two-tier waterfall structure in which a 40% promote is paid over a 15% IRR. In other words, 100% of distributions go into Silo A until the JV members earn a 15% IRR on their invested capital. Thereafter, 60% of cash flow is distributed into Silo A (i.e. 100% less the 40% promote), and 40% goes into Silo B.

Here is the summary:

JV Equity Contributions: 80% LP, 20% GP

Tier I Distributions: 100% into Silo A, 0% into Silo B

Tier II Distributions: 60% into Silo A, 40% into Silo B

In each tier, the LP receives 80% of the cash flow distributed into Silo A, and the GP receives the other 20% of Silo A distributions PLUS 100% of Silo B distributions.

In Tier I, 100% of the distributions go into Silo A, so the LP receives 80% of the cash flow distributed (i.e. 80% of the 100% into Silo A), while the GP receives 20% of the cash flow (i.e. 20% of the 100% into Silo A + 100% of the 0% into Silo B). If we assume that \$100 of profit is distributed in Tier I, the LP gets \$80, and the GP gets \$20.

In Tier II, 60% of the distributions go into Silo A and 40% go into Silo B. Now let's assume that \$100 is also distributed in Tier II, meaning \$60 is sent into Silo A and \$40 into Silo B. Silo A distributions are split pro rata, so \$48 is distributed to the LP (i.e. 80% of the \$60 into Silo A = 48% of Tier II), while the GP gets the other \$52 distributed in Tier II, including \$12 from Silo A (i.e. 20% of the \$60 into Silo A = 12% of Tier II) PLUS \$40 from cash flow into Silo B (i.e. 100% of Silo B's \$40 = 40% of Tier II).

Occasionally, the GP's equity is invested on a non-promoted basis, meaning that it does not get diluted when a promote is paid. In the above example, this means that the GP equity receives 20% of distributions in each tier, such that the GP would be paid the same \$52 in Tier II as before, but the amount of that considered the promote would be only \$32, or 20% less than the \$40 considered promote above. This distinction may seem small, but it can be of major importance when the GP itself is a JV between the sponsor and investors because the GP JV can be structured such that investors within the GP may be entitled to less than their pro rata share (or even 0%) of any promote cash flow.

H. Roark:
First of all, this is awesome, thank you.

I just had a colleague who has waterfalled himself to death, many times, go through this with me. Apparently the real answer here for the OP is that nobody does a 70/30 tranche in a 96-4 arrangement. The whole premise is worded wrong. If it's a 96-4 agreement, then if they want a 30, they do a 67.2 / 32.8.

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