Modelling a GP catch-up with no GP contributions
Hi there.
I'm working on a deal where the developer has a 10% stake in the LP, but is also taking a promote as the GP.
The first hurdle is a priority return to the LP up to a 10% IRR i.e. the developer's LP stake gets 10% of distributions at the first hurdle and the other LP gets the remaining 90%.
This is simple enough to model, but the second hurdle is a GP-catch up to a 12% IRR (GP gets 100% of distributions from 10%-12%).
The confusion I'm having when coming to model this is since the GP is making no contributions, what is the 12% IRR based on?
The way I've modelled this currently is that the GP receives all that is required for both the LPs to hit THEIR 12% IRR, and the client has informed me they're happy with this but I'm not too confident that this is the correct way to do it.
I've seen GP distributions be modelled this way by simply dividing the LPs distributions by their share and multiplying by the GP distribution % in that respective hurdle, but since the LPs are receiving nothing in this hurdle I can't do that.
In summary, I've modelled the GP's contributions as whatever the LPs would require to hit their 12% IRR target. I can't think of any other way to do this aside from somehow basing it off of a project-level IRR, but I'm not sure how this would work in practice.
Any help would be appreciated.
I think I would have both LP and GP hit 10% pro rata and pari pissu and then tease out this 10-12% promote and then keep going. All of this would likely come from sale cash flow anyway so thats key to solve for imo.
Thanks for the response.
The first hurdle is set up so that the GP receives nothing. Both LPs are distributed 100% of the returns until both reach a 10% IRR. Only after this does the GP get any promote.
Apologies if I'm missing something, but when you say bring the GP up to a 10% IRR, what are you basing the IRR on if their cashflow has no contributions (no negatives)? I was specifically instructed by the client that this is not referring to bringing the developer's overall GP+LP return up to 12%, which is what led me to model them receiving the returns that both LPs would be distributed if they were brought up to 12%, but again I'm not too sure this is correct.
It's 10% preferred return, then the first hurdle is total LP equity to a 12% IRR with the GP split to 100%, LP at 0%. Then the next hurdle is whatever is in the JV docs.
Thanks for the help.
So does total LP equity to a 12% IRR mean that after the 10% pref return, the GP is distributed whatever would be required for total LP equity to go from 10% to 12% IRR?
The way I'm reading your first sentence, let's assume total equity is $10M. The developer contributed 10% to that. As developer/sponsor he is also entitled to GP promote. Without seeing the formation docs this is all hypothetical. The preferred return is 10% of 10M, the first hurdle is a 12% IRR on 10M, the developer as GP gets caught up 100% to a 12%, then you go to the second hurdle and continue on.
All makes sense, I just don't understand what the GP is being distributed. How can they be brought up to a 12% IRR if they are not making any contributions and therefore my required return calcs will not provide anything on their 0 contributions.
The trouble I have is that the developers contributions are coming from their LP stake, and I've been told that their GP catch-up should not be based on their LP contributions, in which case what does their 12% IRR look like? Is it the following?:
I think that's a better way of describing it, let me know if that makes sense
Yes
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