Preferred Return - Waterfall Calc - Noncummulative/Non-accrual
I'm creating a waterfall model. Need help on definition. The first hurdle says its a non-accruing, non-compounding preferred return. Is non-accruing the same as non-cummulative? Thank you.
it sounds like it would function more as just an equity multiple. no idea who would do this deal but w/e. need to know all the details of the waterfall to help.
have seen this on syndication deals with cash-on-cash return hurdles. Basically means that if you miss pref one year, that doesn't get paid back the following year if you exceed it.
For example: 7% preferred return hurdle then 80/20 split; $100 equity. Year 1 project return of 6% - $6 gets paid to LPs, but the $1 of missed pref is not carried forward to year 2 (non-cumulative) and the LPs are not entitled to a 7% return on that $1 (non-accruing). So year 2 project makes $12, $7 gets paid to LPs for pref, $4 (80% of $5 profit beyond pref) to LPs for profit split, and $1 (20% of $5 profit beyond pref) to GP for profit split.
So you essentially have a new 7% note each year? why would someone do this? The GP could hold all the cash flows for like Capex/Holdbacks and then only pay out on the liquidity event, skip the pref the first 4 years and only pay someone 7% in year 5 and then get a split for themselves on cash that they shouldve paid out.
This could give incentive to someone to not pay cash flows because there is no reason to.
You'd hope that the LP would have some protection from that in the operating agreement. Can't imagine that you'd see that structure in a deal with institutional LPs - you can infer a handful reasons HNWI would accept it (with varying degrees of cynicism) ranging from lack of understanding, access (more money chasing deal than syndicator needs so they can adjust terms to be more favorable to themselves), or maybe just trust - not going to have a lot of repeat investors if you are screwing them out of their pref.
This can't be right...You're saying if the property completely misses the pref return year 1, there is no pref catchup? There's gotta be some penalty to the GP for not hitting pref...
I thought about this.
I could see this being a great way to restructure a deal. Lets say you had a bad deal but it had a 10% pref that was ticking for 4 years, the GP get so far underwater that he knows that he will never catch up and never make a promote. The GP might abandon the project or not put as much time in anymore since the promote will never happen.
You could incentivse a GP this way because then the Pref will stop ticking against him and if he could see the light in a few extra years and be re incentivised.
Other than that which is something that is a little out there I would be so hesitant with this.
The pref would also hurt the GP too, unless it's an LP pref that gets paid out first before GP takes $1. I've never seen this, also there are hundreds of ways to fraudulent convey cash by the GP (inflating expenses, reserves, affiliate txns, etc), all of which are probably violations of the OA but at the end of the day how will the LP even know, especially if it's not a sophisticated investor...
Silly structure for LP dollars. This is how deals were structured early on in the crowdfunding space in an effort to incentivize GPs to use the platform.
I've never seen that stucture also. That's why i posted the question. Here is distribution structure. Even though it's non-accruing, it still incentivize the GP to pay distributions since the LP needs to reach its IRR targets in order for GP to get its promote, correct?
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