What is the difference between a split and a promote?
My understanding is that a split refers to the division of cash flow, whereas a promote refers to the additional cash flow a sponsor might earn over and above their contribution share %. The two concept are interrelated, but not the same.
I.e
Pref to a 6% IRR Pro Rata 80/20 from 6% to a 10% IRR 60/40 from 10%-13% IRR
80/20 refers to the split of remaining cash at the respective hurdle.
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Yes, the split is the differentiation of cash from from the LP/GP. The promote is the excess allowed interest given to the GP FROM the LP after, usually, after a preferred return (EM/IRR accrual). You can solve for the cash distribution split or the implied promote with the following formula.
GP Cash Distribution Split = (LP Initial Interest x Promote) + GP Initial Interest
LP Cash Distribution Split = 100% - GP Cash Distribution Split or = LP initial share x (1-Promote)
Usually there's an additional promote at each given IRR/EM/CoC hurdle.
Agree with this explanation.
In your case (assuming a 90/10 LP/GP investment), that translates to:
pro rata until LP receives a 6% IRR
72% LP / 28% GP (GP gets 20% promote and its 10% is diluted to 8% since 10% *(1-20% promote) = 8%) until 10% IRR
54% LP / 46% GP (GP gets 40% promote and its 10% is diluted to 6% since 10% *(1-40% promote) = 6%) above 10% IRR
Do we have to be careful on the verbiage here?
If someone says "80/20", I take that in the literal sense. They mean 80% of cash flows to LP and 20% of cash flows to GP.
If someone instead says "20% promote", that means what you are saying. I.E. The LP gives up 20% of his position to the GP. (90% * 20%) + 10% = 28% of cash flows to GP / 72% to LP.
In the OPs case, if they say 80/20, I would take that in the literal sense instead of the math you showed. Otherwise, the "80" part of it doesn't really make any sense right?
*EDIT math on the "20% promote"
How are you determining an IRR split when you can only calculate an IRR on a sale? When does the cash flow splits occur annually if the property is not sold?
I’m interested in understanding this as well. Are there cash flows at hurdle points if the hold period is say 20+ years for an owner operator style developer?
You use a capital account that shows the contributions to date and an accrual that calculates how much during every period would have to be distributed to the investor to equal an X% IRR. Your actual distributions are then the MIN(share of the net cash flow, accrued amount to equal the target IRR). The longer the project goes on, the more you need to hit the target IRR. Sometimes the tiers have other restraints such as target IRR AND target equity multiple so you have to satisfy multiple conditions.
This. I've seen IRR and Pref % used interchangeably. Its based on accruals.
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