Trouble understanding waterfall
I have trouble understanding what the “Promote %” means.
If the promote in this example is 10% in Hurdle 2 (for returns between 10-15% IRR), why is the Sponsor % only 19? … should it not be 20% (10% contribution + 10% promote)?
Sorry for dumb question.
Sponsors get promoted(greater %) with each hurdle. so it may be an IRR of X, but sponsor gets more of the cash flows that percentage of capital he put in the deal.
I know that a "promote" means a greater % of the cash flows ... but it still does not make sense to me.
If the original GP/LP contribution % was 10/90 ... and the Promote in Hurdle 2 is 10% ... why is the GP % of cash flows only 19% and not 20% (10% original contribution + 10% promote). Apologies for not adding a picture before
.
The GP promote of 10% means that the GP receives 10% of the total CF generated above the given hurdle rate, plus their pro rata share of the remaining cash flows. So GP receives the 10% promote, then the remaining 90% of total cash flows are split pro rata between GP and LP based on their respective equity contributions. So for the example above, the math works out like this:
GP % = Promoted Interest + (GP Equity Contribution %*(Total Equity Investment - GP Promote))
GP % = 10% + (10%*(100%-10%))
GP % = 10% + (10%*(90%))
GP % = 10% + 9%
GP % = 19%
the way this is quoted is that the GP gets a 10% "promote" of the LP's share, not the total share.
You don't get 10% of the whole pizza, you get 10% of the LP's share of the pizza.
Same concept with the 30% promote.
So for the 10% promote:
It's 10% + (90% * 10%) = 19%
For the 30% promote:
It's 10% + (90% * 30%) = 37%
This has been really helpful. Thank you!!!
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