Waterfall/Promote Nuance
Hey WSO - I'm spending some time learning how to model waterfalls and I have come across two different approaches for calculating LP interest per tier/hurdle based on various promote %'s.
Can someone help explain the difference between the below examples?
Example A: Assume 90%/10% LP/GP Split Tier 1: Pro-rata up to some preferred return Tier 2: 10% Promote up to X% IRR LP Interest in Tier 2 = (90% - 10%) = 80%, such that 80% is used in the MIN/MAX function for the LP's distribution at the respective tier
Example B: Assume 90%/10% LP/GP Split Tier 1: Pro-rata up to some preferred return Tier 2: 10% Promote up to X% IRR LP Interest in Tier 2 = 1-([GP's Initial 10%]+[LP's Initial 90%]*10%) = 72%, such that 72% is used in the MIN/MAX function for the LP's distribution at the respective tier
Thank you!
The correct methodology for promoted interest is shown below. Alternatively, what we do is utilize a simple cash flow split so there is no confusion about profit CF distributions.
Promote: Tier 1: 90%/10% LP/GP pari passu Capital Return and Preferred Return CF distribution Tier 2 (1): (90%-(90%*10%)) = 81%/19% LP/GP CF split up to X% IRR
(1) LP is promoted 10% of all cash flows after pari passu Capital Return and Preferred Return up to X% IRR meaning the LP gives 10% of 90% (9%) of their base capital split to GP
CF Split Tier 1: 90%/10% LP/GP pari passu Capital Return and Preferred Return CF distribution Tier 2: 80%/20% LP/GP CF split up to X% IRR
Isn't the GP promoted such that LP gives 10% of their 90% interest (9%) to the GP?
So that the GP is contributing essentially 1% of the equity? Doubtful. InVinoVeritas has it right. Technically you can structure a promote waterfall however you want, but that is the most common way by far, in my experience.
No, the LP is the one "promoted" despite that this sounds counter-intuitive. This has been confirmed repeatedly by seasoned MD's in the industry. If you read my reply you can see that LP gives 9% of their base pari passu cash flow split to GP in Tier 2.
Yeah I always find it helpful to think of it as the more formal "promoted interest" rather than a simple promote. As in, the interest is being promoted off of the LP. Makes it slightly less confusing.
Quia officia veritatis itaque. Omnis qui sit repudiandae saepe accusamus alias. Nihil omnis sunt quos quo quasi laboriosam. Ullam voluptatem et recusandae sapiente a vel. Quia consequatur voluptas nihil ut molestias eaque.
Odio saepe ex porro voluptatum inventore. Sunt reiciendis qui consequatur laudantium eius ut. Asperiores et qui hic non deserunt.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...