How would I run a recapitalization event through an equity waterfall?
We will be recapping 50% of a current investor as they need to be taken out. I was just wondering how to model that for waterfalls and how it flows through
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You're right, this is a difficult modelling question...the reason being it is an even more difficult theory question. All types of words have been painted for it, such as "crystallization". Essentially, with the market where it is a how hard it might be to deploy capital...many development JVs are entertaining the idea of recapitalizing their structure to hold the deal long term, not merchant builder model. Obviously the waterfall/OA would have been very different had either side planned on holding long term. Conversely, sometimes one party wants to exit, the other wants to stay...short of using a forced buyout, it really is a blank canvas on how to treat.
I understand confidentiality, but you would really need to provide more info for anyone to help on this, as it really is so open ended. How is this buyout occurring? Are you taking their ownership over, or are you refinancing and using the loan proceeds as a capital event to pay them out? When you say 50%...are you buying 50% of your equity/investor out entirely, or one investor's 50% equity interest?
Again, without knowing a lot, I would respond using the KISS principle. The waterfall would work such that at the capital event, in order to buyout the investor entirely (assuming no predetermined buyout clause which is rare), you would need to generate enough capital to payout their outstanding pref + capital contribution. You would then "re-balance" the remaining equity partners and carry out future pari passu pref's on that basis, as well as for all splits going forward. If they are only getting a 50% takeout, then you would apply the same principle but revise the payouts down to equate to a 50% value on the scenario above. Of course everything is a negotiation here...is it well before the pre-determined proforma sale date? If so, and an equity partner wants out, I would say you need to take a haircut...so again, more detail for a specific response...
Thank you this provides so good framework with which to start the waterfall. I will try to provide specifics currently the buyout is occurring during refi, but we plan on raising crowd funding to make up for the difference. My first question do I pay them the amount of their cumulative carry plus their pref or do I pay them their current pro rata share of the value of the property minus debt. AKA their prorate share of the equity value of the property. I ask because these numbers are different. We are currently buying out 50% of an entity, but in this case this equates to 100% of our previous fund as the entity is made up of two parties. I am trying to determine what % of the refi proceeds go
wouldn't you just treat it as a sale?
Doesn't make sense to do a pro rata share of the equity since you're ignoring the waterfall and they are only subject to their share of the cash flow based on the hurdles. The way I've done this before is at the time of refi you assume a sale and see what their cash flows would come out to based on the waterfall (cap contribution + pref + promotes, etc) and that is the value of the equity to be paid out to them at the time of refi. If the refi is insufficient to take them out whole, then you either have to agree to enter into an installment agreement with them where they sweep cash until they're taken out or you have to fund the balance with equity/another capital source. We're doing this right now with an Opp Zone fund as an aside.
Ok yes this is what I've done, but to take it a step further what if we crowd fund the remainder of the equity? Does the crowd fund investor now become another LP in the waterfall?
If you are going through a refi, then I would assume the above scenario. If it's a refi, then it is more than likely after the proforma hold period (Assuming you loan is due and rather than sell you want to refi and hold long term). That is a lot easier, as described above, you simply treat the refi proceeds as a sale...and just run the $ through the regular waterfall. The more difficult scenario is when BOTH parties want to stay in long term...this is where that crystallization mess starts to be negotiated.
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