This came from an actual JV proposal with sample cash flow, so I wanted to see if this was common within the REPE world.
90/10 JV, pari passu to a 10%, then a straight 80/20 split thereafter. Fairly simple.
Assume that after each side gets their 10%, there is $1MM in remaining cash to be distributed. I was always under the assumption in that case, the LP would get $800K and the GP would make $200K.
In the cash flow exhibit attached to the JV term sheet, it shows something different. It shows the $200K going to the GP, but on the $800K piece, it shows it getting split 90/10 so $720K goes to LP, and $80K (plus the $200K) goes to GP.
Does this sound standard and what's the logic behind it?
Sounds like a GP catch up of some sort. Never seen that type of structure at the deal level though.
I've heard this described as a "Wall Street Split" and it's fairly common. Basically all the investors both GP and LP get their share of the LP piece of the deal at every level of the waterfall. The promote piece (20% in your example) only goes to the GP while the remaining 80% goes to all investors based on their equity contribution (90% LP's/10% GP in your example).
This journal article does a great job explaining this in extreme detail.
http://www.pircher.com/media/publication/50_SACArticle.pdf
Haha picklemonkey I was literally about to refer to this exact article when WSO showed "new comment - click here to refresh"...
Anyway, in response to Egold, the additional 80k is to account for the initial equity split which the GP is contributing. Most importantly one needs to distinguish between what is being split and by whom (see pg 31 of the article referenced above).
It's probably fairly common (I've never seen it, but then again, I've only done half a dozen or so truly private equity deals), but the issue I have (reading this thread) is that the sponsor was not particularly forthright with the terms--it was burying the lede, so to speak. The sponsor headlined the deal with terms that are actually different than the deal itself and then did a poor job (or none at all) of explaining what's going on.
it does sound legit
See this most all the time at our shop. It's also very important to know the exact language used and the intentions behind it. Time based hurdles without careful consideration can be used to mask massive promotes.
For example, at a previous shop we raised money at a 16% pref and 50/50 promote thereafter. High net worth money that was unsophisticated and focused on the 16. The deal was a land deal that we exited for 1.5x in 3 months. We paid back 1.04x to investors and split the remaining 46% profits 50/50.
I mean, my position on that is if the investor is happy with the risk/return profile then it's a win-win deal...
The GP is always entitled to the capital he puts into the deal - the splits only refer to the LP's portion of the capital. So the 80% / 20% is 80% of the 90% - 18% allocating 28% of the profit to the GP in total.
I would mostly agree, but it's never always the case. I've seen many times where the GP will contribute capital that won't earn a pref in exchange for a higher promote. Typical of operators that see more upside than risk and use their own money rather than funds raised from family/friends.
This is the only way I've ever seen a waterfall, working from the LP side with class-A GPs in the US.
So it sounds like the structure that I initially described is fairly common. It's not truly an 80/20 split of the promote but rather 20% to GP and then remaining 80% split pro rata based on equity contribution.
what are the equity contributions? Some companies will calculate the promote as 80/20 split multiplied by their ownership. Ive seen similar language as the one you posted on term sheets, and this was the reason for it..
GUYS FFS SPLITS =/= PROMOTES and it's not ALWAYS one OR the other. They can be very different things depending on how the terms are worded and this is why it's extremely important to document the equity return splits very clearly in documents if you want to avoid bad blood and expensive legal battles.
For instance, what the OP posted could easily be a split OR a promote (depending on how you finish the sentence). The JV is a 90/10, so the partners (in this scenario) are pari passu to a 10%. Thereafter, one of two things can happen:
A) 20% goes to the sponsor and 80% goes to the LP. This would be a simple SPLIT.
B) 20% goes to the sponsor and 80% goes to the PARTNERSHIP. This would be a PROMOTE to the sponsor. The sponsor would get 20% plus 10% of the remaining 80% going to the partnership. So 20% + (80% *10% = 8%) = 28%. NOT THE SAME.
I have seen this done both ways. Usually, it's the LP trying to fleece the sponsor if it's not written clearly. OP, if you're on the GP side, your offer sounds like option A, so you would be getting a simple split and not a promote (aka less money).
+1, this. It's very commonly done both ways, in some cases intentionally if one side is savvy, in some cases it's a result of unclear structuring/language.
Fairly common. Great way to leverage the equity invested by the GP.
Once first hurdle of 10% is reached GP distribution % = 1 - (Equity Share LP * LP Split %) = 1 - (90% *80%) = 28%.
LP distribution percent = (1 - GP distribution %) = 72%
One could add more hurdles to further leverage the GP's equity contributions. For example:
Hurdle 1: Up to 10% IRR to LP; Promote Structure = 0%/100%; Distribution = 10%/90% Hurdle 2: >10% IRR up to 12% IRR to LP; Promote Structure = 20%/80%; Distribution = 28%/72% Hurdle 3: >12% IRR up to 15% IRR to LP; Promote structure = 30%/70%; Distribution = 37%/63% And so on and so forth.
IRR/Waterfall QUestion (Originally Posted: 10/17/2017)
Does anyone have a model or know how to calculate a multiple-hurdle waterfall where GP and LP invest capital at different stages of the deal? (Basically, GP and LP are not putting in $ at the same time so therefore the pref on each starts at different times) Thanks!!
I detest complicated structures like this because I think truly smart people make things more simple (see the Apple iPhone). Then again, my investors are not necessarily real estate people, so we pitch to them simple, easily digestible promote structures.
Truly smart people make money and do so by using complicated structures like so in order to more effectively leverage one's equity.
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