Value-add profit split

If you had value-add deal which is currently structured at 95/5 equity contribution between LP/GP with a flat 70/30 distribution structure (no waterfall) after debt service. Now if say the GP then contributes 40% of the equity, how would you say the deal would change?

Comments (7)

WSO Monkey Bot

Rank: Human
14,009

Aug 3, 2019 - 2:10am

Hi greenlander., just trying to help:

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How the hell can I be a value add in my networking attempts? Recently attempted to network with a MM IB MD in the Midwest region, and he replied with a link to a book about networking. He essentially told me in the body of the email to screw off because I couldn't offer him value. I get it. You're busy, b ...
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More suggestions...

I hope those threads give you a bit more insight.

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AB84

Rank: Senior Orangutan
401

Aug 7, 2019 - 2:38pm

Well 95/5 to a 70/30 is around a 26% promote.

So on a 60/40, assuming the same promote, the splits would be around 45/55 after debt service.

Though 55 is higher than 30, it is still dilutive to the GP since you are using the same promote over a smaller LP equity contribution. Their disproportionat split is not as significant as the 95/5 structure.

As to how this would play out in real life? Idk, I would imagine the promote would be much larger since the LP has a much lower risk at 60% contribution. However, I've never seen a structure that goes straight to promote with no pref return hurdle anyway.

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CREPATH

Rank: Orangutan
340

Aug 9, 2019 - 11:09am

AB84:
Well 95/5 to a 70/30 is around a 26% promote.
So on a 60/40, assuming the same promote, the splits would be around 45/55 after debt service.
Though 55 is higher than 30, it is still dilutive to the GP since you are using the same promote over a smaller LP equity contribution. Their disproportionat split is not as significant as the 95/5 structure.
As to how this would play out in real life? Idk, I would imagine the promote would be much larger since the LP has a much lower risk at 60% contribution. However, I've never seen a structure that goes straight to promote with no pref return hurdle anyway.

Can you explain in greater detail how this would be dilutive (possibly show the math)?

I have a similar situation I'm thinking through right now and I was asked "why is more equity dilutive to our return (the gp)" The way I generally thought about it is it's essentially getting less financing (leverage), but, we're pari passu to a 10% pref and 70%/30% above that regardless of equity contribution. Financing is typically less than your cost of equity so it's accretive, but in this situation the cost of equity for GP and LP is equal (unless I'm thinking about this wrong).

Authored by: Certified Real Estate Professional - 2nd Year Associate Certified Real Estate Pro

AB84

Rank: Senior Orangutan
401

Aug 9, 2019 - 1:56pm

I just double checked it in my model. Hard to show the math without sending my full blown waterfall, but I'll try to explain it more simply:

Going from a 95 (LP) / 5 (GP) to a 70 (LP) / 30 (GP) is an additional 25% of profit split to the GP
Going from a 60 (LP) / 40 (GP) to a 45 (LP) / 55 (GP) is an additional 15% of profil split to the GP.

Another way to think about it is:

5 (GP) to a 30 (GP) is a 600% increase in cash flow
40 (GP) to a 55 (GP) is a 137% increase in cash flow

If your fund was $40mm, would you rather do one $40mm deal with a 137% increase in net cash flow or eight $5mm deal with a 600% increase in cash flow?

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CREPATH

Rank: Orangutan
340

Aug 13, 2019 - 3:10pm

AB84:
I just double checked it in my model. Hard to show the math without sending my full blown waterfall, but I'll try to explain it more simply:
Going from a 95 (LP) / 5 (GP) to a 70 (LP) / 30 (GP) is an additional 25% of profit split to the GP
Going from a 60 (LP) / 40 (GP) to a 45 (LP) / 55 (GP) is an additional 15% of profil split to the GP.
Another way to think about it is:
5 (GP) to a 30 (GP) is a 600% increase in cash flow
40 (GP) to a 55 (GP) is a 137% increase in cash flow
If your fund was $40mm, would you rather do one $40mm deal with a 137% increase in net cash flow or eight $5mm deal with a 600% increase in cash flow?

Yep... that makes perfect sense. Much appreciated. + Banana

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greenlander.

Rank: Senior Monkey
96

Aug 15, 2019 - 12:47am

Yeh I should've phrased this better. I was trying to figure out how much larger the promote could be if the GP were to raise another 35% of the equity.

So equity would be
5%- GP common
35% - LP2 -pref
60% - LP1-common

I had an idea of turning the additional 35% equity raised into preferred equity and trying to push for a better split than the 70/30 maybe 60/40 bc this would steer all the upside (project currently underwritten to hit 30% IRR) to the GP and LP1.

Then I saw how the GP could squeeze more money out by sticking with the 70/30 split (LP/GP) and utilizing the 35% additional equity as quasi-preferred. GP would collect 30% (on their 5% contributed) + any upside over the pref (from LP2).

Authored by: Certified Real Estate Professional - Vice President Certified Real Estate Pro