pe distribution waterfall example in European and American Private Equity

In European private equity, the distribution waterfall typically follows a specific order: management fees are paid first, followed by carried interest, and then the remaining profits are distributed to investors.

The management fee, usually around 2% of the fund's capital, is deducted from the fund's profits before any other distributions are made.

In contrast, American private equity firms often have a different approach, with carried interest being paid out before management fees in some cases.

Private equity is a type of investment where a firm or individual provides capital to a private company, with the goal of eventually taking the company public or selling it for a profit.

Private equity firms typically invest in companies that are undervalued or have potential for growth, with the intention of improving their operations and increasing their value over time.

Private equity investments can take many forms, including leveraged buyouts (LBOs), growth capital, and mezzanine capital.

Private equity firms usually have a clear exit strategy in mind, such as taking the company public or selling it to another company.

Private equity investments are often structured as a partnership or limited liability company, with the private equity firm owning a majority stake in the company.

Private equity firms typically have a team of professionals with expertise in areas such as finance, operations, and strategy, who work together to identify and invest in companies with growth potential.

Private equity firms usually have a significant amount of capital at their disposal, which they use to invest in multiple companies at the same time.

A distribution waterfall is a crucial component of private equity investments, and understanding its structure is essential for investors and fund managers alike.

The distribution waterfall typically starts with the Return of Capital (ROC), which is the priority for returning limited partners' (LPs) initial investments.

This is often achieved through profits from divestments or portfolio income, as seen in the Carlyle Partners V example, where the fund's priority was returning LPs' initial investments.

In a distribution waterfall, the preferred return is usually a percentage of the fund's profits, typically ranging from 8-10% per annum, before the general partner can participate in profits.

For instance, in the Carlyle Partners V example, LPs received a preferred return after the ROC had been met.

The carried interest is the percentage of the fund's profits that the general partner is entitled to, often ranging from 20% to 30%.

In the Carlyle Partners V example, the Carlyle Group was entitled to 20% carried interest after the preferred return had been met.

The final component of the distribution waterfall is the waterfall splits, which determine how the remaining profits are split between LPs and the general partner.

In the Carlyle Partners V example, the remaining profits were split between LPs and the Carlyle Group in a predetermined ratio of 80-20 or 70-30 in favor of LPs.

Here's a summary of the distribution waterfall components:

A real estate private equity (REPE) fund's distribution waterfall is a crucial mechanism that ensures all stakeholders receive their fair share of profits. The waterfall tiers are designed to allocate funds in a specific order, with each tier having its own set of rules and conditions.

There are typically four to five tiers in a real estate waterfall, each with its own unique characteristics. Tier 1 is the return of capital, which ensures that limited partners (LPs) are repaid their original investment. This tier is also known for its preferred return, which is usually between 6% to 8% per annum.

The preferred return is calculated by multiplying the preferred rate by the beginning balance. For example, in Tier 1, the preferred return is 8%, so the calculation would be 8% of the beginning balance.

Here's a breakdown of the typical waterfall tiers:

Each tier has its own set of rules and conditions, and the funds are allocated in a specific order. The promote or carried interest is a performance-based contingency payment that flows to the general partner (GP) after reaching the target returns.

The internal rate of return (IRR) and equity multiple are important metrics used to evaluate the performance of a real estate fund. In the examples provided, the IRR and equity multiple for the LP and GP cash flows are calculated to be 15.4% and 1.8x, respectively.

The main difference between European and American distribution waterfalls lies in how carried interest is treated. In a European waterfall, sponsors aren't entitled to receive carried interest until the limited partners (LPs) are made whole, meaning they've recovered their original capital contribution and a predefined preferred return.

The American waterfall, on the other hand, allows sponsors to receive carried interest on a deal-by-deal basis, before the LPs are made whole. This is often referred to as the deal-by-deal approach.

The European waterfall prioritizes the interests of the limited partners (LPs), reducing their downside risk. In contrast, the American waterfall is perceived as more favorable to sponsors.

Here's a comparison of key differences between European and American waterfalls:

In a European waterfall, preferred return is often used at the investment level, meaning each investment must meet the preferred return threshold before any carried interest is distributed to the general partner. This is in contrast to the American waterfall, where preferred return is applied at the overall fund level.

Calculating returns is a crucial step in the private equity distribution process. A preferred return, typically 8%, is ensured to limited partners before further profits are distributed.

A preferred return is a predetermined percentage that guarantees a specific rate of return on investment for limited partners. This ensures they receive a fair share of the profits.

The waterfall distribution calculation engine provides transparency in the distribution of profits to investors. LPs can see how profits are being allocated and have a better understanding of their potential returns.

A waterfall calculation engine uses sophisticated algorithms to calculate the distribution of profits accurately. This ensures that investors receive their fair share of the profits based on the fund's performance.

Here are the key benefits of using a waterfall calculation engine for scenario modeling:

Private placement offerings are a key part of the PE distribution waterfall example. They allow private equity firms to raise capital from a limited number of high-net-worth investors.

These investors typically receive a higher return on investment than public market investors. Private placement offerings can be used to raise funds for a specific investment or to replenish the private equity firm's capital.

The private equity firm typically offers a higher return on investment to attract these high-net-worth investors. This higher return is often achieved through a higher dividend yield or a preferred return.

Private placement offerings are often used by private equity firms to raise funds for a specific investment. The investment may be a new company or an existing portfolio company.

The private equity firm will typically negotiate the terms of the private placement offering with the high-net-worth investor. The terms may include the dividend yield, preferred return, and repayment terms.

A distribution waterfall is a crucial concept in private equity and hedge fund investments. It determines how gains from a pooled investment are allocated between investors in the pool.

There are generally four tiers in a distribution waterfall schedule: return of capital, preferred return, the catch-up tranche, and carried interest. These tiers are designed to ensure that investors receive their fair share of profits.

The Carlyle Group's private equity fund, Carlyle Partners V, is a great example of a distribution waterfall in action. The fund's structure prioritized returning limited partners' (LPs) initial investments before the general partner (the Carlyle Group) could participate in profits.

The preferred return in Carlyle Partners V was typically 8-10% per annum, which is a common range for this tier. This means that LPs received a fixed percentage of the fund's profits before the general partner could take a share.

Carried interest, on the other hand, is the share of profits that the general partner receives once the preferred return is met. In Carlyle Partners V, the Carlyle Group was entitled to 20% carried interest.

Here's a breakdown of the typical distribution waterfall structure: