Carried Interest with Catch-up Provision, version one. In this workout, we are going to calculate the total distribution to the limited partners and the general partners in a deal which has a carried interest provision and also a catch-up provision as well. And what the catch-up will do is it basically will work in tandem with the true preferred return that is being offered to the LP. So the LP is being offered a true preferred return where they will receive the hurdle rate on their investment before the GP sees any return of capital or profits. And then there will be a catch-up provision that will allow the GP to catch-up their returns to get back in line with the 20% split that is the parameter of the deal. So there's a 20% catch-up provision and a 20% carried interest. These two tend to be the same rates. And what they allow for is the overall split of the deal to be at 80, 20 by the time the waterfall is complete, and we will see that in action in this model. So the deal parameters are, it's 100 investment, 95% being provided by the LP, 5% by the GP, five year exit with equity proceeds of 212. The hurdle rate is 8%, which is being offered to the LPs alone. And the carried interest and catch-up are at 20%. So we'll start first with the investment, which will be the negative 100. And then the asset pays no distributions in years one through four. And then year five, it returns 212 of equity value to the investors. So the preferred returns will be the first waterfall. And again, this is a true preferred, so this is money. These are returns that have been promised to the LPs, to them alone to entice them to come into the deal. They will receive the first 8% of return on the deal, and this is an annualized 8%. So the way we're gonna calculate this is we're going to do the initial investment growing at 8% over five years. I want this to show as negative because I'm doing a distribution waterfall, which will hopefully get to zero at the end. And then I also need to put an a min formula because that distribution can never be greater than the proceeds for the deal. In this case, the 212 will more than cover that, but in case it doesn't, we need to put in a min formula to handle that. So it's going to be minus min.

And the first argument will be the calculation of the hurdle, which is going to be the negative 100 times 95% times one plus the hurdle rate of 8% raised to the fifth year. And my years are numbers, they're just coded so that they show up with text in front. And in case I don't achieve that amount I never want to achieve or I never want to pay more to my LPs than the deal actually achieves. So I will set that against the value in H16. And that returns 139.6. But if the deal were to fall below that 8% hurdle, let's say it's at 125, it would only pay the 125.

So again, this is more of a European style waterfall where we're basically paying the return, the hurdle return and the capital back to the LP before the GP sees anything, and that's obviously much more advantageous to the LP and not so to the GP that has to wait longer for their capital to be returned. But we're showing the European style here just 'cause it's much cleaner from a teaching perspective. So the remaining profits in this deal are going to be the net of those two amounts, and that's the 72.4. Now it's at this point that the catch-up provision kicks in. And the catch-up provision, it does more than simply say that the GP takes 20% of the profits that are remaining because that would actually be replicating what the carried interest does. What the catch-up provision does is it actually goes back to the first waterfall and it says, well if this 139.6 is in fact what we paid to the LPs, let's assume that that payment represents 80% of what was paid out, not 100%. So we're going to take the opposite of the 139.6.

We will divide it by one minus the 20% of the catch-up provision. And again, what this is doing is it's taking the 139.6 and it's grossing it up to be 80% of what would have been paid out if the GP were in fact in the first waterfall. And then we're going to, in order to calculate what the GP share of this is, we'll just back out what we paid to the LPs, which is the 139.6. So I'll simply go ahead and add H17 to that because it's a negative in the waterfall. And what that leaves is 34.9. So let me put my formulas out here to the right so we have them and we'll just take a look at that one more time. It's essentially, again, the preferred return of 139.6 divided by one minus the catch-up of 20%.

That's effectively grossing this number up by 80%, assuming that it is 80% of the first waterfall payout, not 100% which in fact it was, but 80%. And then we're backing out what was paid to the LP in that hypothetical first waterfall and coming to the amount that the GP is calling its catch-up provision. So what that does is now kind of tilts the scale back to the GPs and it puts them kind of back in that 80, 20, in that 80, 20 split. So now in terms of the actual amount that the GP can can count on as profits at this point, it's going to be the opposite of the min of that catch-up calculation and whatever is available. And I'm basically showing this intermediary step so that we can just make sure we understand that catch-up calculation. If for example, the deal had not done well then what we have is a situation where there's only 10.4 of remaining profits, and even though the catch-up provision calls for 34.9 in payments to the GP, we would only see a payment to the GP of 10.4. And that's what that minimum formula does for us. So I will undo that and we can continue on with the waterfall. The remaining profits is simply the net of the remaining profit after the first waterfall and the catch-up. Now for the remaining profits, we're going to calculate according to the carried interest provision which is going to be a 80, 20 split. So for the LP, their remaining interest is going to be the 37.5 times one minus the carried interest.

And we need to make sure that we make that a negative.

And for the GP it'll be the 37.5 times the 20%.

And again make that negative and we will get to profits of zero.

And we'll do the return calculations here. The LP's investment is simply the 100, anchor the row times the pro rata distribution of 95%.

We'll go here and anchor my pro rata amount so that I can copy this through year four. And now in terms of the ultimate payouts, total payouts to the LP and GP, I need the sum of the payouts along the way. So it's going to be the sum of these negative amounts which I'll then flip to a positive at the end. So the 139.6 and the 30 are the two payouts to the LP.

As far as the GP goes, they're going to get the 34.9 and the 7.5.

And if we add these up, we should get the overall terms of the deal, which are 100 going in, 212 going out. So my IRRs I can calculate very easily now just using the cash flows from above. Now let's take a look at the multiple of money which is going to be the total payout over the opposite of the total investment.

Put the formulas out here and we'll check the math by looking at the splits. In a carried interest calculation with a catch-up provision, if the catch-up provision and the carried interest are the same, which they typically are, we should see a split that is reflected exactly that reflects exactly those numbers, 20% to the GP, 80% to the LP. So what we'll do is we'll take the LP total return over the total return and there's the 80. And now we'll take the GP total return over the total deal return and there's the 20. So we see that the catch-up provision allows the returns to align perfectly with the carried interest provision and the profit splits of the 20% to the GP, 80% to the LP.