Okay, I think we should get started.

Welcome everybody. Thanks for joining this webinar.

My name is Alistair Matchett.

I started out in banking at JP Morgan doing um, m and a advisory work in the oil and gas and financial institution sectors.

Then I went into private equity for our fund in the UK called three I or Investors in Industry and then went into the education business.

So we've got about an hour together and what I want to try and do in that hour is cover the modeling and complexities around carried interest.

And I'm gonna cover the carried interest, which is applicable to the general partners, but also understand how the limited partners return interacts with that as well. So we'll cover limited partners and general partners. When I say general partners, what that means is, is that the private equity executives, limited partners are the institutions investing in the fund.

So a private equity firm will raise a fund and its executives will be the general partners who run the fund and the investments and the limited partners will be the institutional investors.

We're also gonna cover, promote modeling and promote modeling's. Very, very similar to carried interest, except it's specifically for the, um, real estate sector as opposed to general corporate.

So we're gonna cover both and we're gonna do quite, quite a bit of, um, Excel examples of this because it's the easiest way to explain some of the complexities, particularly, um, some of the items.

So what I'm gonna do now is share my screen.

If you are, if you want to ask questions, really please feel free to do that.

I'm really, really happy for you to ask questions as we go.

What I'm also going to do is you'll have a, um, chat window and a question and answer window.

What I'm going to do immediately is I'm going to put the, um, files I'm going to cover in the question and um, I'm sorry in the chat window.

So I'm gonna put the files I'm gonna cover in the chat window.

So let me just do that now.

So I'm just going to do that now.

So let me go to the workout files and in the webinar chat window on a second, lemme just make sure it's sent to everyone.

I'm gonna put the Excel files. It's gonna be a zip folder.

Now some of you may not have access to that depending whether um, your firm has shut down the, um, chat window and zoom.

Some firms do. So I'm really sorry if that's not there.

We will email you the files, um, ahead of time.

So you should get, there's a zip file in the webinar chat window, but please put your questions in the question and answer window.

I know that's a bit confusing, but that's of, um, the zoom setup for you.

Okay, let's get started.

So you should be able to see my screen, which has got some PowerPoint slides on.

And as I said, we're gonna have cover both carried interest and promote modeling.

So we're gonna go through management fees, then the carried interest and this kind of waterfall mechanism that you need to understand in order to be able to model it.

And that water will waterfall consists of returning of the initial capital that's been invested.

Then something called a preferred return.

And this is typically where usually just the institutional holders but not always get the first dibs up to a certain percentage, usually around 8%.

And then there may or may not be a catch up provision.

And then there's the classic carried interest and the carried interest is this kind of unequal, um, distribution of the returns between the institutional investors and the general partners.

And then we'll cover the promote modeling, which is more focused around real estate.

So one of the, that's not related to the carried interest that the general partners get is the management fees and the management fee is based on the funds raised.

And that's usually, well historically that's been 2% because the terminology rather like hedge funds as well was a two and 20 model.

So you've got a 2% management fee and then you've got 20% carried interest.

However, that's changed a bit.

Some of the public funds have got so big that actually a 2% fee is really, really, um, huge amounts of money and investors have kind of pushed back on that particularly because some of the really big PE funds, you could argue that almost morphing into asset managers rather than classic PE funds because some of them, and I won't mention any names, the one, there's one very, very, very large fund where they do a lot of deals which have really come very low risk and it's almost like a kind of leveraged asset management plan.

So the management fee have been pushed down to about 1%.

Some of the smaller funds, which kind of niche, um, because you it, it probably takes the same amount of manpower or a person power to run a smaller deal as it does a bigger deal.

They may push it up to two to 3%, but you'd get expect corresponding higher returns for that.

Now there is some um, kind of idea, well the idea behind the management fees is that they're there to cover the operational costs of running the funds.

So front costs, partner salaries, um, the building, the office building, they operate in it, et cetera.

Um, however, the management fees accrue whether or not the fund is successful.

So you can have bad fund but they'll still pick up the management fees.

Now you do see a leverage effect in the fund is that as the fund gets bigger, you generally don't need a correspondingly larger set of employees to run the fund, particularly if you're doing larger transactions.

So there is a little bit of kind of, um, competitive advantage to larger funds. Certainly profitability advantage to the larger funds because they will get a correspondingly much greater management fee for managing a larger money when you don't necessarily need a lot more people.

So there's kind of operational leverage within that.

Now I'm gonna say much more about the management fees other than say that some of the funds are more like asset managers and that's why the management fee has been pushed downwards.

What we are interested in today is carried interest and there's a little bit of history behind carried interest. Carried Interest is an old term, it came about in the 16th, 16th century where captains of ships in Europe would go to a supplier of produce and say, okay, I can export this to you either to the Americas or to Asia, but in order to take the risk of the crossing I, I'm not gonna charge you a flat fee.

I actually want a kind of profit share.

So I will take a 20% fee or charge for transporting your product and selling it at the other end.

So we'll kind of give you 80% and we'll take 20% and known as the carriage interest, hence term carry.

So that's the history of it.

Now how does this actually work in practice? Well the first thing that happens of course is investors put money into the deal and that money will come from debt holders and we're really kind of ignoring the debt holders until we get to the real estate analysis.

But you'll have the limited partners or LPs and the GPS limited partners are the institutional investors and the GPS are the PE execs, okay? And the um, returns when you exit the deal.

And usually in the classic private equity deal there won't be um, distributions in between.

Um, the entry and exit but in a classic deal will just be at exit.

You'll get the original capital returned.

Okay, that's your base.

But then what will happen is you'll have a hurdle or a preferred return.

And what that means is that the limited partners can get a base return out of the investment and that typically is usually an 8% return.

So what their limited partners are trying to do is lock in an 8% return, then above that level, the surplus above the preferred return is split usually on an 80 20 roll.

So the general partners will get 20% of everything else and the limited partners will get 80% of everything else.

Now bear in mind that the private equity executives won't put in very much money at all. Literally, you know, between one and 5% of the original investment, but they're potentially getting up to 20% of the uplift.

So the internal rate of return for the general partners is usually way in excess of the kind of industry standard of 20%.

And we'll go through the modeling of that.

So limited partners get a return of their hurdle rate plus part of the surplus.

The general partners will get a management fee and that is baked into their returns. When they're looking at returns, they'll incorporate management fee and the carried interest and ideally they'll get their money back as well.

Now the modeling becomes complex.

It starts easy and gets complex.

So the first thing it happens in the waterfall is waterfall. You return the original capital.

Okay, that's pretty straightforward.

The next thing that happens in the waterfall is you get a preferred retort return.

Okay? So, and that's always to the limited partners, sometimes to the general partners as well.

And we'll model both situations and that's usually 8% per AUMs. What that means is you are giving the institutional investors a base IR of 8%.

Now if the cashiers in excess of that preferred return, they're distributed 20% to general partners and then 80% to the limited partners.

And that's irrespective of what the general partner's putting with the deal. But the, what the general partners printed the deal will be really pretty small, maybe like 1% or 5%.

So they will get a really great bump, have their returns magnified.

But private equity executives are pretty smart cookies.

And what you also see in some structures are catchups.

So if you think about it, you are as a limited partner, you're getting your capital returned and you're locking in this 8% preferred return and then you're sharing the benefits above that in an 80 20 split.

Well if you've got a general partner who is very well experienced and got a really good track record, they often can negotiate really hard.

And one of the things that they may negotiate is saying, look, what this means is that the overall split because of this preferred return is not 80 20.

It's something like maybe 73%, 27%.

So actually what we'd prefer to do is we are okay with you getting everything up until you hit your 8% threshold.

But then what we want to do is a pendulum to flip.

So after that 8% has been reached, everything comes to us until we are equal in the 80 20 split.

And at that point it then reverts to 20% to me, 20% to general partners, 80% to limited partners.

So this is like a catch up and the way you kind of kind of think about this is that if you think about the general partners return while you've got that 8% preferred return, it's completely fat flat, okay? There's no return to them at all.

Then they have the catch up period.

Sorry, lemme make that a little bit smaller.

Oh come on, lemme see if I can get my eraser.

There we go. Just take that out. Brilliant.

Um, they get this kind of catch up and there they're getting all the money.

I mean you can almost represent that as a kind of direct, in fact, let me, well no 'cause that's, that's, yeah.

And then what happens Then they revert to the 2080 split.

So the catch up, what it does, it kind of corrects for the fact that if it's a good return that 8% preferred return gets kind of extinguished by the catch up and you revert to all the excess being split to 20 80%.

Now you're probably asking, well under what circumstances do people get these catch catchups and when do you get them when you don't get them? It really depends on the track record of the general partners.

The more successful general partners as in life will be able to get negotiate harder terms with the investors, the less successful or newer general partners will have to have more um, less beneficial terms.

And that's kind of what drives these structures. These things are negotiated.

Now we do have some slides on the real estate promote modeling, but I'm gonna come back to those 'cause I now want to jump to Excel and go through some modeling with you.

Okay, so I'm going to open up the first Excel file and it's got a will a little suffix ahead of it.

And that is called current interest true Preferred.

And we're starting with this 'cause it's kind of nice and basic.

So I'm gonna go to the tab um, worksheet and we've got a little example here.

Let me just zoom out a little bit so I can see a little bit better.

And in this case we've got in investment in the deal of a hundred million, the limited partners, which are the institutions opening in 95% and they're general partners which are the PE executives.

Okay, we're gonna exit in year five with about 212 million, which is the money multiple around two times, which seems pretty reasonable.

And we've got this hurdle rate.

So this is the preferred return to the limited partners, okay? And then the carried interest is the 20%.

So let's just have a look slowly what this kind of looks like.

So they're investing a hundred million and we'll just do it on the basis of cash flows, the whole deal, they're getting nothing for four years.

And then in year five what they're getting is 212 million when they sell the business.

Now the first thing to do here is to say okay, we need to calculate what the limited partners need out of the deal to get an 8% threshold.

So the first thing I'm going to do is I'm gonna calculate how much they put in.

So it's a hundred million but it's 95% of that a hundred million times one plus the 8% threshold IRR to the power of five years.

So they need to get at least 139.6 million out of the transaction to be able to get a return of 8%.

Now that's great because in this case they get 212 million and that's way more than 139.

But there could be situations where the exit in the deal is less than 139.

So they would just get everything then.

So what we should do to make the modeling a little bit more complex or not complex or accurate, is just to edit this.

And I'm gonna put in the front of this a min function.

So this is going to be the minimum of that calculation that I have just done, but I've gotta make it a positive number and the exit proceeds.

So here I zoom out just a tiny little bit. There we go.

Um, you can see that if for example the exit was 125 million so loath on that threshold they'd just get 125 million.

So I can now calculate what the remaining profits are and the remaining profits is just a two 12 minus that threshold return, preferred return.

And that in this simple example is gonna be split 80%, 20%.

Okay, so here I'm gonna take the um, 72.4 times the carried interest percent percent and I should make that negative.

And then the limited partners are gonna get everything else just the surplus or 80% of that surplus. There we go. And so the remaining profits should be zero.

Now what this means is that if you look at the total proceeds and if you just take a look at the limited partner return, they put in the 95% of the capital, the general partners put in a tiny 5% and it can be even less than that. Sometimes it can be almost nothing. It's kind of shocking.

No one gets anything in the intervening years.

But at exit limited partners are gonna get their preferred return and they're gonna get their remaining interest and the general partners are gonna pick up their carried interest here.

Now if I just sum this up, you'll see that these percentages, so the limited partners are getting Didn't mean to do that.

Sorry, there we go.

The limited partners are getting about 93% and the general partners are getting six point or about 7%.

Now remember when I said to you is that 'cause of that preferred return that reduces return that the PE executives get? So it's not a true 20%, 80% split and that's where that catch up mechanism comes in where if the deal is successful, they kind of get everything until they get back to that 20 80% split.

But we're just staying simple initially before we do the catch up mechanism.

And I want to do the internal rate of return.

So if I just do the overall deals IRR first, so the total deal gets our IRR of 16.2%, not great, but the limited partners get a slightly less than that but the general partners get a significantly more than that.

So the carried interest kind of skews the returns in favor of the general partners now.

So that's our true preferred return.

And what that means is, is that the private equity executives are getting a return after a preferred chunk to the limited partners.

Now what what I'm going to do is I'm going to do a slightly different version that will favor the private equity executives.

And so if they're a little bit more experienced and they can negotiate this with their investors, we're gonna show you how we can improve the private equity executives lot in the general partners.

So let's do the cash flows just as normal, I'm using the same deal 'cause it's kind of easy for you then to compare the analysis between all of them.

And then the exit is 212 million at the end of year five.

Now in this case this is known as a persu preferred structure and what that means persu, it's the same as term loans in leveraged buyouts where you are on the kind of same level but you get a prorata share.

So what this means in this example is that instead of just limited partners having that threshold return of 8%, you get the threshold return of the 8% to both the limited partners and the general partners.

So here what we're going to do is what we did before is we'll take the investment times how much they invested times one plus the hurdle rate power of five years and then I'm gonna do the same for the general partners but they're obviously gonna put 5% in and then they get their hurdle rate.

So this is on a persu basis to power of five.

But what I should also do is I should just wrap this with a min function because if they don't make 212 million, if they make less than these two amounts, then we will need to pro ratter it down.

So I'll do that just with a min function again.

So I'm doing minus the minimum here of minus that because I need to flip the sign and then what I'm going to do is compare it to the um, amount of money left second, okay? Um, the amount of money left but multiplied by their stakes. So for the limited partners, that's C seven and there we go.

And then do the same for the general partners.

I'm making things minus because it's an extraction and then in this case it's gonna be the proceeds times that ownership stake.

So what you can see here is that currently we have surplus over and above that um, preferred return.

But if the deal doesn't work and let's say we get 145 million, you can see here they are ratcheted downwards.

So they will just have a split of the proceeds according to their ownership stake.

Okay? So that's just how that works.

Now the carried interest works in the same way that we just did previously.

So the general partners carried interest is gonna be the 20% of the surplus proceeds after both the um, preferred return for both the limited and general partners is taken out.

And then the limited partners just get the surplus which is 52 million and then there shouldn't be any remaining profits just to check.

No there's not. And now let's do the internal rate of return.

So the deal IRR will be exactly the same as before, okay, 16.2% no change there.

The limited partners they're putting in the a hundred million times their percentage ship, 95%, the general partners are putting in the a hundred million times their 5% and as I said, that can be really low.

They're not getting anything in between.

And then the exit, the limited partners are getting their preferred return for their capital and surplus and then the general partners are getting their preferred returns 'cause it's period passio preferred and they're getting their period interest as well.

Now here into this case, if we look at the internal rate of return and I copied it up twice here, now you can see the, if I go back to the prior deal then the prior deal limited partners had 15.8 and the general partners had 23.7.

But this per passio structure where the general partners get their get their preferred return as well, they've boosted their returns to 32%.

So again, this is gonna be negotiated and depending on whether they've got much influence or track record, they can kind of slot these things in.

So that's the second structure.

Now, structure number three, what we're going to do here is we're gonna take a look at a catch up provision.

And this is where it gets a little bit more complicated because in the catchup provision what we have, I'll just open it up again.

Um, oh I've filled this out earlier so me just completely clear this out. There we go. So the catch up provision here, we've got a standard deal. So let me just put in the standard deal terms.

So they're investing a hundred million in, they're getting no proceeds for four years and then in year five they get the X in amount in the deal.

Now in this situation we're using a true preferred return for the limited partners.

So this is where we say okay, we'll take their investment a hundred million times the ownership stake.

So this is what we've done before times one plus the preferred return for the power of five.

And then I'll just do a quick min function around that to be complete because I want to make sure that they don't, you can't pay them money that you don't have and they will just get the whole proceeds in this case 'cause there's only one preferred return and I should make that negative.

Let me just change that to make sure it's negative.

There we go. Brilliant. So that's standard.

This is a true preferred return only the institutional investors get the true return, not the general partners.

So the remaining profits, we've got a nice surplus there of $72 million.

Now this is where it gets a bit complicated.

What we're saying here is that because the institutional investors have got this preferred return, it means as you saw in our prior example that if I come down to my, or might go to my prior example, where did I put this? It was in the other one. Lemme just go back to the other one. Did I close that? I hope not.

Or maybe, uh, number one, do you remember I calculated this split over the returns and actually the limited partners got 93% and the general partners got 6.8%.

Now if I go to the second one and do that same calculation, you can see that the limited partners get 90%.

So it's a bit better but it's still not that 80 20% at all.

So what this catch up provision is trying to do is say okay, you can get your preferred return, no problem.

But if the deal is successful, we are gonna kind of unwind that preferred return as we make more and more money to correct this split.

So we get an 80 20 split overall between the general partners and the limited partners.

So let me just take you through this.

So the catch up calculation, what we're gonna do is we're gonna say okay, how much do we need to catch up to make the general partners good effectively? Well if I take the um, the proceeds, the preferred returns for the private equity investors or the the sorry, the limited partners, I'm gonna gross sell up because that represents 80% of the value.

And if I gross that up by one minus the catch up.

Now the catch up actually really is it's should be the carried interest amount of 20%.

So just imagine those are two assumptions are the same.

Okay? So that means that's how much they need.

Um, that's the includes the original capital, that's a hundred percent.

But what I want to do is I want to take out what has already been given to the limited partners and that means I will just get what is due to the general partners.

So what this means is to get back to an 80 20 split, we now need to give the general partners the next 34.9 million and that will mean that the general partners and limited partners are now equal, not equal but on a 20 80% rule.

So you can only pay that though if you have the money.

So the next thing to do is to check that you indeed have enough money to pay the catch up.

If not, you'll just get all the proceeds and they do have enough money and then there's the remaining profits, which is just everything after that 34.9 million.

Then what we do is we just do our standard split of the remaining profits.

So the GP remaining interest is just the carried interest percentage, 20% times the 37.5 times minus one and then the limited partners will just get everything else, okay? Now what this means is that the remaining profits should be zero, but we can do a little check when we're doing the internal rate of returns here.

So if I look at the cash flows, the standard cash flows for the whole deal, I do the deal IRA is gonna be the same as before. So there's no difference at all.

16.2 if you do the limited partners they put into the transaction the 95% of the initial investment and the general partners put in this tiny little 5% of the general partners.

So I'll multiply that, there we go.

And then they're gonna assume they get nothing in the intervening four years and that was silly to do.

So I've got this some new shortcuts which I'm kind of learning in this little add in. Let me just un hide. There we go.

Um, so I'm gonna get, make sure this is zero.

Now at exit the limited partners are going to get their preferred returns and any surplus returns, the general partners are gonna get their catch up and then their carried interest.

Now what we should see here, if I do these percentages or let me just put my formulas and I'll put the percentages next to them, if I do the percentages, you can see here what this is doing, it's correcting this catch-up is making sure that overall of course assuming the deal goes well overall, even though there's a preferred return, if the deal is successful, the catch up calculation correct the distribution.

So it's 80% limited partners, 20% to general partners.

So that's what the catch up does is it kind of levels of playing well, not levels of playing field, but it kind of gets everyone back to an 80 20% split assuming the deal is successful if the deal is not successful.

So let's assume the deal, let's go down um, and make it make sure there's not enough catch up.

So let's say I make it one 90, um, no they still can do the catch up.

So let me make it one 70. Yep.

So you can, you see here, they really need to have a catch up of 34.9 but they can't get it because there's not enough money in the pot.

So in that case can you see it's not an 80 20 split because the deal isn't successful enough.

So they only get that 80 20 split if the deal is successful.

So lemme just put it back two 12.

Now of course this means on an IRR basis limited partners get shaved a bit and the general partners of course 53%.

Isn't that just amazing? That is amazing.

So this, this works really, really well.

If you have a situation where the deal goes well, now let's just redo this because it's quite an important feature of this type of modeling.

But we're gonna do a situation where there's not enough money to sort it out. So I'm just gonna do it again because it's quite useful just to redo this.

But I'm gonna do a situation where there is not enough money there.

So in this case I'll just quickly do the exit proceeds, nothing for year four, but in this example, oh gosh, there's just 145 million left.

So the, the guaranteed or preferred returns will take their investment of 95% of that and then we will compound it by five years, 139.

So there is some remaining profits here, but they're pretty small.

I'm not gonna do the min function just to save a little bit of time. They're pretty small so the catch up calculation will be as normal.

So I'm gonna take that amount divided by one minus the 20% less what we have already given to the limited partners.

And then you can see in this case the catchup distribution.

Actually there's not enough money in the pot.

So what do we do? Well unfortunately in this case the remaining profits are zero because the catch up has taken everything but the catch up won't be good enough because the LP Will take the hundred 39 and the general partners will take in this case just 5.4 and let's compare that to what they put in.

So if I take the 95% and then I'll take the 5%, there we go.

And then they've got no interim cash flows and then we will do the internal rate of return.

So you can see here, and this is actually quite instructive because these structures, they look fantastic, but actually if the deal goes wrong, the general partners will get screwed.

So here the limited partners have got that preferred return of 8%, but the general partners that IRR has collapsed to 1.8%.

And if you take it on the basis of the whole structure, you can see that the limited partners are going to get the lion's share of the proceeds.

So these, these structures look fantastic and actually they are fantastic but they are only fantastic if the deal goes well.

If the deal goes badly, it's not such a great situation.

Okay, I've done the classic carried interest modeling.

Now what I want to do is I want to flip to a real estate structure.

Now in real estate we don't typically call it carried interest, we call it a promote.

It's similar, very similar to carried interest, it's the same kind of concept but in real estate, I don't know why, I guess it's just convention, they call it promotes.

So it's another way of giving the general partners a boost.

So in commercial real estate, the general partners that's actually in a private equity deal, they'll find the transaction.

So a good network's important, they'll negotiate, they need to be able to negotiate well, they'll kick the tires and make sure the business or property in this case is um, a good investment.

Then they will raise debt financing and they'll manage the transaction, manage the asset over time.

And critically, and this is really important skill for um, general partners, is that they will prepare the asset for sale, whether it's company or property and they'll find a buyer.

And you know, one of the other things about the network, the network will be good for finding companies to buy but they'll have network will also be for for finding buyers of companies in their portfolio.

And those are kind of important skills.

In fact, my neighbor is a private equity executive and he said to me, um, we did an analysis over 30 years of 30 years of all our portfolio companies and we tried to distill down the thing that really um, was a key criteria in deciding whether the transaction was successful or not.

And I was thinking, I'd kinda think what was it in the management team or was it the EBITDA improvement? And interestingly, and actually on reflection it makes total sense.

He said no, it's just the price paid.

Like if you pay a good price, if you buy assets cheaply, you are much, much more likely to get a decent return.

So one of the really big risks in private equity transactions is overpaying.

'cause if you overpay you're much less likely to get good return.

And instinctively that actually totally makes sense, right? Because if you buy cheaply, even if it's a pretty horrible asset, you should be able to sell for a reasonable price.

But if you buy something too expensively, it doesn't matter if it's a good quality asset, you may not be able to sell it.

Well now in real estate, good little example here.

So we're buying a building for about a million dollars and we're gonna fund it with some leverage, some debt financing, 60% and then the rest are by equity.

But that equity is paid for unequally by the GP and LPs.

So the general partner's putting in 10% and the limited limited partner's putting in 90%.

So this is what the kind of sources of fund looks like.

And we've got the huddle rate return again of 8%, but we've got this promote share of 30%.

Let's take a look at how this works.

So they're putting in different components, general partners putting in 10% limited partners, putting spending 90%.

What do the general partners get out? Well they get their 10% of the value out because that's, remember they own 10% so they get that out.

However, what they'll also do is they're kind of dip into the limited partners pie and say oh actually we want 30% of that.

So they'll get 30% of the limited partners, part 30% in this case of 90%.

And then the limited partners will just get 70% of their 90%.

So this is known as a promote and it's used typically in real estate.

So let's have a go at building a model of this just to see how this works.

So I'm just gonna go to my next um, file and we're gonna do a um, pretty basic one promoted interest.

So this is a real estate deal so let me just narrow this down a bit and I will send you all the answers to these files.

So we've got a price of a building of a million dollars, 6% debt funding and they're this split of 10% and 90%.

So the debt funding is just going to be 60% of the million.

And Nick equity invested is just going to be the remaining amount, the 400 million and that is gonna be split by a 10% contribution of the general partners only to the equity, not the debt.

And then the limited partners are gonna put in everything else.

So that's our kind of structure here.

Now what we're going to do is we're going to model out as we have done before, a preferred hurdle and in this case we're gonna do a preferred hurdle for both the general partners and the limited partners.

And I think that's probably more common in real estate in any case.

So what I'm going to do is I'm gonna go and calculate their investment.

So there uh, we're doing the limited partners. So they'll take their investment times one plus the hurdle rate IRR and that's an IRR, the hurdle rate.

So the power of five years, um, times minus one.

And then we're gonna do the same thing for the general partners will take their investment in this case the 40,000 times one plus the hurdle rate return the IRR of 8% to the power of five years times minus one.

But again, what I should do to be good is I should wrap that with a min function.

So let me edit this and I'm just gonna put um, minus min here one second.

Let me just minus the minimum and I'm gonna compare that to their share of the exit proceeds.

Okay? So I'm gonna take that times in this case for the limited partners that 90% and then I need to make that negative.

So let me just see what I've done. Yeah, I need to put a second.

I've taken, lemme just see that, make that negative.

There we go. Yeah, I didn't actually need to make that negative. There we go. Or that, let me just take that out and we'll take that out. There we go. Perfect. And we'll do the same thing for this.

So I'm gonna do minus the minimum of that calculation Or their share and their share is gonna be the proceeds times the 10%.

Okay? Then I'm gonna sum up the remaining profit there and we get 1 62 and that can be distributed.

Now this is a preferred return for both parties here and we've got the promoted interest.

So the promoted interest, the general partners gets their share.

So they will take the 162,000 and multiply it by their ownership stake, which is 10% and I should make that negative just so everything distribution is negative.

And then for the their promoted interest, they are gonna take the remaining amount times their promoted interest.

So they are stealing, well that's a bit pejorative of that word, um, but they're taking 30% of the limited partner share and then limited partner literally gets everything that's left.

Okay? So they will get everything that's left and the remaining profit in this case should be zero, okay? Which it is. So let's take a look at the overall returns here.

So the LPs are investing 360,000.

The general partners are investing the 40,000 and then there's no interim cash flows.

And then in year five the limited partners are getting their preferred return and their capital back and the share of the S return.

But the general partners are making out like bandits because they're getting a preferred return, they're getting their interest, equity interest and they're getting their promote, which kind of make things unequal.

And if I just sum it up, that gives the total proceeds. And let's just take a look at the kind of ownership stake or the exit stake.

So the Limited partners are getting about 84% and the general partners are getting about 15%. So it's not quite the same as the correction that I did earlier, but the internal rate of returns can be really significantly different. So the deal IRR, I'll just put zeros here.

So the deal IRR, if we look at the whole transaction is gonna be about 13.4%. And remember this is a real estate deal, so that's pretty, pretty good.

IR but the limited partners IRR is gonna be slightly less 'cause it's a zero sum game.

If you are giving more to the general partners, limited partners will reduce really kind of zero sum general partners though they're getting 24%. So they're getting double more than double the return of the limited partners with this promote mechanism.

So promotes are used in real estate, the carried interest and the catch up provisions are used in general corporate transactions, but both transactions may have a preferred return of this 8% threshold.

The reason why any of these clauses may or may not be in the structure is all about the power of the general or power and reputation of the general partners. The more successful they've been and the more track record they have, the more likely they're going to swing the pendulum in their favor.

And the less track record they have, the less likely that will be.

But that's most of what I wanted to cover today is go through those mechanisms of showing you preferred return and then the carried interest and the a true preferred return, a per passio, um, preferred return, a general carried interest or a carried interest with a catch up. Those are all things that you will see documented in private equity transactions.

And then the promote mechanism that we use in real estate.

What I'm gonna do is I'm going to put my answers into the webinar chat window.

So if you can put the answers in the webinar chat window, oh sorry.

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