Private Equity 20 Lectures (6) How are the GP and LP of a private equity fund divided?

Performance fee is actually the GP's share, we can call it performance fee, or in fact, in layman's terms, we most often hear another term for it is carried interest, or sometimes directly abbreviated as carry, this word we have certainly heard.

I. Performance fee (Performance Fee) ratio calculation

So since it is a performance fee, the premise is that the fund makes money, to earn more out of the part to calculate. The calculation of this share, the simplest way to understand, is two or eight open, GP take two, LP take eight.

Of course this is a very simplified two-step model, in fact there are also three-step and four-step these models, of which the most common or four-step. Let's look at the specific calculation of the most common four-step model.

1. Return of principal to Limited Partners. 2.

2. Plus an 8% cummulative return on principal to Limited Partners.

3. Then a 20% full catch for GP equivalent to 20% of all distributions in steps 2 and 3. 4.

4. Finally, an 80 / 20 split between GP / LP.

For your understanding, let's assume a project where the LP invests $10 million, and after 5 years of development, the project company is acquired by a large company and sells a total of $30 million at the time of exit:

The first step is well understood, in fact, it is the LP's 10million principal first to pay back.

The second step is to give the LP 8%, then we take a look at this table how not 8%? $10,000,000 if you add 8% is $10,800,000, here how how is 14,693,281, so much more, in fact, should be 8% annualized, that is, 1.08 five times, that is, the first step of the repayment and the second step of 8% annualized calculation is 10,000,000 * (1 + 8%)^5, so the first step and the second step down a total of So the total amount to be paid back to LP is 14,693,281 before the GP's turn.

The third step is also called catch-up, from this literal meaning can also be seen, the purpose of this step is because the previous LP has been divided into two steps, before the final two or eight open, first to allow the GP to catch up to 20% of the previous allocation, and then do the final allocation. So in fact, this step can be understood by a simple equation, we set the amount allocated to the GP in the third step as x, to count 20% of the sum of the second and third step allocation, then it is [(14,693,281-10,000,000)+x]*20% = x

This gives x as 1173322

But if we switch to the original formula:

[10,000,000*(1.08^5-1)+x]*20%=x

x=10000000*(1.08^5-1)*25%=1173320.192

After the first three steps, the remaining money is 14,133,399, then this part is divided directly into 20% and 80% on it.

After such a series of complex calculations, GP got 4 million LP got 26million, we will find that, in fact, in addition to LP's capital 10 million, GP and LP each earned 4 million and 16 million, then originally it was 28%. So in fact, the four steps are calculated and directly calculate the results of the two eight open no difference. Then we make so much trouble why? The reason is that it is very likely that these four steps will not be complete, that is to say, the first step may pay back the LP's principal and then there is no money, or the second step to pay back the 8% annual yield and then there is no money. Therefore, the four steps are divided into four steps to ensure a priority order.

Second, the allocation time of Performance Fee (Performance Fee)

Unlike hedge funds that give GP a regular share every once in a while, private equity funds are only divided when the portfolio project is exited. (of course, there is the fixed management fee we talked about in the last issue), and only after the second half of the project company exits can we start to share the money.

Usually, there are two types of performance fee distribution schedules:

1. Deal-by-Deal, I call this " a single settlement ". That is, for example, the total amount of AUM (asset under management) of this fund is 3 billlion, that is, 3 billion, used to invest in 30 projects, each project invested in 100 million, that is, 100 million, then in the middle and later stages of the fund, the projects are exited one after another, each time in 100 million As a unit, look at the 100 million inside how much was earned and how much was lost, without caring about the other 29 projects. This model is more common in the United States.

2. All-Capital First, I call this "capital first". Or the example just now, 30 projects is not 100 million for each project separately, but to LP investment to the entire fund of all the principal 30 billions all refunded, the GP can start to share the money, which means that perhaps the first 10 projects are exited, the GP has not got a penny, all to the LP to pay back the principal. This model is more common in European and Asian funds.

Then we will find that the first Deal-by-Deal (a single settlement) situation, it is likely that the initial share more, such as the first 10 projects are developing very well to the GP share a lot of money, the next 20 projects all lost, so in this case the extra money to the GP how to do? This involves the private equity fund back to the system (clawback), the details will not explain, we just remember that it is to balance the beginning of the extra money to the GP can be.

Third, the performance fee (Performance Fee) settlement method

In fact, it is very simple, there are two kinds: 1:

1. Distribution in Cash

2. Distribution in Kind

Then we think, must be more want cash, right? However, in a few cases, the LP would prefer kind, that is, stock, that is, in the case of portfollio project company listed in the legal documents as marketable securities ("marketable" securities), but as you can imagine, this line of circumstances Very few. A fund invests in 30 projects, almost 20 of them fail, and most of the remaining 10 end up in acquisitions, and it is good to have one listed, and most of the time there is not even one listed project in 30 projects. So in fact, most of the performance fee sharing is distribution in cash rather than distribution in kind.

After reading these, you should have a more in-depth understanding of how the GP and LP of private equity funds are divided, and the private equity fund share is no longer so mysterious.