A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

INDUSTRY OVERVIEW

• Catch-up and carry/return to LPs Once the LPs receive their capital contributions and the preferred return, the next distri- butions made by the private equity fund are typically allocated between the GP and the LPs. The catch-up provision allows the GP, once the preferred return is reached, to receive all distributions until profits are split according a defined percentage (generally 80/20) between the LPs and the GP. This amount distributed to the GP is referred to as the carry . This performance fee mechanism aims at creating real economic incentive for fund managers to achieve significant capital gains. The European waterfall is to be distinguished from the US waterfall business model: > With a European waterfall, the LP receives all its capital and its preferred return before the GP receives carry. This is already largely in place with European GPs and signifi- cantly reduces the LP’s risk. > With a US waterfall, the GP’s carry is calculated and paid out on a deal by deal basis as each transaction is realised, with the performance of all prior realised and written-off deals included in each successive calculation of carry. • Claw back As the manager’s share of gains may be paid out during the life of the fund, investors are generally granted a claw back provision, which ensures that any excess distributions representing more than the specified percentage of the cumulative profits is returned back to the LPs by the GP. The typical fee structure at partnership level usually reads 2-20-8, meaning 2% manage- ment fee, 20% carry and 8% catch-up with claw back, but many other creative variations are possible. Another concept that has emerged to deal with the issue of credit risk on excess distribu- tions is the mechanism of escrow account , which foresees that as long as LPs have part of their committed capital at risk, the GP agrees to pay part or all of the carry distributions into an escrow account to guarantee the repayment of potential excess distributions. F und structures : direct funds versus fund of funds The investment fund structure is typically determined by the nature of investments and their means of ownership, as well as tax considerations. Fiscal aspects are detailed further in chapter 3.1. Direct funds must be distinguished from fund of funds: • Direct funds In this case, investments are: > Either directly held by the fund. For example, as illustrated in figure 5, a private equity real estate fund can purchase various buildings and directly hold them in its portfolio.

1.1

A thorough understanding of PE | page 17