�Waterfall Workshop

03/25/2025

Agenda

Second Presentation Recap

• Define your core strategy (e.g., Growth Equity, Value-Add), and why it aligns with current market opportunities.
• Capital Deployment Plan: Investment criteria, valuation metrics, and approach to capital allocation.
• Capital Returns: Present expected IRR/MOIC.

Industry Returns

• Despite 2024 being a challenging year for fundraising with a decline compared to 2023, total capital raised in the private markets still exceeded 1 trillion.
• Given this substantial deployment of capital, what return expectations are being set across the industry?

2024 Global Private Market Fundraising

Sources: Reuters, Mckinsey, Pitchbook

Industry Returns (cont.)

• Each industry and investment strategy has a target IRR that typically reflects its level of risk — the higher the target IRR, the higher the associated risk.
• This is important because it directly influences the return structure of the investment.

Waterfall Structure

Management Fee

• Fixed annual fee paid by LPs to the GP for managing the PE fund
• Creates stable income for the GP, even if investments underperform
• Covers operational costs (salaries, due diligence, admin, etc.)
• Typically 1.5% - 2% per year of committed capital or invested capital
• Common Fee Structures
• Standard Model (No Repayment)
• Fee Offset Against Carried Interest
• Step-Down Model

Hurdle Rate

• Minimum rate of return required by an investor
• LPs receive this return BEFORE the PE firm can take its carried interest
• Industry standard is typically 8% per year
• Ex. PE firm raises $100M
• After 5 years, the investment grows to $180M
• If the hurdle rate is 8% per year, LPs need at least:
• $100M × (1.08⁵) = $146M before the PE firm earns carried interest

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Manager Catch-Up

• Phase in the waterfall model where the GP “catches up” on profits
• LPs First → Receive their initial capital + hurdle rate
• Catch-Up Phase → GP receives 100% of profits until it has reached the agreed upon 20% carry
• Standard Split → Once the GP is caught up, remaining profits are split 80% LPs / 20% GP
• Ex. PE firm raises $100M Total Fund Profit = $50M
• Fund Profit After Hurdle Rate = $50M - $46M = $4M
• GP needs ???, but does not receive their full carried interest

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Carried Interest

• The share of the profits from an investment fund paid to the manager
• GPs receive this AFTER LP’s have received their preferred returns
• Industry standard is 20% of total profit
• Incentivizes PE firms to generate strong returns
• Ex. After giving LPs $146M, the remaining $34M profit is split:
• 80% to LPs (27.2M)
• 20% to the PE firm ($6.8M carried interest)

Cash-on-Cash v MOIC

• Cash-on-Cash / Multiple on Invested Capital
• Often used interchangeably (Cash-on-Cash more often in Real Estate)
• MOIC calculates return on DOLLARS
• Target return
• Investors typically target a minimum of 2.0x (varies per asset class)
• Total Proceeds
• Total value = Sum of all cash inflows (i.e. profits, distributions, and proceeds from sale of the investment)
• Invested Capital
• Total Invested Capital + Fees (Total cash outflows)

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IRR – Internal Rate of Return

• Internal Rate of Return
• Accounts for both the TIMING and MAGNITUDE of future cash flows.
• Ex: If MOIC = 2.0x
• IRR (6 Months) = 300% IRR
• IRR (1Y) = 100%
• IRR (4Y) = 32%
• Levered v Unlevered
• Unlevered IRR: Returns from operations, no debt involved.
• Levered IRR: Includes impact of debt; higher but riskier.

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Waterfall Structure

You raised and invested $100,000 5 years ago as a GP. You just sold your investment for $250,000.

Assumptions: 8% Preferred Return, 10% Initial Management Fee, 80/20 Split

Questions?

Template

Open up the excel file shared on Slack

Thank you