{"id":22060,"date":"2020-03-04T00:02:57","date_gmt":"2020-03-04T05:02:57","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=22060"},"modified":"2024-10-18T18:58:13","modified_gmt":"2024-10-18T23:58:13","slug":"waterfall-distribution-lbo-model","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/waterfall-distribution-lbo-model\/","title":{"rendered":"Waterfall Returns Distribution in an LBO Model (19:18)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Waterfall Returns Distribution in an LBO Model<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/waterfall-distribution-lbo-model\/#What_is_a_%E2%80%9CWaterfall_Returns%E2%80%9D_Schedule\" >What is a &#8220;Waterfall Returns&#8221; Schedule?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/waterfall-distribution-lbo-model\/#How_Do_You_Model_This_Scenario\" >How Do You Model This Scenario?<\/a><\/li><\/ul><\/nav><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"What_is_a_%E2%80%9CWaterfall_Returns%E2%80%9D_Schedule\"><\/span>What is a &#8220;Waterfall Returns&#8221; Schedule?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>CONCEPT:<\/strong> In a leveraged buyout or any deal where an investment firm acquires another company, they&#8217;ll often own close to 100% of it&#8230;<\/p>\n<p>But sometimes management will retain a small portion, or another investor group might retain a certain portion.<\/p>\n<p>Sometimes it ends there &#8211; but sometimes, that smaller group gets ADDITIONAL ownership and a higher stake upon exit if the investment performs well.<\/p>\n<p>This is called a &#8220;management promote&#8221; (if it&#8217;s the management team that receives this as an incentive).<\/p>\n<p><strong>EXAMPLE:<\/strong><\/p>\n<p>A new leveraged buyout takes place, and the PE firm structures the deal to heavily incentivize the management team:<\/p>\n<p>For an IRR up to 10%, PE firm gets 95% and management team gets 5% of the proceeds.<\/p>\n<p>Then, for the portion of the IRR between 10% and 15%, the PE firm gets 90% and the management team gets 10%.<\/p>\n<p>For the portion of IRR between 15% and 20%, the PE firm gets 85% and the management team gets 15%.<\/p>\n<p>Then for the IRR above 20%, the PE firm gets 80% and the management team gets 20%.<\/p>\n<p>A PE firm might do this to create a &#8220;win win&#8221; scenario &#8211; yes, it loses some of its IRR by giving up a % to the management team&#8230; but if all goes well, the team should outperform and help the PE firm achieve a higher overall IRR.<\/p>\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<h2><span class=\"ez-toc-section\" id=\"How_Do_You_Model_This_Scenario\"><\/span>How Do You Model This Scenario?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>1) Make assumptions for the initial investment and proceeds upon exit, plus the ownership percentages.<\/p>\n<p>2) Make assumptions for how the proceeds split changes at different IRR levels.<\/p>\n<p>3) For each &#8220;tier&#8221; of IRR, take the initial investment and calculate the amount of net proceeds upon exit that would correspond to that IRR.<\/p>\n<p>Example: $1,000 initial investment, and 10% IRR tier &#8211; multiply by (1 + 10%), then multiply that number by (1 + 10%), and so on until the exit year.<\/p>\n<p>4) Determine the split of proceeds within that tier.<\/p>\n<p>If the actual proceeds are $1,500, for example, and $1,611 would correspond to a 10% IRR, you&#8217;re done &#8211; just split the $1,500 between the PE firm and management team in a 95% \/ 5% split.<\/p>\n<p>But if it goes beyond that $1,611, you just split up the $1,611 according to those numbers and then save the rest for the next tier.<\/p>\n<p>5) Determine the proceeds to distribute in the next tiers.<\/p>\n<p>For $3,000, for example, you&#8217;d distribute $1,611 and save ($3,000 &#8211; $1,611) for the next tiers.<\/p>\n<p>If you&#8217;re at the 10% level and you get something below $1,611, you&#8217;d set the &#8220;proceeds for the next tiers&#8221; number to $0 (use a MAX function for this).<\/p>\n<p>6) Keep doing this for each tier of IRRs until the end.<\/p>\n<p>The formulas get trickier as you move up because you need to use MIN and MAX to ensure that you don&#8217;t get negative or nonsensical values.<\/p>\n<p>In Level 2, for example, the &#8220;Amount to Distribute and Split&#8221; is:<\/p>\n<p>=MIN(Net Proceeds That Correspond to 15% IRR in Year 5 minus Net Proceeds That Correspond to 10% IRR in Year 5, MAX(Total Net Proceeds minus Net Proceeds That Correspond to 10% IRR in Year 5, 0))<\/p>\n<p>So you&#8217;re taking the lesser of the proceeds between 10% and 15% IRRs, or the total remaining amount that can be distributed AFTER the Level 1 distributions.<\/p>\n<p>And that same type of logic continues as you move down, until the last tier.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>What is a &#8220;Waterfall Returns&#8221; Schedule? CONCEPT: In a leveraged buyout or any deal where an investment firm acquires another company, they&#8217;ll often own close to 100% of it&#8230;<\/p>\n","protected":false},"featured_media":22070,"template":"","class_list":["post-22060","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-leveraged-buyouts-and-lbo-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/22060","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/22070"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=22060"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}