Five Myths about Carry Calculations and its Finesse

By Istvan Lajtai, Head Advisory & Implementation, qashqade AG

This article is directed towards questioning and eliminating 5 common myths that we at qashqade feel are most common to waterfall and carry calculations and which we have encountered over the last years. At the same time, we are providing you with an insight why they are not reality and how to solve them

Digitalization in private capital markets unfolds at an unprecedented speed, and we at qashqade provide solutions and advisory to fund managers, investors, fund administrators and other service providers in the industry. Technology, digitalization, software solutions, automation (and similar terms) are meant to empower stakeholders to make fast-paced robust business and investment portfolio decisions. GPs and LPs both increasingly look for a tool that can 1) deliver rock-solid quantitative analysis throughout the lifecycle of their funds, 2) cover within one tool their carry and fee calculations and allocation, and 3) cater to portfolio and scenario analyses – all part of the qashqade solution

In the current technical paper, we divert from the conventional approach of a single-topic deep-dive, and for a reason: we would like to illustrate how GPs and LPs face similar challenges in private capital markets, and how these challenges can be addressed with a single integrative approach. We present five samples from industry professionals and participants which well fit the double purpose of this paper

1. destroying myths about what cannot be digitalized, and

2. showing how much more valueadding it can be to focus on ‘increasing the total amount instead of cutting off a piece from the cake’ keep only one secret to ourselves: whether we heard these

Myth #1: My waterfall is too complex to fit in a single quantitative mode

However complex LPA waterfall distribution terms are, they can all be broken down into three distinct pieces of logic: funding (Financing), paydown (Payout), and allocation.

Financing: How much money must be returned in each waterfall step? Is that amount conditioned on a metric or capped at a certain value? Sounds easy but the devil is always in the details. For example, if a fund has multiple tiers of cumulative IRR-based hurdle intersected by LP/GP-shared catch-up steps, fulfilling the net IRR target of individual investors becomes a real challenge for every person who should figure that out, despite the help of the computer program or the spreadsheets.

Payout: What types of distributions and realizations pay down select waterfall steps? Are the accrued amounts paid down right away, or are they held-back and released only upon meeting certain criteria for example claw back provisions? Or do they even stay in that step or are they getting diverted to another step, deal, or investor based on specific LP provisions? For example, the catch-up step of each and every deal within the fund might only be paid down by dividend distributions1 (and not by incremental NAV changes) and be held-back until all deals return capital and pay preferred return (“the release trigger event”).

Allocation: In what proportion do the LPs split the paid amounts among themselves and with the GP? Is there an allocation schedule? For example, the GP is entitled to 15% of the gains if the fund multiple is below 1.5x, but it is 20% if the multiple soars above 1.5x.

The challenge is that you have to find a way to capture the flexibility of a spreadsheet with the transparency and user-friendliness of a digital tool

At qashqade we have developed the Step Logic Creator to do exactly this. The Step Logic Creator allows you to create each step you need in your waterfall completely customized and with its own logic (see Exhibit 1).

Once the individual terms/steps (e.g., capital return, hurdle, catch-up, carry split)

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