3 Tiered Preferred Equity Template - Simple

This is a 'soft' preferred equity waterfall for any kind of joint venture (real estate or otherwise). That means the user has the option to share cash between the limited partner (investor) and general partner (owner/operator) while the LP has their equity paid back. There are 3 tiers and in each tier the cash is split differently.


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LP = Limited Partner (investor)
GP = Owner / Operator

The reason this logic is nice is in how simple the hurdles work. It allows a new startup or joint venture to be able to structure their deals in a more sophisticated way that may be more in line with the risk that the LP is willing to take on the endeavor. This template will allow the user to input the equity contributed by the LP and the annual available cash flow. From those inputs, all logic flows.

Here is how each tier / hurdle works within this cash distribution waterfall structure.

  1. Tier 1 splits cash at a defined % until the LP has been returned all their equity. This would typically be something like 70/30 or 80/20 in favor of the LP. If you want to make it a 'hard' preferred equity deal, then you can enter 100/0 until all the equity is paid back to the LP that was put in.
  2. Tier 2 splits cash at a newly defined % until the LP has received a defined equity multiple. i.e. if you put this input at 1.75 it means cash is split at the defined rate of this tier until the LP has been returned their entire equity + achieved an ROI of 75%
  3. Tier 3 splits cash at a final defined % based on any cash remaining after making it through the first two hurdles. This would typically be flipped for the LP and GP so that the LP would have less and the GP has more. Normally, by year 10 an exit or terminal value would be entered.
I included a 'summary' tab with a DCF (discounted cash flow) analysis for the LP and GP as well as the final IRR and equity multiple after considering the result of all cash flows. There is also a visual to show the cash flow splits per year over 10 years.

The assumptions for the %'s and equity multiple for each hurdle can be adjusted as needed by the user. Everything is fully dynamic and the logic is able to do partial cash return as the hurdles are met and the cash changes distribution %'s.

The easiest way to explain how the cash flows are flowing is that the LP gets the majority share of profits until they have been fully paid back. Then, the LP gets a more even share until a certain profit target is hit (as defined by the equity multiple), and then beyond that the LP gets a lesser share. 

The reason why LP's are willing to give up future potential profit is in return for more security in the near term as they would be getting their initial money back more quickly. The GP likes this because they get to play the long game and hold more security over future potential profits that may happen.

The percentages can be structured in any way that the user would like to have done and it will vary deal by deal depending on what kind of risk and potential profit may exist in the joint venture.

In order to make this fully dynamic, it actually took a great deal of clever formulas and helper rows. It is harder than you may think to do, but now that it is done, I think this is a great option for deals to be structured around.

Template goes for up to 10 years on an annual basis. It is not too complex to adjust for additional years if needed.

You will notice there is no preferred return included in this like the previous preferred equity template I put together. There are a million different ways to structure these deals, it just depends on what each party can agree on.