In finance, a cash flow waterfall refers to the distribution of cash flows from an investment or project among various parties, such as investors, sponsors, and lenders. The internal rate of return (IRR) cash flow waterfall is a specific type of cash flow distribution that allocates cash flows based on the IRR achieved by each party.
The number of hurdles in an IRR cash flow waterfall can impact the distribution of cash flows among the parties involved. Hurdles are specific IRR thresholds that must be met before the cash flows are allocated to the next party in the waterfall.
Here are some benefits of having more or fewer hurdles in an IRR cash flow waterfall:
More hurdles:
- More hurdles can provide greater protection to senior investors, as they will receive their cash flows before more junior investors or sponsors.
- More hurdles can also incentivize sponsors to perform better, as they will only receive their cash flows if certain IRR thresholds are met.
Fewer hurdles:
- Fewer hurdles can simplify the cash flow distribution process, making it easier for investors and sponsors to understand and manage.
- Fewer hurdles can also reduce the risk of delays in the distribution of cash flows, as there are fewer IRR thresholds that must be met before cash flows are distributed.
Ultimately, the number of hurdles in an IRR cash flow waterfall should be determined based on the specific investment or project and the preferences of the parties involved. It is important to consider the potential benefits and drawbacks of having more or fewer hurdles in order to design an IRR cash flow waterfall that is fair and effective for all parties involved.
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