Everything You Need to Know About the General Partner Catch-up

For example, let’s say the LPs are offered a 7% preferred return and the profit split is 70% to the LPs and 30% to the GPs. At the conclusion of the partnership, 70% of the total project cash flow (ongoing cash flow and profits from sale) must have gone to the LPs and the remaining 30% must have gone to the GPs.

There are two main types of GP catch-ups. The most common is a GP catch-up at sale. The other, less common, is an ongoing GP catch-up.

The advantage of the ongoing GP catch-up is that the GPs can receive distributions immediately rather than waiting until sale.

Whichever GP catch-up you decide to pursue, make sure it is properly defined in your waterfall in the PPM.

To explain how each of these two GP catch-ups work, let’s use the following dataset as an example:

• Preferred Return to LPs: 7%
• Profit Split (LP/GP): 70/30
• LP Equity Investment: $1,000,000
• Year 1 to 5 Cash Flow

• Profit at Sale (After $1,000,000 in equity is returned): $1,500,000

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GP Catch-Up At Sale

For a GP catch-up at sale, the LPs receive their preferred return first. Then, the profits above the preferred return are split 70/30. At sale, after the LP equity is returned and before the profits are split 70/30, a catch-up distribution goes to the GP until they have received 30% of the cumulative cash flow up to this point.

Here is a breakdown to the ongoing distributions to LPs and GPs:

Based on the “Total” column, the LPs have received 93.08% of the profits and the GPs have received 6.92% of the profits. Therefore, the first portion of the $1,500,000 profit at sales goes to the GP until they have received 30% of the total profits.

Here is how you calculate that amount:

X equals $150,000.

After the $150,000 distribution, promote catch up the LP has received $423,500 and the GP has received $181,500, and the 70/30 split is achieved.

The remaining profits, $1,350,000, are split 70/30. This equates to $945,000 to the LP and $405,000 to the GP.

Here is the updated data table for cash flows to the LP and GP:

The total distribution is $1,955,000. $1,368,500, or 70%, went to the LP. $586,500, or 30%, went to the GP.

Ongoing GP Catch-Up

With an ongoing GP-catch up, the LPs still receive their preferred return first. However, before the remaining profits are split 70/30, the GP receives a promoted catch-up distribution. This distribution is equivalent to a 70/30 split.

Here is how that amount is calculated:

X equals 3.

Therefore, the GP receives a 3% return based on the total LP equity investment. Any unpaid GP catch-up is accrued and paid out when possible. Once both the LP and GP have been paid, the remaining profits are split 70/30.

Since our sample equity investment is $1,000,000, the LP receives $70,000 annually and the GP receives $30,000 annually.

Year 1 Cash Flow is $71,000, which means the LP receives $70,000, the GP receives $1,000, and $29,000 is owed to the GP.

Year 2 Cash Flow is $77,000, which means the LP receives $70,000, the GP receives $7,000, and an additional $23,000 is owed to the GP. Total amount owed to the GP is $52,000.

Year 3 Cash Flow is $84,000, which means the LP receives $70,000, the GP receives $14,000, and an additional $16,000 is owed to the GP. Total amount owed to the GP is $68,000.

Year 4 Cash Flow is $93,000, which means the LP receives $70,000, the GP receives $23,000, and an additional $7,000 is owed to the GP. Total amount owned to the GP is $75,000.

Year 5 Cash Flow is $130,000, which means the LP receives $70,000 and the GP receives $30,000. The remaining $30,000 also goes to the GP to pay down the accrued amount. Total amount owed to the GP is now $45,000.

At sale, after the LP equity is returned, the accrued amount owed to the GP, $45,000, is distributed. Then the remaining profit, $1,455,000, is split 70/30. The LP receives $1,018,500 and the GP receives $436,500.

Here is the data table for cash flow to LP and GP:

As you can see, the “Total” 5-year distributions to the LPs and the GPs are the same for each catch-up types. However, for the ongoing GP catch-up, the GPs receive more money sooner, which – in turn – means that the LPs receive money later. As a result, the LP internal rate of return (IRR) is lower with the GP catch-up.

Therefore, the GP catch-up at sale is more advantageous for the LPs and the ongoing GP catch-up is more advantageous for the GPs, even though both the LP and the GP receive the same total cash distributions in each scenario.