Private equity preferred return (hurdle rate) net, question, company, return

d2rockstar

Given PE company X

at time 0, X = 100
at time 3 (exit), X = 135 (net of fees)

preferred return is 10%. Carry is 20%. How much does the GP make?

The IRR is 10.52%, above the hurdle, so there is some amount of carry.

Here is my question.

Is the carry the full 20% of the profit, or is it that portion above a 10% Net IRR?

Stated differently, is it:

A:

.2 * 35 = 7 (this is how Schweser solved it)

or, B:

35 - [profits required to ensure LPs have 10% IRR, or about 33.1] = 1.9 (what I expected)

or, is it only 20% of the amount above the preferred return, .2 * 1.9? (what I saw on random website X)

I could swear that the most common terms you find in PPMs are in the form of B, but I'm not sure what CFA expects. Maybe I should read the books :s ----thanks



Edited 1 time(s). Last edit at Wednesday, May 26, 2010 at 11:52PM by hawgdriver.

llxx

There is such a thing as a soft hurdle (A) and a hard hurdle (B).

I think CFAI will take the simple general approach unless stated as a hard hurdle. If the GP can meet the set hurdle rate, s/he is entitled to 20% of the profits 135-100=35x.20= 7M. You are just using the set hurdle rate to test if they get carried interest or not, if they do, they get their %, if not, they get nothing..it all goes to the LP investors.

Be careful that if the GP also contributed money, they get 80% of the profits as part LP plus 20% carried interest as GP.

-Interpretation compliments of CAIA Program.