PE Fund Accounting Treatment - Fund Income Distribution

Published on 2021-02-03

The profit distribution model of private equity funds (PE funds) involves the interests of managers and fund investors and is one of the most important concerns of all parties in the process of concluding fund contracts.

Distribution Waterfall, the profit distribution order of PE funds, which represents the sequence of flow of fund profits.
In this issue, we will explain to you how to calculate the income distribution of PE funds, taking a limited partnership PE fund as an example.
Common Models of Fund Income Distribution 
The Deal-by-Deal distribution model is more favorable to the fund managers than the other one. Because the GP will receive the Carried Interest earlier. For the investor, the limited partners will recover their investment at a slower pace under the Deal-by-Deal model, and a "Claw Back" may be implemented in the event of a loss in a subsequent investment.
Compared with the Deal-by-Deal model, the All Capital First model provides stronger protection for the LPs' interests, and the possibility of implementing the " Claw Back" is greatly reduced, which is why it has become the commonly adopted fund income distribution model.
Illustraton: Fund Income Distribution
A LP type A single GP PE fund A raises RMB 2 billion, and the agreement stipulates that 20% of the carried interest is distributed to the GP (fund manager) as performance-based compensation, and the remaining 80% is distributed to the LP, with a threshold rate of 8%/year, calculated on a simple interest basis. The GP participates in the fund distribution using a 100% catch-up model. The fund is withdrawn after 5 years of operation, during which time no distribution is made, and the final distributable balance is RMB 4 billion.

The first round of distribution: the return of investment principal of RMB 2 billion
The second round of distribution: the return of threshold return: (4-2) *8% *5=0.8 (billion); remaining distributable return: 4-2-0.8=1.2 (billion)
The third round of distribution: the catch-up - catch-up amount = 0.8 * 20% / 80% = 0.2 (billion); remaining distributable return: 1.2 – 0.2 = 1 (billion)
The fourth round of distribution: the carried interest distribution - GP distributable return: 1.0*20%=0.2 (billion); LP distributable return: 1.0*80%=0.8 (billion)

Final LP return: threshold return + carried interest =0.8+0.8=1.6 (billion)
Final GP return: catch-up amount + carried interest = 0.4 (billion)

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Terms Related to Income Distribution
  • Preferred Return, Hurdle Return
  • Internal Rate of Return
  • Benchmark Yield
  • Carried Interest
  • Catch-up