Can someone explain waterfalls and carried interest testing to me like I’m a 5 year old?

likefunny
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Don’t go chasing waterfalls

likefunny

This is what I’m here for

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They are both ways that investment managers get paid.

The terms of those calculations vary from one investment to the next. You have to read the partnership agreements and the private placement memorandum to know the specifics for each partnership.

The term pro rata wouldn't be used with a 5 year old but I assume you can understand it.

Carried interest: The people managing the investments get some extra money (compared to their initial investment) just for the work of finding & managing the investment. So say the GP pays $1 and limited partners pay $99. The investment returns $100, the first $20 might go to the GP and the $80 might get split pro rata to all the investors based on the money they put in. That $20 for the GP will be set aside until everybody gets back the total they put in (or the investment paid them back 100% and then gave them some agreed upon additional amount, the hurdle rate), and then it is actually the GP's money.

Waterfall: the people managing the investments get extra money when investments do well. So same as above: GP put in $1 and LPs paid $99. The investment has already returned $100 total to the original investors pro rata and now it returns $100 more. Of the second $100 the GP might get $5 and then the $95 is split pro rata to everybody. This can be on an individual investment level or for an entire fund.

I think.

likehelpful

Well said!!!

Money goes to a first then to b if any remains. Lather rinse repeat

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Thank you so much senior accountant 1!

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Lol someone explained it to me as a fountain metaphor and I was worse than when I started 🤣

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