In a programme of JV deals the promote can be earned deal by deal or on the pool. The difference is largest exactly when one deal fails.
In a programmatic JV a deal-by-deal promote pays the sponsor on every deal that clears its hurdle, whatever the others do, while a pooled or cross-collateralised promote pays only on profit left after the whole programme has returned capital and the preferred return. The difference is largest when one deal fails. On three fictional deals that earn 8.19 per cent together, deal-by-deal pays 6.24 of promote and leaves the investor 6.97 per cent; pooled pays 0.23 and leaves it 8.15 per cent.
Worked in full in Real Estate Joint Ventures by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A programmatic JV, an investor and a sponsor agreeing to do a series of deals on common terms, has to decide where the promote is measured. Measured per deal, the sponsor keeps the upside of its winners and the investor alone absorbs its losers, which gives the sponsor something like a portfolio of call options. Measured on the pool, winners and losers net off first. Term sheets argue hard about the hurdle and the promote percentage; the basis can matter more than either, and it is often settled in a line.
| Input | Value |
|---|---|
| Equity a deal: investor / sponsor | 36.0 / 4.0 |
| Preferred return, compounding annually | 8% |
| Above the hurdle: promote / pro rata | 20% / 80% |
| Deal A: proceeds in year 3 | 76.0 (1.90x) |
| Deal B: proceeds in year 4 | 60.0 (1.50x) |
| Deal C: proceeds in year 5 | 24.0 (0.60x) |
| Programme: 120.0 in, 160.0 back | 1.33x, 8.19% IRR |
For clarity the promote has no catch-up, so it is 20 per cent of whatever exceeds the hurdle account.
Each deal's 40.0 compounds at 8 per cent to its own exit; anything above that is split, 20 per cent to the sponsor first.
Deal A: hurdle 40.0 × 1.083 = 50.39; promote = 20% × (76.0 − 50.39) = 5.12
Deal B: hurdle 40.0 × 1.084 = 54.42; promote = 20% × (60.0 − 54.42) = 1.12
Deal C: hurdle 58.77; proceeds 24.0; promote 0.00
Total promote 6.24. Investor IRR 6.97%, below its own 8% hurdle; sponsor IRR 18.26%
One hurdle account holds the 120.0 of programme equity and compounds at 8 per cent; every distribution pays it down before any promote is due.
| Event | To the hurdle account | Account after | Excess | Promote |
|---|---|---|---|---|
| Year 3: account grown to 151.17, deal A pays 76.0 | 76.00 | 75.17 | 0.00 | 0.00 |
| Year 4: deal B pays 60.0 | 60.00 | 21.18 | 0.00 | 0.00 |
| Year 5: deal C pays 24.0 | 22.87 | 0.00 | 1.13 | 0.23 |
Total promote 0.23. The investor receives 143.80 instead of 138.39 and earns 8.15 per cent; the sponsor earns 8.53 per cent, close to the programme's 8.19. That is the point of pooling: the sponsor is paid for the programme the investor actually received.
| Deal C multiple | Programme IRR | Promote, deal by deal | Promote, pooled | Investor IRR, deal by deal | Investor IRR, pooled |
|---|---|---|---|---|---|
| 0.6x | 8.19% | 6.24 | 0.23 | 6.97% | 8.15% |
| 0.9x | 10.11% | 6.24 | 2.63 | 8.96% | 9.70% |
| 1.2x | 11.87% | 6.24 | 5.03 | 10.78% | 11.15% |
| 1.5x | 13.50% | 6.48 | 7.43 | 12.43% | 12.50% |
The deal-by-deal promote barely moves: 6.24 whether deal C returns 0.6 or 1.2 times. The pooled promote tracks the programme. And at 1.50x the order reverses: pooled pays 7.43 against 6.48. When every deal clears, pooling can favour the sponsor, because deal A's early profit retires pool capital in year 3 and stops the preferred return accruing on it, whereas deal by deal each 40.0 compounds to its own exit. The investor's IRR is still marginally higher under pooling, because that promote is paid in year 5 rather than mostly in year 3. Pooling is a risk-sharing device, not simply a discount on the promote.
The common mistake is to compare the two bases on a base case where every deal works. There the difference is small, or even in the sponsor's favour under pooling, and the investor concedes deal by deal for a lower headline rate. The cost appears only when deals diverge, which in a programme of any size is the normal case. Run the comparison with one deal at a loss before agreeing the basis.
The usual middle ground is deal-by-deal payment with a programme-level lookback. Here the sponsor would receive 6.24 as the deals exit, and a lookback restoring the investor to 8 per cent on the programme would claw back 5.45 in year 5, leaving 0.79. The total is close to pooling, but the investor now holds a receivable from the sponsor rather than cash, so the lookback is only as good as its escrow or guarantee. The mechanics are worked in how a promote lookback works in a JV; the fund-level version of the same trade-off is in European versus American waterfalls.
Real Estate Joint Ventures covers interim promote, the clawback and the lookback, and its waterfall workbook ends with a sheet for a deal of your own; it is among the free workbooks for the book, and a blank version sits in the JV waterfall and promote template.
It means the promote is tested on the combined cash flows of all deals in the programme rather than on each deal alone, so a loss on one deal must be made up from the profits of others before the sponsor earns promote. On the fictional three-deal programme that cuts the promote from 6.24 to 0.23, because a 0.60x deal absorbs almost all the profit of the other two.
No. It pays less when deals diverge and one loses money, but when every deal clears its hurdle a pooled structure can pay more, because early profits retire pool capital and stop the preferred return accruing on it. In the fictional programme, with the third deal at 1.50x the pooled promote is 7.43 against 6.48 deal by deal.
A lookback lets the sponsor take promote deal by deal and then returns enough at the end to restore the investor's hurdle on the whole programme. On the fictional deals the sponsor earns 6.24, and an 8 per cent lookback claws back 5.45, leaving 0.79. The investor is protected only if the sponsor can still pay at the end, which is why lookbacks come with escrows or guarantees.
This article is one calculation from Real Estate Joint Ventures. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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