The catch-up rate decides how fast the manager reaches its carry share above the hurdle, not how much carry it earns when the fund does well.
Nothing, once the catch-up completes; the difference lives only in a narrow band of outcomes. With 100 of capital, 30 of accrued preferred return and 20 per cent carry, a full catch-up completes at 137.5 of distributions and an 80 per cent catch-up at 140.0. At 137.5 the GP has 7.50 under a full catch-up and 6.00 under an 80 per cent one, a gap of 1.50; from 140.0 upwards both pay exactly 20 per cent of profit. The catch-up tier is c × pref ÷ (k − c).
Worked in full in How to Read a Limited Partnership Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Term sheets present the catch-up rate as a split: 100 per cent to the general partner, or 80/20, or 50/50. It is read as a negotiation over how much carry the manager receives. It is not. The catch-up rate only controls how fast the manager reaches its full share once the hurdle is cleared. The amount of carry at any outcome above the band is fixed by the carry rate alone.
| Input | Value |
|---|---|
| Contributed capital, returned first | 100 |
| Preferred return accrued to the distribution date | 30 |
| Carried interest | 20% |
| Catch-up rates compared | 100%, 80%, 50% |
A preferred return of 30 corresponds, roughly, to 8 per cent compounding on capital held for three and a half years. A fund holding its capital for five years at 8 per cent would accrue 46.9, and every tier below scales with it.
The catch-up ends when the GP holds its carry share of all profit distributed so far. During the tier it receives a share k of every unit distributed. Call the size of the tier T:
k × T = c × (pref + T), so T = c × pref ÷ (k − c)
Full catch-up, k = 100%: T = 0.2 × 30 ÷ 0.8 = 7.50, all to the GP. Completes at 137.50, or 1.375x.
80% catch-up: T = 0.2 × 30 ÷ 0.6 = 10.00: 8.00 to the GP, 2.00 to the LPs. Completes at 140.00, or 1.400x.
50% catch-up: T = 0.2 × 30 ÷ 0.3 = 20.00: 10.00 each. Completes at 150.00, or 1.500x.
In Excel, with carry in B1, pref in B2 and the catch-up rate in B3: =B1*B2/(B3-B1).
Check each against the test that matters: at completion the GP must hold 20 per cent of profit. Full: 7.50 of 37.5. Eighty per cent: 8.00 of 40.0. Fifty per cent: 10.00 of 50.0. All exactly 20 per cent. A lower catch-up rate makes the tier longer, so the GP ends up with the same share, later.
| Distributions | Full | 80% | 50% | No catch-up | Full minus 80% |
|---|---|---|---|---|---|
| 130.0 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| 135.0 | 5.00 | 4.00 | 2.50 | 1.00 | 1.00 |
| 137.5 | 7.50 | 6.00 | 3.75 | 1.50 | 1.50 |
| 140.0 | 8.00 | 8.00 | 5.00 | 2.00 | 0.00 |
| 150.0 | 10.00 | 10.00 | 10.00 | 4.00 | 0.00 |
| 200.0 | 20.00 | 20.00 | 20.00 | 14.00 | 0.00 |
The largest gap between a full and an 80 per cent catch-up is 1.50, a fifth of the full carry, and it occurs at a single point: where the full catch-up completes. Between 130 and 140 the investors receive 2.00 under either structure; the full catch-up simply pays the GP first and the investors last. Under a 50 per cent catch-up the gap at 137.5 is 3.75 and the band runs to 150.
The real difference is with no catch-up at all. A hard hurdle pays 14.00 at 200, 14.0 per cent of profit, against 20.00 under any catch-up. That is a negotiation over the amount of carry. The catch-up rate is a negotiation over its timing near the hurdle.
The band scales with the preferred return. At a pref of 20 the tiers are 5.00, 6.67 and 13.33; at 30, 7.50, 10.00 and 20.00; at 46.9, five years at 8 per cent, 11.72, 15.63 and 31.27. A fund whose capital is held long accumulates a large pref, and with it a wide catch-up band. That is where a 50 per cent catch-up starts to matter: a band of 31.27 is almost a third of contributed capital, wide enough for a modest fund to finish inside it.
Where the band sits. The catch-up band sits just above the hurdle, between roughly 1.3x and 1.5x on these inputs. A partial catch-up is worth most to investors in a fund that just clears its hurdle, and nothing in a fund that does well.
The common modelling mistake is to change the catch-up rate in a waterfall but leave the tier sized for a full catch-up. Pay 80 per cent on a tier of 7.50 and the GP receives 6.00, then moves on to the 80/20 split. At 200 of distributions it holds 18.50, 18.5 per cent of profit, and it is 1.50 short at every outcome above the band. The model looks plausible and is wrong forever. Solve the tier from the formula, and test that the GP's share of profit is exactly the carry rate at a high outcome.
The catch-up rate changes who is paid first near the hurdle, not how much carry the manager earns when the fund does well. Size the tier as c × pref ÷ (k − c), check the 20 per cent test above the band, and spend negotiating effort on the hurdle and the carry rate instead. A blank fee and waterfall model for your own fund is in the free workbooks for this book. For the full catch-up solved on one distribution, see how the GP catch-up is actually solved, and for where carry first switches on, at what multiple carry switches on.
A catch-up tier in which the GP receives a share k below 100 per cent of distributions, the LPs the rest, until the GP holds its carry share of profit. With 30 of preferred return and 20 per cent carry, an 80 per cent catch-up runs for 10.00 of distributions: 8.00 to the GP and 2.00 to the LPs.
Solve k x T = c x (pref + T), which gives T = c x pref / (k - c). With a 20 per cent carry and 30 of pref, the tier is 7.50 for a full catch-up, 10.00 at 80 per cent and 20.00 at 50 per cent, completing at 137.5, 140.0 and 150.0 of distributions.
No. Once the tier completes, the GP holds exactly 20 per cent of profit, as under a full catch-up. The gap is widest at 137.5 of distributions, where the full catch-up completes: the GP holds 16.0 per cent of profit under the 80 per cent version against 20 per cent, and the gap closes by 140.0.
This article is one calculation from How to Read a Limited Partnership Agreement. 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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