A shotgun notice names a value for the building; the price of each interest comes out of the waterfall, and the promote makes it convex.
A buy-sell notice names a gross value for the property, not a price for anyone's interest. Each partner's price is what the joint venture agreement's waterfall would pay it if the asset were sold at that value, net of the loan and deemed sale costs. On an illustrative 90/10 venture named at 140 against a 60 loan, the sponsor's 10 per cent interest is priced at 9.57 and the investor's at 68.33, not the 7.79 and 70.11 a pro rata split of the 77.90 net equity suggests, because the promote moves with the stated value.
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 buy-sell, or shotgun, lets either partner serve a notice stating a value for the whole asset. The other partner then chooses: sell its interest at the price that value implies, or buy the notifying partner's interest at the same implied price. Because the recipient chooses the side, the notifying partner is pushed to name a fair number. That is the theory. The arithmetic between the stated value and the cheque is where the clause is actually decided.
Most joint venture agreements convert the stated value through a deemed liquidation: the asset is treated as sold at the stated value, the hypothetical sale costs and the debt are paid off, and the net is run through the distribution waterfall as if it were cash. Each partner's price is its share of that hypothetical distribution.
| Input | Value |
|---|---|
| Investor equity | 45 |
| Sponsor equity | 5 |
| Senior loan outstanding | 60 |
| Preferred return, compounding, pro rata | 8.0% |
| Tier two: 20% promote until the investor reaches | 12.0% IRR |
| Tier three: promote above that | 30% |
| Deemed sale costs, of gross value | 1.5% |
| Gross value named in the notice | 140 |
With a 20 per cent promote and the remaining 80 per cent shared 90/10, tier two pays the investor 72 per cent and the sponsor 28 per cent. Tier three pays 63 and 37.
Net equity: 140 − 1.5% × 140 − 60 = 140 − 2.10 − 60 = 77.90
Tier one, capital plus the 8.0% preferred return: 50 × 1.084 = 50 × 1.3605 = 68.02, of which the investor 61.22 and the sponsor 6.80
Tier two capacity: the investor needs 45 × 1.124 = 70.81 to reach 12.0 per cent, so 9.59 more. At 72 per cent of each unit, tier two holds 9.59 / 0.72 = 13.31
What is left after tier one: 77.90 − 68.02 = 9.88, all inside tier two: investor 7.11, sponsor 2.77
In Excel, tier two is =MIN(remaining, MAX(hurdle_balance-tier1_investor,0)/0.72), and tier three takes whatever remains.
| Step | Total | Investor | Sponsor |
|---|---|---|---|
| Tier one: capital and preferred return | 68.02 | 61.22 | 6.80 |
| Tier two: 72/28 | 9.88 | 7.11 | 2.77 |
| Tier three: 63/37 | 0.00 | 0.00 | 0.00 |
| Price of each interest | 77.90 | 68.33 | 9.57 |
The sponsor's 10 per cent of the equity is priced at 12.3 per cent of the net. The investor would pay 9.57 to take the sponsor out; the sponsor would pay 68.33 to take the investor out, and would also have to refinance or assume the 60 loan, which almost certainly carries a change of control clause. At this value the investor is earning 11.01 per cent a year and the sponsor 17.61 per cent.
| Stated value | Net equity | Investor price | Sponsor price | Sponsor share | Sponsor pro rata |
|---|---|---|---|---|---|
| 110 | 48.35 | 43.51 | 4.83 | 10.0% | 4.83 |
| 120 | 58.20 | 52.38 | 5.82 | 10.0% | 5.82 |
| 130 | 68.05 | 61.24 | 6.81 | 10.0% | 6.81 |
| 140 | 77.90 | 68.33 | 9.57 | 12.3% | 7.79 |
| 150 | 87.75 | 74.85 | 12.90 | 14.7% | 8.78 |
| 160 | 97.60 | 81.05 | 16.55 | 17.0% | 9.76 |
The promote first becomes payable at a stated value of 129.97: the value at which net equity just covers capital and the preferred return. Below it, the sponsor's interest moves 0.99 for every 10 of stated value. Between 130 and 140 it moves 2.76, and between 150 and 160 it moves 3.64. The sponsor's price is convex in the stated value; the investor's is concave.
That convexity is the strategic content of the clause. An investor that believes the asset is worth 140 can serve a notice at 130. If the sponsor sells, it receives 6.81 instead of 9.57 and gives up virtually all of its promote. If it buys, it must raise 61.24 for the investor's interest, about 9.0 times the value of its own position, plus a new loan for 60. A sponsor that cannot raise that money in the response period has no real choice, and the investor knows it.
A buy-sell price is a waterfall run at a hypothetical sale, so compute it with the same engine as the distribution model. Then do the two things the clause invites: find the stated value at which the promote switches on, and compute the cash each side would need to accept the other side of the offer. Both numbers belong in the term sheet discussion, not the dispute. The waterfall engine, with the buy-sell among the other chapters' arithmetic, is in the free workbook for this case, and the tiers are explained in what a 20 per cent promote actually pays. A blank version sits in the JV waterfall and promote model.
It treats the asset as sold at a stated value, pays hypothetical sale costs and the debt, and runs the net through the distribution waterfall to give each partner's price. In the illustrative case a stated value of 140 leaves 77.90 of net equity, of which 68.33 goes to the investor and 9.57 to the sponsor.
Because the promote is earned only above capital and the preferred return. In the illustrative case it switches on at 129.97. A notice at 130 prices the sponsor at 6.81 against 9.57 at 140, and buying instead would require 61.24 for the investor's interest plus refinancing a 60 loan.
Only if the agreement says so, which is why the clause must be read. Deducting 1.5 per cent at a stated value of 140 removes 2.10 and moves the investor's price from 69.84 to 68.33 and the sponsor's from 10.16 to 9.57.
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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