The hypothetical liquidation worked tier by tier, and why the accrual moves faster than NAV in the catch-up band.
Accrued carried interest is calculated by running the whole waterfall as if the fund sold everything at its quarter-end NAV: return of capital, the compounded preferred return, the catch-up, then the split. On a fund with $400m paid in, $150m distributed and a $420m NAV, that hypothetical liquidation gives $34.0m of accrued carry, and an NAV to the limited partners of $386.0m. The shortcut of 20 per cent of profit gives the same figure here, and the wrong one a quarter earlier.
Worked in full in The Private Equity Fund Controller Playbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The accrual is the largest judgemental-looking number on a fund's balance sheet that is in fact pure arithmetic. Once the NAV is set, there is one right answer, and it moves in a way that surprises people who think of carry as a flat fifth of the gain.
| Input | Value |
|---|---|
| Capital called at year 0 | 200.0 |
| Capital called at year 1 | 200.0 |
| Distribution at year 3 | 150.0 |
| NAV at quarter end, year 4 | 420.0 |
| Preferred return, compounding annually | 8% |
| Carried interest, full catch-up, whole-of-fund | 20% |
Roll every contribution forward at the preferred rate to the quarter-end date, and roll every distribution forward the same way. The difference is the capital plus preferred return the limited partners must still receive before the general partner gets anything.
200 × 1.084 + 200 × 1.083 − 150 × 1.081 = 362.04
In Excel, with amounts in B (contributions positive, distributions negative), dates in C and the quarter-end in F1:
=SUMPRODUCT(B2:B4*(1.08)^((F1-C2:C4)/365))
Of the limited partners' total entitlement, $400m is capital and the rest is preferred return: 150 + 362.04 − 400 = $112.04m. That figure drives the catch-up.
The NAV of $420.0m is treated as the final distribution. The first $362.04m clears the hurdle balance. The excess, $57.96m, goes to the catch-up until the general partner holds 20 per cent of all profit distributed so far.
Full catch-up C solves C ÷ (112.04 + C) = 0.20, so C = 0.20 × 112.04 ÷ 0.80 = 28.01
| Tier, hypothetical liquidation at NAV | Amount | To LPs | To GP |
|---|---|---|---|
| Hurdle balance (capital and preferred) | 362.04 | 362.04 | 0.00 |
| GP catch-up | 28.01 | 0.00 | 28.01 |
| Residual split, 80/20 | 29.95 | 23.96 | 5.99 |
| NAV | 420.0 | 386.0 | 34.0 |
Total profit on liquidation is 150 + 420 − 400 = $170.0m, and $34.0m is exactly 20.0 per cent of it. The test passes because the catch-up has cleared.
In a partnership the accrual is normally booked as a reallocation from the limited partners' capital accounts to the general partner's, not as an expense, so it changes who owns the NAV rather than its size. The investor statements show $386.0m, and that is the figure every LP's own TVPI should be built on.
A quarter earlier, at year 3.75, NAV was $370.0m. The hurdle balance then was $355.14m, so the excess was $14.86m, short of the $26.29m catch-up needed at that date. All of the excess was catch-up, and the accrual was $14.86m, 12.4 per cent of profit rather than 20.
Over the quarter NAV rose $50.0m and the accrual rose $19.14m, or 38.3 per cent of the movement. That is not an error. In the catch-up band, every dollar of NAV goes to the general partner; below the hurdle, none does; above the band, 20 cents does. Investors who see the net-of-carry NAV rise by less than four fifths of the gross movement are seeing the catch-up working.
| NAV | Profit | Correct accrual | 20% of profit | Overstatement | Net NAV to LPs |
|---|---|---|---|---|---|
| 340.0 | 90.0 | 0.00 | 18.0 | 18.0 | 340.0 |
| 360.0 | 110.0 | 0.00 | 22.0 | 22.0 | 360.0 |
| 380.0 | 130.0 | 17.96 | 26.0 | 8.04 | 362.04 |
| 400.0 | 150.0 | 30.00 | 30.0 | 0.00 | 370.0 |
| 420.0 | 170.0 | 34.00 | 34.0 | 0.00 | 386.0 |
| 440.0 | 190.0 | 38.00 | 38.0 | 0.00 | 402.0 |
Two thresholds govern the table. Carry starts to accrue at an NAV of $362.04m, the hurdle balance. The catch-up clears at $390.05m. Between them the net NAV to limited partners is flat at $362.04m: the investors gain nothing from the first $28.01m of value above the hurdle.
The shortcut, 20 per cent of NAV plus distributions minus contributions, ignores the preferred return. It is right only once the catch-up has cleared. At an NAV of $360.0m it books $22.0m of carry on a fund that has not yet earned its hurdle, overstating the general partner's capital and understating every limited partner's by the same amount. At $380.0m it overstates by $8.04m.
The hurdle keeps growing while NAV stands still. Between year 3.75 and year 4 the hurdle balance rose $6.9m on compounding alone. A fund sitting just above the hurdle can see its accrual fall in a quarter where NAV is flat. A controller who sees that should not reverse it as a mistake.
The four-tier waterfall behind this accrual, with the catch-up set as a solve, is in the free workbook for this case. The catch-up equation is worked on its own in how the GP catch-up is actually solved, and the money at stake if the accrual is later reversed in what a clawback actually collateralises.
In most partnership structures it is a reallocation between partners' capital accounts, not an expense. NAV stays at $420.0m in the worked case; $34.0m of it is attributed to the general partner and $386.0m to the limited partners. The treatment depends on the fund's legal form and accounting framework, so the financial statements should say which applies.
Because the preferred return keeps compounding. In the worked case the hurdle balance grows by $6.9m in one quarter at 8 per cent. A fund just above the hurdle, or inside the catch-up band, loses accrual dollar for dollar as the hurdle rises, even if the portfolio is marked flat.
Only once the full catch-up has cleared. In the worked case that happens at an NAV of $390.05m. Below it the shortcut overstates the accrual: by $8.04m at an NAV of $380.0m, and by $22.0m at $360.0m, where the correct accrual is zero.
The whole-of-fund waterfall behind this accrual is worked in chapter 30 of The Private Equity Fund Controller Playbook. 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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