Syndication Partnership Equity After Payback PLEASE HELP

[Daniel G.]

I understand that the preferred rate of return is eliminated after they are paid back their initial investment. But does the actual equity split change? Assume that at the beginning of the deal Limited Partners put down 80% of the equity and the Sponsor the remaining 20%. Until pay back the sponsor paid out an 8% pref and succeeded in paying back everyone’s principal through a cash-out refi.

After this would the equity split between LP’s and the sponsor change to 50/50 due to a carried interest agreement? So after investor’s principal is paid back all cash flows would be distributed 50/50 in perpetuity or until the property is sold? I’ve also seen an initial LP and GP equity split of 95/5 change to 65/35 after payback.

Suppose that a sponsor raises capital for a multifamily property acquisition between himself (General partner) and other limited partners. The initial equity split is 80/20 meaning that 80% of the equity capital needed was paid for by the limited partners and the sponsor put in the remaining 20% of capital.

In years 1-4 the sponsor paid all members an 8% preferred rate of return and in year 5 paid back all of their principal through a liquidation event. Following this the equity split changes from 80/20 to 50/50 due to a clause on the operating agreement everyone signed.

My question is how exactly is the sponsor able to do this? Mathematically speaking all of the limited partner's outside basis (80% interest) would have to be multiplied by .63 to compress to 50%. The sponsor's basis or interest on the other hand would be 2.5X his initial interest.

How the heck does this logically work? How does the sponsor reduce the LP's previous equity position? 

[Anthony Chara]

To answer the latter part of your question, Daniel, it's all set up in advance in the Operation Agreement. However, if you have a 'liquidation event' as you put it, doesn't that mean that you've sold the property entirely? In which case, the investors would receive a payout of 80% of the equity according to your example.

If you plan on paying them back their equity stake at a refi, then again, how their equity stake drops will be outlined in your OA. I would suggest that you get them their preferred return for the 5 years you're showing above, plus, an extra bonus at the time of refi. That 'bonus' is up to you to determine, but that will make the reduction in equity easier to palate. Perhaps, since they currently own an 80% stake, you give them 80% of the cash out money once all expenses have been paid pertaining to the refi?