CAPITALIZE ON STRUCTURE
FinaTech advises, boosts return, and minimizes risk.
UNLOCKING THE FULL POTENTIAL OF PE FUNDS
Today, the private equity industry primarily uses structured finance in CFOs and NAV financings to leverage older, more mature LP interests. Structuring the equity stack itself at the inception of a fund, however, can also opens up a myriad of new securities, as illustrated below.
The Basic Senior/Subordinate Structure
The following example is predicated upon a fund that delivers a 14% net annual return to its LP investors. Numerous possibilities open up simply by dividing the LPs into senior and subordinate classes. The figure below shows a waterfall in which the senior LPs receive distributions until they receive a set preferential return, after which the junior LPs receive the remainder of the return. The table shows how different preferences for the senior class affect the junior LPs' returns.
If a PE fund or REIT were structured like this, the senior and junior tranches would appeal to a broader range of investors than a straight limited partnership unit does today. An investor desiring the same exposure that they have today would buy both an A and a B unit.
Expanding The Waterfall
The illustration below shows a leveraged portfolio with an equity stack divided into three classes.
Generating a 54% From a Portfolio Earning 9%
The table below shows how the above structure would perform for a $4B portfolio having an annual return of 9% and servicing $3B in debt at an interest rate of 5%. If the senior and mezzanine classes earned 8% and 12% respectively, the subordinate class would earn 54%. All three tranches would appeal to very different investors, illustrating the potential of the structure.
Sensitivity Analysis for the Above Structure
The below table is a sensitivity analysis for how the subordinate LPs in the above structure would fare under a range of portfolio returns.
Temporal Sequencing
As a fund's portfolio matures, the equity stack can be restructured as show in the illustration below, producing a series of short term securities with IRRs being calculated over shorter periods of time.
