LP/GP Flashcards
Catch Up Provision
A provision included in certain real estate partnership agreements, whereby a special distribution tier is included in the equity waterfall that allows for the general partner (GP) to “catch up” with the limited partner’s (LP) cash flow distributions. The reason for why the general partner’s distributions might lag, or the amount that must be made up with the “catch up” tier, depends on the terms of the partnership structure.
Catch up provisions are most common to structures where the limited partner receives 100% of distributions until it achieves some preferred return requirement, at which point the GP receives 100% of excess cash flow thereafter until some equitable balance between the LP and GP distributions is achieved.
For example, imagine a limited partner contributes 100% of required capital to a real estate venture in return for a 12% preferred return and 50% of all excess cash flows above that threshold. The agreement states that the limited partner will receive 100% of all cash distributions until it has earned a 12% internal rate of return, at which point the GP receives 100% of cash distributions until both partners have received 50% of profit distributions. Once the GP has caught up with the LP, both partners receive any remaining excess cash flow 50/50
Clawback Provision
A provision included in certain real estate partnership agreements, whereby a special distribution tier is included in the equity waterfall that allows for the limited partner (LP) to “clawback” cash flow previously distributed to the general partner (GP).
Reasons for including the clawback provision vary, but generally are related to instances where the GP is distributed cash flow before the LP reaches a preferred return hurdle. In the event at the end of the venture the LP has not achieved some preferred return, the GP must give back some or all distributions previously made to the GP until such point that the LP hits its preferred return.
Crystallization
Also referred to as a partnership crystallization, a crystallization is a provision in a real estate joint venture agreement where the partners agree to adjust the ownership share in the venture at some pre-defined point in the future. It is most common to value-add and opportunistic investments, where a large increase in value is likely to be realized early in the investment.
The purpose of the crystallization is to allow the GP to earns its promote by way of a resetting of the ownership share percentages. The concept goes something like this:
At a point in time when the crystallization is to occur, the partners run the proceeds of a hypothetical sale through the equity waterfall to calculate the expected distribution to each partner. Based on that expected distribution, the ownership share is adjusted to reflect the share of the distribution each partner would hypothetically receive.
So for instance, imagine a JV where the GP owns 10% and the LP 90%. At crystallization, the partners assume a $100 million sale and run those proceeds through the waterfall model. The model calculates that, based on the promote structure and terms of the JV agreement, the GP would be distributed $17 million at sale and the LP would be distributed $83 million at sale.
The ownership share (i.e. the percentage distributed to each partner) from that moment forward would be 17% to the GP and 83% to the LP. And no further promote would be paid to the GP (i.e. the promote would be frozen).
