Why multiple IRR hurdles are an overkill
Simple alignments beat fancy structures
Happy Sunday!
A typical multi-hurdle promote (sometimes referred to as tiers of the waterfall) on a real estate deal might look like this:
8% preferred return to LP
70/30 split to a 13% LP IRR
60/40 split to an 18% LP IRR
50/50 split thereafter
I see these structures a lot, and - candidly - I think most are unnecessary for both GPs and LPs. Today I’d like to explain my thesis behind this and also touch on providing LPs multiple investment options, which I wrote on in some detail below.
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Let’s get some basics out of the way:
I recommend reading the introduction to Top 15 Syndication Mistakes prior to going further - the gist of this is that the more experienced a GP is, the more they can dictate a structure that’s “outside” of what market is
Another important caveat is that some GPs are playing short term games, while others are in this for the long haul - neither is right or wrong, it just is
The more a GP is in the latter bucket (or just don’t have a huge LP investor base), the more I’d recommend staying closer to market on splits and fees early on - you don’t want your LPs to leave you once they realize that what they signed up for isn’t market
This touches on the broader point that your best LP is almost always your existing LP
Now, obviously the multi-hurdle promotes exist for a reason and that reason is clear - the perspective from the GP is “if the deal happens to succeed beyond a certain point, I’d like more share of the upside because you (the LP) have gotten a decent amount of upside already.”