MOTTA, FERNANDES ROCHA
ADVOGADOS
PRIVATE EQUITY & VENTURE CAPITAL – NEWSLETTER
DECEMBER, 2013
Distribution Waterfalls in the Brazilian Private Equity Funds:
Deal by Deal x Back End
In the private equity and venture capital industry, there are basically two
systems for the distribution of fund earnings: the deal by deal and the back
end. The adoption of each of these models may bring big differences to
investors and general partners.
In the deal by deal model, the distribution of results considers each
investment on an individual basis for the calculation of the carried interest.
In that way, in case a divestment occurs, the general partner does not need to
return to the investors all the capital invested in the fund, plus the hurdle
rate, to be entitled to the carried interest; he may return only the capital
effectively contributed to each investment or invested company plus the
hurdle rate.
As an example, we can mention the situation whereby the amount
invested by the fund is of R$300,000,000.00 and a divestment takes place in
only one of the invested companies in the amount of R$100,000,000.00,
where the capital invested by the fund in such company was of
R$20,000,000.00 and the hurdle rate was of R$10,000,000.00. Following
the deal by deal system, the general partner would be entitled to the carried
interest over the sum of R$70,000,000.00, regardless of the success of the
other investments.
The deal by deal is largely favorable to the general partner, since it allows
him to benefit from the carried interest from the first divestment, instead of
waiting the total return of the capital invested in the fund. However, its
adoption can generate conflicts, such as the situation in which only the first
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MOTTA, FERNANDES ROCHA
ADVOGADOS AND PRIVATE EQUITY
Founded in 1956, Motta
Fernandes Rocha - Advogados
was one of the first law firms to
set up a private equity group
providing a combination of deep
local
knowledge
and
international experience in the
Brazilian and Latin American
markets.
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Law Company. Active member of
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Private Equity and Venture
Capital - ABVCAP.
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divestment of the fund was successful, but the other ones were unsuccessful,
to the extent that, considering the return of the fund as a whole, the general
partner would not be entitled to the carried interest paid by reason of the
first divestment.
To resolve such conflicts, foreign funds that adopt the deal by deal
usually have clawback clauses, whereby the general partner is obliged to
return the carried interest received in excess, and there are even cases where
part of the carried interest is left in escrow until the liquidation of the fund to
guarantee the payment of the amounts paid in excess to the general partner
as carried interest.
The back end model (or return all capital), in its turn, is adopted by most
Brazilian funds, which considers all the investments made by the fund for
the calculation of invested capital, the hurdle rate and the carried interest. Its
adoption offers investors the assurance that all their investments will be
returned before the general partner receives any amount by way of carried
interest.
PARTNERS RESPONSIBLE FOR THE
NEWSLETTER - PRIVATE EQUITY &
VENTURE CAPITAL
Luiz Leonardo Cantidiano
([email protected])
Daniel Kalansky
([email protected])
AUTHOR
This article was signed by:
The choice of each model of distribution of results must be carefully
discussed between general partners and investors in the setting up of the
fund, since it can generate large gains or losses to each of the parties, if
mistakenly planned.
Rafael Biondi Sanchez
([email protected])
Rafael Biondi Sanchez
The present publication is for information and debate purposes only and shall not be considered or interpreted as a legal opinion for any operation or specific
business deal.
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