So how does a waterfall work in
a syndication or a fund? What

are the steps? What are the
different kinds of things that

can go on, that's what we're
gonna talk about.

Thought it'd be helpful to have
a visual representation of what

exactly happens in a waterfall
and how to think about it. That

makes it real clear, because it
really isn't very complicated.

And but seeing it on paper
sometimes can make all the

difference in the world. So
let's go to the handy

whiteboard. So let's talk first
about a direct investment deal

where we know what it is, let's
say it's a piece of real estate.

Most of my clients are real
estate, but we have a number of

private equity firms, hedge
funds, businesses, all sorts of

other people that raise capital,
but most are in real estate. So

let's stick with that. So we've
got a piece of real estate

we have a piece of real estate,
and let's say let's talk about a

capital event first. So capital
event is when the property

sells. Yay, capital event. All
right, so capital event occurs.

So money comes down. And it hits
this pool, right? So there's a

big pool of money here. pool
money pool. Alright, so there's

big money pool. And now out of
this pool, first what has to

happen? So before you give any
money back to your investors,

the next step that happens is
expenses. These are expenses

that happened before so that we
can end up with net profits at

the end, and that those net
funds, so expenses, I mean, the

big one obviously would be
something if it was real estate

is to pay back the loans, oh, my
goodness. The other one, the one

that's matters most to you is
payment of fees.

To you, Manager. Now, important
side, note the payment of fees,

most of the time these fees
portion is going to be treated

as income on your taxes. So keep
that in mind when you're doing

your tax planning. So this
happens first, right, so we pay

off those, we pay out all the
expenses, the loan, the whatever

there is left, sometimes there's
taxes, I've got other videos on

that. But most of the time, it's
you know, you got to pay your

loans, you got to pay your fees,
whatever else is owing, which

ends you up at the end of the
day with your net proceeds.

So you've got your net proceeds
that's supposed to look like $

sign, there you go. So you end
up with your net proceeds now

from the net proceeds. This is
where we really start thinking

about waterfalls. The most
common first step out of the out

of a waterfall is a return of
capital. This goes to your

investors. Right so that that
money goes to your investors,

it's returning the amount of
money that they have. So you're

probably paying out all those
Class A units, that amount of

their initial capital
contribution 99% of the time,

this is what what is in the
operating agreement and the PPM

and it's described accordingly.
So after Return of the capital,

what happens next? So a lot of
times there'll be a step here,

that is the preferred return. So
the preferred return let's say

it's 6%. That goes to the
investors. Okay, this return of

capital here as long as it is a
return of capital to your

investors is not taxed

as long as it's not at tax to
the point of which is this their

basis, of course, cost
segregation, other things like

that can adjust that but I just
giving you that brief like idea

just so that you know. So your
preferred return is coming to

your investors. Now the
preferred return probably is

taxed, and it would be taxed as
long as you've held the asset

for more than one The year it's
going to be taxed your investors

as a capital gain after the
payment of the preferred return,

sometimes and this isn't very
common, especially in a real

estate deal, but it certainly
does happen and maybe 20 to 30%

of the of the formations that
are right the structures that

are right. And that is what's
called a catch up. And that

catch up will be normally it
will be to the whatever that

percentage is of the preferred
return. And this gets paid to

manager. So that catch up to the
manager is a amount of money

that is to bring them to this
6%. So what you're basically

saying is, okay, investor,
here's all your money back, I'm

also going to give you a
preferred return, which means

I'm going to make sure that you
get 6% of your money back before

anybody else gets any money. And
so we give you 6% of the money

back. But what that actually has
done is it's decreased the size

of this pool here. It's
decreased that size of the pool

such that now it's not in line
with whatever buddy wouldn't

necessarily think it is. So you
can do the preferred return as a

pure catch up of 6%, to the
manager to make everybody fair,

but that alone would essentially
be a 50/50 split, right? So that

first 12% of profits would
basically be okay, we're going

to split that 12% 50/51, we're
going to pay the investor, then

we're going to pay the manager.
But that's probably not what

your investors are normally
thinking that a catch up should

be. Because if you're doing, for
example, an 80/20 split, maybe

it should be something
different. Let's use a

different, different math here
so that I don't have to do the

math. But let's say we do a
catch up, up to an additional

say, say we're doing a split of
75. So that would be to the

manager, we do a catch up of
hey, manager, we're gonna catch

you up a little bit because you
didn't get to participate in

that first 6%. And so we're
gonna give it make sure that you

get some profits, as you would
expect from that next pool.

After this now we're in
splitsville. So here, we might

say something like, okay, split,
we're gonna give 80% Actually,

since we were doing 75, let's
do, we're gonna give 75% to the

investor. And we're gonna give
25% to the manager. After, let's

say that we want to do a more
complex waterfall than then

would be normal. So we're going
to say, we're going to split

that pool of money, but we're
not going to split all that

money, we're going to say, let's
split the profits that way for

just the next up to 20% of
profit. And then after that,

we're going to say, we're going
to split the remaining profit

5050. And that's it. Right? So
let's put some actual numbers to

it. I think that might be useful
as well. So let's say at the end

of the day, our net proceeds
equals $5 million. Right? And

for that 5 million, let's say
our investors invested two and a

half million, so two and a half
million goes into this category,

right? So that leaves us with an
additional now we've got here

we'll write it here. So now
we've got 2.5 million left to

divide. Right. Okay, so now
we've got to make a division of

other preferred return.
Typically, you'll do that

preferred return of 6% on the
amount that they invested, which

works out fine here. So the next
150,000 goes to your investors,

which leaves us with 2 million
350. Right. Now we've got this

catch up piece here. And so that
is equal to just an additional

35.25k. That leaves us with With
2,000,003 852 50. Okay, so now

we're going to divide that pool
up, just up to 20%. And because

of my math, it's much easier to
do this in Excel. I'm not going

to do that here. And let's just
say, we're going to do this

simple waterfall here, because
you'll get the point. So, so

we've got that admission
additional to $2,385,250. So of

that, now, we give to the
investor we're giving 1,000,007

88 937. And the remaining there
we go. The manager gets

$596,313. Not bad, right? So the
manager on this deal alone, just

from the capital transaction is
made that 596313 plus the 35 to

50. Plus plus whatever amount
that they made to in the in the

fees, which means that outside
of fees, they've made a good

$631,000 So this is the way that
a that a waterfall works. Now if

my name is Tilden Moschetti, I
am a syndication attorney with

the Moschetti syndication Law
Group. If we can help you put a

syndication or fund together,
we'd be happy to talk about it.

We work exclusively under
Regulation D Rule 506b or Rule

506c. That's what we do every
day and make sure we can help

you be successful.