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

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

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

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

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

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

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And but seeing it on paper
sometimes can make all the

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

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

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

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

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

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

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

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

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capital event first. So capital
event is when the property

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

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

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

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

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

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the next step that happens is
expenses. These are expenses

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

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

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big one obviously would be
something if it was real estate

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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their initial capital
contribution 99% of the time,

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

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

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

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

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

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

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investors is not taxed

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

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basis, of course, cost
segregation, other things like

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

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

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your investors. Now the
preferred return probably is

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

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

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

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

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

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of the of the formations that
are right the structures that

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

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

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

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

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

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

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also going to give you a
preferred return, which means

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

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

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

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

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

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

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

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

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

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

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

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your investors are normally
thinking that a catch up should

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

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it should be something
different. Let's use a

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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other preferred return.
Typically, you'll do that

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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We work exclusively under
Regulation D Rule 506b or Rule

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

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you be successful.