Deal Syndication in Private Equity

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Deal Syndication in Private Equity

• Educational Presentation #11 – Private Equity

• 17.03.25

• Property of the ESCP Alternative Investment Society (AIS)

• Sources: Moonfare, WallstreetPrep

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Section I: Introduction

ESCP Alternative Investment Society

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I: Introduction

The Role of Syndication in Private Equity Transactions What is Deal Syndication

Deal syndication refers to the process where multiple private equity (PE) firms or financial institutions collaborate to funda leveraged buyout (LBO) or other investment. This approach helps distribute financial risk while enhancing deal execution capabilities

Purpose: balancing diversification and exposure • Diversification of Risk: Reduces exposure for any single investor by spreading capital commitments across multiple firms • Enhanced Capital Access: Allows firms to undertake larger deals without over-leveraging their own balance sheets

Risk Sharing

Larger Deal Execution Regulatory and Structural Benefits

• Can facilitate smoother regulatory

• Enables access to bigger transactions that

• Spreading financial and operational risk among multiple investors

approvals and better structuring for tax

a single firm might not fund alone

efficiency

Deal syndication enables PE firms to pool resources, share risks, and execute larger investments efficiently

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Section II: LP-GP Structure & Liability Considerations

ESCP Alternative Investment Society

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II: LP-GP Structure & Liability Considerations

Liability Structures for LPs and GPs

• LPs have limited liability and act as passive investors, while GPs actively manage the fund and bear greater financial and legal risk

• The following slides cover the most common structures for liability in LP-GP relationships

Limited Partner (LP) Liability

General Partner (GP) Liability

Carried Interest & Risk Exposure

• Limited to Investment Amount: LPs are only liable for the amount they commit to the fund • No Operational Control: LPs do not participate in fund management, reducing exposure to legal or financial risks • Legal Protection: Structured as passive investors, shielding them from fund debts or lawsuits beyond their committed capital

• Unlimited Liability: GPs are responsible for fund operations and can be held personally liable for fund debts if structured as individuals • Fiduciary Duty: Must act in the best interest of LPs, including duty of care and loyalty • Mitigation via Entities: Most GPs set up Limited Liability Companies (LLCs) or Limited Partnerships (LPs) to cap liability exposure

• Performance-Based Compensation: GPs earn carried interest (typically 20% of profits) but must meet return hurdles (e.g., an 8% preferred return) • Skin in the Game: GPs often commit their own capital, ensuring alignment with LPs. • Regulatory & Compliance Risks: GPs face scrutiny from investors and regulators on fund governance, conflicts of interest, and transparency

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II: LP-GP Structure & Liability Considerations

GP-LP relationship and fund structures

Understanding how fund structures shape GP-LP dynamics

• The following fund structures are typical in a GP-LP relationship, shaping liquidity, control, and alignment while balancing flexibility with governance

Closed-End Fund

Evergreen Fund

Continuation Fund

• Fixed lifespan (typically 10 years) with defined exit timelines • Capital is committed upfront and called as needed • LPs cannot withdraw funds before exits occur

• No fixed end date; allows for continuous capital inflows • Profits can be reinvested rather than distributed • Offers more liquidity but requires strong governance

• Extends the life of selected assets from an existing fund • Provides liquidity options for existing LPs • Aligns long-term interests of GPs and investors

Fund structures balance risk, capital efficiency, and flexibility, shaping GP-LP alignment and optimizing deal execution

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II: LP-GP Structure & Liability Considerations

Chart on Fund Structure

CAPITAL

MGMT. FEES

Financial

Sponsor

Buyout Fund

CARRIED INTEREST

GP Mgmt. Co.

LP 1

LP 2 PC 1

PC 6

LP 3

PC 2

PC 7

PORTFOLIO CO. FEES

PC 3

PC 8

PC 4

PC 9

PC 5

PC 10

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II: LP-GP Structure & Liability Considerations

Co-investments and their role in syndication

• Co-investments give LPs direct deal exposure, reducing diversification but enhancing return potential

• GPs use co-investments to scale deals, optimize capital, and strengthen LP alignment

Benefit to LPs • Co-investments reduce fees as LPs invest directly, bypassing fund-level charges

• Co-investments let LPs select deals, allowing targeted exposure and capital control

Benefit to GPs • Co-investments let GPs raise deal-specific capital for larger transactions

• Co-investments deepen LP engagement and align incentives with GPs

Liability Impact • LPs take on direct investment risk rather than diversified fund exposure

• GPs retain fiduciary duty but share financial risk with co-investors

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II: LP-GP Structure & Liability Considerations

How the Co-Investment Structure Works in Practice

How co-investments are layered into the broader fund structure, detailing capital flow, ownership, and role separation

• Co-investors commit directly to portfolio companies often via an SPV outside the fund

• GP allocates deal portions between fund and coinvestors based on size and strategy

• Co-investors can also be LPs, but participation in the fund is not required

• Co-investments often bypass management fees and carried interest

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II: LP-GP Structure & Liability Considerations

Chart on Co-Investments

Visualizing capital flow and ownership structure

MGMT. FEES

CAPITAL

Financial

Sponsor

Buyout Fund

CARRIED INTEREST

GP Mgmt. Co.

LP 1

LP 2 PC 1

PC 6

LP 3

PC 2

PC 7

Co-Investor

PORTFOLIO CO. FEES

PC 3

PC 8

PC 4

PC 9

Co-investor may also be an investor in the fund; but doesn’t have to be

PC 5

PC 10

SPV

Direct co-investment on PC level; by-passing fund related fees

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II: LP-GP Structure & Liability Considerations

Special Purpose Vehicles (SPVs)

A Structured Entity for Isolating Risk and Managing Investments

• SPVs are separate legal entities created to hold specific assets or liabilities, protecting the parent company from financial risks and regulatory constraints

Advantages Disadvantanges

• Risk Isolation: Shields the parent entity from financial and legal liabilities 1 1 • Regulatory and Compliance Complexity: SPVs may face extensive reporting and legal scrutiny

• Investment Flexibility: Enables tailored financing, tax efficiency, and asset management 2 2 • High Administrative Costs: Requires ongoing legal, tax, and operational oversight

Private equity firms use SPVs to acquire and hold assets, keeping liabilities separate from the main fund. This is common in structured finance,

securitization, and real estate transactions

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Section III: Distribution Structure in Deal Syndication

ESCP Alternative Investment Society

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III: Distribution Structure in Deal Syndication

Importance of Distribution Structures in Deal Syndication

The establishment of a distribution structure is essential in syndicated deals involving investors and sponsors

• Distribution structures defines how profits are shared, ensuring compensation is fair and the risk incurred by LPs and GPs is proportionally recognized

• While LPs provide the capital, the expertise and management is provided by the GPs. A proper structured compensation model ensures that both parties have aligned interests

• With no structured compensation, GPs could simply earn fees for managing capital regardless of the investments made. Compensation models ensures GPs are rewarded for performance

Hurdle Rates Key Performance Metrics Waterfall Frameworks Distribution Structure

Overview

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III: Distribution Structure in Deal Syndication

Hurdle Rates

Hurdle Rates help ensure fair returns in syndicated deals by recognizing the financial risk incurred by LPs

• A hurdle rate is the minimum return that investors must receive before the PE sponsor earns a share of the profits made

• Typical hurdle rates hover around 7-9% in the PE space, approximately 80% of PE firms setting the rate at 8%, and are usually set by the GPs alongside the offering documents

• Investments that surpass the hurdle rate unlock carried interest for PE investors, making it one of the most lucrative components of their compensation

• Although hurdle rates are very common some notable PE firms such as Thoma Bravo and TA Associates have operated without them in the past

Key Elements:

Investor Protection It acts as first claim on profits for LPs, ensuring they earn a minimum return to compensate for the risk associated in investing in this type of vehicles

Incentive alignment Encourages GPs to focus on tot tier, high potential investments instead of simply relying on collecting management fees

Prevents unfair overcompensation If returns are weak, a hurdle rate, prevents GPs from benefitting from poor investments at the fund level

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III: Distribution Structure in Deal Syndication Types of Hurdle Rates

Soft Hurdle Rates are the preferred distribution structure among GPs

Soft Hurdle Rate: GPs earn carry on all profits, but only after the LPs meet the established hurdle rate

Hard Hurdle Rate: GPs are only entitled to carry on profits above the hurdle rate

• This structure is more common among PE firms and preferred by GPs as it enhances returns

• Although less common in the PE space, some firms may still employ hard hurdle rates

Example

Investment

100M€

Hurdle Rate

8%

Return after Y5

140M€ (8.45% IRR)

Carried Interest 20€

Total Profits: $40M Fund exceeds 8% hurdle rate; GPs earns carry on all $40M of profits Carried interest (20%): $8M goes to GP, $32M to LPs

Total Profits: $40M LPs receive hard hurdle return ($8M), GPs earns carry on profits above the hurdle; $32M Carried interest (20%): $6.4M goes to GP, $33.6M to LPs

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III: Distribution Structure in Deal Syndication

Key Performance Metrics

Key financial indicators determine the success of investments and how profits are allocated in deal syndication

• Specific metrics are used at fund/deal level to evaluate investment success and establish distribution returns based on hurdle rates

• This performance metrics, along the hurdle rate and other components are essential in the creation of Waterfall structures

Internal Rate of Return (IRR) Multiple on Invested Capital (MOIC) Equity Multiple

• Annualized return of an investment • Most important metric in return and hurdle rate analysis • The IRR must surpass the hurdle rate for GPs to unlock carry

• Measures how much LPs take after the hurdle rate and profit splits • For example, in a profit split of 80% LPs and 20% GPs, the equity multiple will accurately reveal returns for LPs

• Measures return multiple without factoring time value of money • MOIC helps LPs find if capital was efficiently deployed to exceed the hurdle rate • A high MOIC but a low IRR can reveal slow capital recycling

IRR (%) = (Future Value of CF / Present

MOIC = Total Cash Inflows / Total Cash

Value of CF) ^(1/periods) – 1

Outflows

Equity Multiple = (Distributions + Residual Value) / Capital Invested

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III: Distribution Structure in Deal Syndication

General Waterfall Framework

No GP Catch-up

GP Catch-up

Waterfall Structures

Framework used to determine the capital gains from cash flows, refinancing, and sales are distributed among LPs

100% LPs

100% LPs

and GPs. Set hurdles are thresholds, predefined by investors that must be met, before the next distribution may

be allocated

American Waterfalls

European Waterfalls

(deal-by-deal waterfall)

(global-style waterfall)

100% LPs

100% LPs

• Higher priority to LPs, as the funds require 100% capital repayment before profit split with GPs

100% GPs

• Individual investment deals, allowing GPs to extract a share of the profits with every deal • ‘clawback’ features allow LPs to bring GPs share back from old deals to LPs if the aggregate baseline is not met

20% GPs

20% GPs

Shift from the European to the American Model, as most funds US-based

80% LPs

80% LPs

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III: Distribution Structure in Deal Syndication Waterfall Structures (with GP Catch-up)

Waterfall Structures (with GP Catch-up) Visualization Explanation

#1 Initial Capital Returned

100% LP

LPs recover their initial equity investment

100% LP

#2 Preferred Return Hurdle & GP Catch-up

80% LP 20% GP

If first hurdle is met, catch-up on 20% of all distribution

LPs recover until distributions equal the preferred return (e.g. 8%). If hurdle is met; GPs are entitled to 20% of all profit distributions. Therefore, significantly increasing the return of GPs (example on the next slide)

#3 Performance Hurdle

80% LP 20% GP

80/20 Split until 12% IRR (explanatory values)

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

#3 Performance Hurdle

70% LP 30% GP

70/30 Split until 14% IRR (explanatory values)

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

#3 Performance Hurdle

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

60% LP 40% GP

60/40 Split above 16% IRR (explanatory values)

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III: Distribution Structure in Deal Syndication

GP-Catch-up (case study)

Case

The Limited Partner initially contributed of 1,000,000€ in equity to the acquisition of an asset. During a given investment period, the assets increased in value. The GP is refinancing the existing loan on better terms. Resulting from the refinancing, 2,000,000€ are being distributed to the investors. The preferred return is 8%. After returning the initial capital and preferred return to the LPs and fulfilling the GP Catch-up, the remaining proceeds are distributed to the performancebased profit-sharing arrangement with an 80/20 split.

Description GPs LPs Total

At the time of distribution, the 2,000,000€ will be allocated as follows:

Return Capital - 1,000,000 1,000,000

Preferred Return - 80,000 80,000

1,800,000 200,000

Distributions

GP Catch-up 20,000 - 20,000

90% LP 10% GP

Performace-based Return 180,000 720,000 900,000

Total Distribution 200,000 1,800,000 2,000,000

× GP Catch-up Preferred Distribution

GP-Catch up

Common Mistake: do not calculate 80,000€, this amount only represent the share of LPs. One needs to “gross up” to ensure the distribution to GPs. Thus, the total distribution is 100,000€.

100% - GP Catch-up (%) × 20% 20,000€ 80,000€

100% - 20% =

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III: Distribution Structure in Deal Syndication

Waterfall Structures (without GP Catch-up)

Waterfall Structures (without GP Catch-up) Visualization Explanation

#1 Common Equity Hurdle

100% LP

LPs recover their initial equity investment

100% LPs

#2 Preferred Return Hurdle

100% LP

LPs recover until distributions equal the preferred return (e.g. 8%)

100% LPs

#3 Performance Hurdle

80% LP 20% GP

80/20 Split until 12% IRR

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

#3 Performance Hurdle

70% LP 30% GP

70/30 Split until 14% IRR

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

#3 Performance Hurdle

Profit Split are performance-based, allowing the GPs to receive a greater share of profits if the fund surpasses set IRR expectations

60% LP 40% GP

60/40 Split above 16% IRR

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III: Distribution Structure in Deal Syndication

Types of Waterfall Structures

Cash-Flow Sources Description Example

Cash Flow • Distribute periodic profits (ongoing) • Ensuring stable returns to LPs

• Real Estate asset generating stable rental income

Refinance

• Replacing old loan or extract capital

• Mid-hold strategy to recapitalise • Early returns for LPs, mitigating risk

Sales Promote

• IPO, Asset Sale

• Final profit distribution • LPs recover capital and pref. return • GPs can receive highest share of profit

However, standard waterfalls combine all three sources of cash flow into a single Levered Cash Flow (CF) line, which then serves as the starting

point for the waterfall

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III: Distribution Structure in Deal Syndication

In-depth Excel Application

How to Illustrate a Hurdle on Excel Summarized Distributions

Hurdle 1 - Pref Return and return of capital % Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Property level CF Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Levered Cash Flow (2,500) 175 180 186 191 4,447 Levered IRR 17.3% Equity Multiple 2.07x

Beginning Balance (LP Capital Account) - 2,250 2,273 2,292 2,308 2,321 LP Required return to hit Hurdle 1 8.0% - 180 182 183 185 186 Contributions from LP 90.0% 2,250 - - - - - Distributions to LP (Hurdle 1) 90.0% - 158 162 167 172 2,507 Ending Balance (LP Capital Account) 2,250 2,273 2,292 2,308 2,321 - LP IRR Error Check 8.0% (2,250) 158 162 167 172 2,507

Partnership Structure % Sponsor LP IRR Sponsor Equity Share 10.0% Preferred Return 10.0% 90.0% 8.0% LP Equity share 90.0% Hurdle 2 25.0% 75.0% 12.0% Total Equity 100.0% Hurdle 3 40.0% 60.0%

Contributions from Sponsor 10.0% 250 - - - - - Distribution to Sponsor 10.0% - 18 18 19 19 279 Sponsor IRR Error Check 8.0% (250) 18 18 19 19 279

Total Distributions - 175 180 186 191 2,785 Cash Flow Remaining - - - - - 1,662

Hurdle 2 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Sponsor Cash flow Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Distributions 900 - 18 18 19 19 827 Contributions 250 250 - - - - - Net Cash Flow 650 (250) 18 18 19 19 827 IRR 31% Equity Multiple 3.60X

Beginning Balance (LP Capital Account) - 2,250 2,363 2,484 2,615 2,756 LP Required return to hit Hurdle 2 12.0% - 270 284 298 314 331 Contributions from LP 2,250 - - - - - Prior Distributions - 158 162 167 172 2,507 Distributions to LP (Hurdle 2) 75.0% - - - - - 581 Ending Balance (LP Capital Account) 2,250 2,363 2,484 2,615 2,756 - LP IRR Error Check 12.0% (2,250) 158 162 167 172 3,087

LP Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Distributions 4,279 - 158 162 167 172 3,620 Contributions 2,250 2,250 - - - - - Net Cash Flow 2,029 (2,250) 158 162 167 172 3,620 IRR 15% Equity Multiple 1.90X

Contributions from Sponsor 250 - - - - - Distribution to Sponsor 25.0% - - - - - 194

• Use colour codes: Blue (hardcoded), Black (formulas), Purple (same-sheet refs), Green (cross-sheet refs); hardcodes have yellow fill + black border.

Total Distributions - - - - - 774 Cash Flow Remaining - - - - - 888

Hurdle 3 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

• Use =min and =max functions instead of =if functions to cap or floor distributions within each hurdle tier – avoiding nesting

• To show formulas in Excel, press Ctrl + ` (key above Tab)

Distribution to LP 60.0% - - - - - 533 Distribution to Sponsor 40.0% - - - - - 355 Total Distributions - - - - - 888