The quarterly waterfall calculation runs the fund’s distributable cash against the four-tier framework on the operating-agreement discipline. This article walks the six-step framework against each quarter — from the cash framework through the reserve framework, the four-tier waterfall, and the investor-reporting framework.

Step 1: Calculate distributable cash

The fund runs the distributable-cash framework against the quarter’s operating cash flow. The framework runs the loan-portfolio interest income, the loan-portfolio principal-amortization income, and the loan-payoff cash against the fund’s gross cash. The framework runs the loan-servicing fees, the fund-administrator fees, the fund-management fees, and the operating-expense framework against the gross-cash framework. The resulting cash runs the distributable-cash framework against the quarter.

Step 2: Apply the reserve framework

The fund runs the reserve framework against the distributable cash before the waterfall runs. The framework runs the loss-reserve framework against the operating-agreement’s defined percentage of fund assets. The framework runs the liquidity-reserve framework against the operating-agreement’s defined cash floor. The framework runs the recapture-reserve framework against the tax-recapture and audit-adjustment framework. The framework runs the opportunity-reserve framework against the pending-acquisition pipeline. The resulting cash runs the waterfall framework.

Step 3: Run Tier 1 — Preferred return

The fund runs the preferred-return framework against the lender-investor capital base. The fund calculates the preferred-return rate against the investor’s unreturned capital base on the quarter. The framework runs the preferred-return distribution against the lender-investor base on the cash-on-cash framework or the accrued framework. The fund runs the preferred-return distribution against the investor on the distribution date on the standard.

Step 4: Run Tier 2 — Return of capital

The fund runs the return-of-capital framework against the investor’s contributed capital. The framework runs the contributed capital back to the investor on a defined cycle — the fund-life framework on the closed-end fund or the redemption framework on the open-end fund. The framework runs the investor’s capital-account balance down on each return-of-capital distribution and runs the preferred-return framework against the reduced capital base on the subsequent quarter.

Step 5: Run Tier 3 — Catch-up and promote

The fund runs the catch-up framework against the manager’s pro-rata share of the cumulative preferred-return distribution. The framework runs the manager to the economic-split target before the residual tier runs. The fund runs the promote framework against the manager’s carried-interest share — the operating-agreement’s defined percentage of profits above the preferred-return hurdle — against the distribution cycle. The framework runs the manager’s incentive framework against the fund’s performance discipline.

Step 6: Run Tier 4 — Residual split

The fund runs the residual-split framework against the remaining cash after the first three tiers. The framework runs the residual cash on a defined split between the lender-investor base and the manager on the operating-agreement framework. The fund runs the residual-split distribution against the lender-investor base on the distribution date and runs the manager’s residual-share distribution against the manager-distribution framework. The fund runs the tier-by-tier disclosure framework against the lender-investor base on the investor-reporting cycle.

Related Topics

This article is educational and does not constitute legal, tax, or investment advice. The waterfall framework runs under the fund’s operating agreement, the partnership-tax framework under IRC Subchapter K, and the Investment Company Act framework against the fund. Consult qualified legal, tax, and SEC counsel on the specific waterfall framework against any private mortgage fund.

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