First and foremost, I am not an attorney of any kind and you should consult one before drafting up an agreement. What I am talking about below is just some rules of thumb to consider when you go to explain what you want to someone that is used to drafting joint venture agreements where there is a preferred return in place.
In this kinds of deals, what usually comes first is the legal language and then the financial modelers will go in and build something that represents the agreement. Below are what you should consider before trying to draft something and this is not all-inclusive.
- Define the terms: Start by defining the terms of the preferred return, including the rate of return, the investment period, and any other relevant factors that will impact the investment. This would also include things like if the return is a compounding rate or a simple interest rate as well as if unpaid preferred returns due will accrue or reset each period. It is also important to define if distributions happen monthly, quarterly, bi-annually, or yearly. Be aware that an IRR is completely separate from a simple preferred return. Usually you will se an IRR in a preferred equity situation, which is different and needs to be modeled differently as well.
- Establish the investment structure: Determine how the investment will be structured, including the type of investment vehicle, the minimum investment amount, and any restrictions on the transferability of the investment.
- Set out the investor's rights and obligations: Clearly define the investor's rights and obligations, including their right to receive the preferred return, the timing of distributions, and any restrictions on the investor's ability to withdraw their investment.
- Describe the sponsor's rights and obligations: Outline the sponsor's responsibilities, including their obligation to manage the investment, their right to receive management fees, and any other relevant terms.
- Address potential conflicts of interest: If there are any potential conflicts of interest between the sponsor and the investors, clearly outline how these conflicts will be addressed and resolved.
- Include standard legal terms: The agreement should include standard legal terms such as governing law, jurisdiction, force majeure, and dispute resolution.
- Review and finalize the agreement: Once the terms have been established, review the agreement with your attorney to ensure that it is legally sound and complete.
- Execute the agreement: Have all parties sign the agreement and retain a copy for your records.
Here are a couple example templates that use a preferred return:
- Single Hurdle Preferred Return (option for compounding / accrual)
- Multiple Hurdle Preferred Return (simple interest, non-compounding)
There are all sorts of ways to model joint ventures and you can see all kinds of cash flow waterfalls here that demonstrate various types of logic.
Article found in Joint Venture.
