A Comprehensive Guide to Fund Administration: Answering 5 Important Investment Fund Questions
Navigating investment funds can be complex. Read below as we provide clear answers to common questions, helping both seasoned and new investors understand fund accounting and essential administrative elements.
An investment fund is a collection of monetary assets contributed by investors and pooled together by a fund manager who makes investment decisions on behalf of the fund.
The fund manager is typically the general partner (GP) of the fund who holds a minimal equity investment along with a profits interest in the fund. The fund’s investors are referred to as limited partners (LPs) and they hold varying classes of equity interests in the investment fund.
Investor contributions represent cash inflow into a fund from the partners invested in the fund, increasing their capital balances. Investment contributions, however, are outflows of cash from the fund to the underlying investment assets in which the fund is invested.
On a quarterly or annual basis, a fund will calculate the ownership allocations of its investors using a hypothetical liquidation. The calculation provides ending investor capital balances as though the fund were being dissolved at that period end. The investment fund’s total equity, representing the value of the fund at the reporting date, is run through the distribution waterfall calculation to determine each investor’s ownership of the fund.
The distribution waterfall is the order of allocation of cash proceeds to investors, as defined in an investment fund’s Limited Partnership Agreement (LPA). Generally, the distribution waterfall includes several layers of threshold criteria that need to be met for the GP position to earn full profit potential. Initially, a preferred return is paid to LPs as income on their investment. Once the preferred return rate is met, a return of capital threshold is in effect, in which all partner capital contributions are returned to investors via distributions. During that phase, a current income incentive can be paid to the GP to compensate for the work performed before its profit level is attained. After all capital is returned, a fund moves into the promote phase of the waterfall, where GP profits are paid. There might be several layers to that phase, including the catch up and carried interest residual stages. During catch up, distributions are more heavily allocated towards the GP. Once the cumulative fund distributions equal the full profit potential allocations, for example an 80/20 split between the LPs/GP, those rates are locked in and the residual stage is in effect for the remainder of the fund life.
An investment fund is a collection of monetary assets contributed by investors and pooled together by a fund manager who makes investment decisions on behalf of the fund.
The fund manager is typically the general partner (GP) of the fund who holds a minimal equity investment along with a profits interest in the fund. The fund’s investors are referred to as limited partners (LPs) and they hold varying classes of equity interests in the investment fund.
Investor contributions represent cash inflow into a fund from the partners invested in the fund, increasing their capital balances. Investment contributions, however, are outflows of cash from the fund to the underlying investment assets in which the fund is invested.
On a quarterly or annual basis, a fund will calculate the ownership allocations of its investors using a hypothetical liquidation. The calculation provides ending investor capital balances as though the fund were being dissolved at that period end. The investment fund’s total equity, representing the value of the fund at the reporting date, is run through the distribution waterfall calculation to determine each investor’s ownership of the fund.
The distribution waterfall is the order of allocation of cash proceeds to investors, as defined in an investment fund’s Limited Partnership Agreement (LPA). Generally, the distribution waterfall includes several layers of threshold criteria that need to be met for the GP position to earn full profit potential. Initially, a preferred return is paid to LPs as income on their investment. Once the preferred return rate is met, a return of capital threshold is in effect, in which all partner capital contributions are returned to investors via distributions. During that phase, a current income incentive can be paid to the GP to compensate for the work performed before its profit level is attained. After all capital is returned, a fund moves into the promote phase of the waterfall, where GP profits are paid. There might be several layers to that phase, including the catch up and carried interest residual stages. During catch up, distributions are more heavily allocated towards the GP. Once the cumulative fund distributions equal the full profit potential allocations, for example an 80/20 split between the LPs/GP, those rates are locked in and the residual stage is in effect for the remainder of the fund life.
