Automated waterfall calculation tools offer the potential to simplify one of private equity’s most complex processes. However, evidence would suggest that CFOs aren’t quite ready to switch from more traditional methods. We had off-the-record chats with CFOs from three private equity firms and asked about their thoughts on automating their waterfall calculations.
Do you use an automated waterfall calculation tool?
Person A: We use Excel. That’s it. We’ve actually used the services of two different third-party fund administrators, and administration of the waterfall was, in both instances, part of the scope of work. Neither of them was able to fulfil their service-level agreement, and when they tried, they both ended up using Excel, even though they have some of the more robust systems in the industry. Some things are just complicated and sometimes Excel is a good tool.
Person B: “No” is the short answer. I’ve never seen one that covers the complexity required and, in terms of proven systems, I’ve never seen one that really does it. People make out that waterfalls are really complicated. They are, but essentially it’s just a calculation. It shouldn’t be as difficult as people make it, in my mind. Excel should be perfectly adequate. I would love there to be something other than Excel, but I’ve never seen automated waterfall software that works.
Person C: No. We are actually in the process of reimplementing Yardi to try to automate the waterfalls. It finally got unwieldy to do it in Excel.
What are the issues around automating waterfall calculations?
Person A: You could program waterfall calculations, but unfortunately there’s just a level of complexity which is, in our instance, largely self-created. It’s the complexity of our limited partner agreement: the product of a lot of LPs with different fee structures, different waterfall structures, different timing of when they entered the fund, and different parallel vehicles with different cost structures. In essence, there could potentially be a different waterfall for basically every LP.
Person B: If waterfall calculations were all the same, then no one would need their own system. It would be really simple. The reason it’s complicated, and the reason everyone struggles with it, is because every firm and every fund tend to be different. Particularly, if you were a managed account of a JV investor rather than a large pooled fund, you could end up with 20 different waterfall calculations, which would be a nightmare.