10 GP and Fund Economics Waterfall Structure A standard all-contributions-plus-preferred-return- back-first, i.e., whole of fund, model is best practice. For models other than whole of fund distribution of profits: • Distributions should be based on return of all realized cost for a given investment with continuous makeup of partial unrealized impairments and write-offs, and return of all fees and expenses to date (as opposed to solely the pro rata fees and expenses related to any single realization). • For the purposes of a deal-by-deal waterfall, all unrealized investments should be valued at the lower of cost or market. • Accrued carried interest should be held in escrow accounts with significant reserves (e.g., 30% of carry distributions or more) and require additional reserves to cover potential clawback liabilities. Calculation of Carried Interest With respect to the treatment of carried interest in a private equity fund, the following guidelines should be considered: • Carried interest should be calculated based on net profits (not gross profits), factoring in the impact of fund-level expenses. • Carried interest should be calculated on an after-tax basis, i.e., foreign or other taxes imposed on the fund should not be treated as distributions to the partners. • No carry should be taken on current income distri- butions. • Amendments in the calculation of carried interest linked to changes in tax policy personally impacting members of a GP should be limited, reasonable and not triggered automatically; such amendments should be subject to LPAC consideration and approval. • Carried interest should only be paid on recapital- izations once the full amount of invested capital is realized on each investment that was recapitalized. • The preferred return should be calculated from the date capital is called from LPs to the point of distribution; in cases where capital is drawn from a bridging or other short-term financing facility collateralized by uncalled LP capital commitments, the preferred return should be calculated from the date capital is at risk, i.e., the date on which the facility is drawn, rather than the date at which the capital is ultimately called from LPs. • Subscription lines of credit should be used primarily for the benefit of the partnership as a whole, i.e., administrative ease or serving as bridge financing, rather than chiefly for the purpose of enhancing reported IRR in order to accelerate the accrual and distribution of carried interest. Such lines should be of short duration, e.g., outstanding for no more than 180 days, and limited to a maximum percentage of fund commitments, e.g., 20%. The line should not be used to fund early distributions. • Calculation of preferred return should be made on the basis of the partnership’s cumulative invest- ment history starting at the point an investor’s capital is put at risk via the partnership’s initial investment, i.e., when the investor’s liability to contribute capital to the initial deal is recorded, until such time that the amount representing the preferred return for the partnership’s last exited investment is fully distributed to the investor. Whatever accrual method is used to calculate the preferred return and carried interest, that methodology should be fully transparent and consistent over the life of the fund. • To mitigate investor risks, the carried interest calculation should ideally utilize a “hard hurdle” whereby the GP’s carried interest is based only on the portion of profits that exceed the LPs’ preferred return. A GP may consider using a hard hurdle to foster a greater alignment of interest. GP AND FUND ECONOMICS