An 8 percent compounding pref against a 10 percent simple pref with a better upside split

Non-cumulative reads brutal to me. It means the sponsor's incentive during a rough stretch is to skip the quarter and start clean, and I can't see how a passive investor ever prices that. Am I misreading how those clauses usually get drafted, or is it as bad as it looks?

Question about pref structures, since I'm still learning the vocabulary. Cumulative means unpaid pref piles up and has to be paid later, non-cumulative means a missed quarter just evaporates? And compounding means the pile itself earns pref? If that's right then Deal B's 10% only beats Deal A in a deal that pays every single quarter on time, which sounds like the deal nobody actually gets.

@bmoreno23 the definitions are right. Worth adding where the promote actually gets paid from. In a structure like A, the sponsor sees nothing until the accrued balance, including compounding, is cleared, so in a slow deal the sponsor's upside gets pushed entirely to the sale. That changes behavior, and not always in the LP's favor, because a sponsor with no promote in sight until exit has a reason to swing for a big exit rather than a safe one.

Run it on $100k with no distributions until sale, which is the stress case. At 8 percent compounding, the year 4 accrual is about $36.0k, year 6 about $58.7k, year 7 about $71.4k. At 10 percent simple, year 4 is $40k, year 6 is $60k, year 7 is $70k. So simple 10 is ahead through about year six and compounding 8 pulls in front somewhere in year seven. Both of these deals say five years, which puts the crossover past the stated hold, and that favors B on the pref alone. Then the split does the rest of the work. On a deal that returns $100k of profit above the pref, 80/20 gives you $10k more than 70/30. That is a bigger swing than the pref difference over a five year hold in most scenarios. B wins unless distributions get suspended for multiple years, in which case non-cumulative wipes out the whole advantage and A wins by a lot. So you are really voting on whether you think this deal pauses distributions. @nicole_adeyemi what is the sponsor's history on that, and does B define what a "missed" quarter is or just leave it to the manager's discretion?

@hannah_west29 that is the clearest version of this argument in the thread. The trouble with B is that it asks a first time LP to bet on the good case, when the whole reason to choose a first deal carefully is to survive the bad one. For that investor the structure that keeps working when distributions pause is worth a few points of upside in the years when they don't.

The stated five year hold is doing more work in this comparison than either pref rate. Every deal I've watched from the outside ran long, and once you're in year seven the compounding cumulative pref is the only clause that still cares about you. I'd want to know what the agreement says about extending the hold and who gets to decide, because that single provision moves @hannah_west29's crossover date into the range where A is clearly better.