Catch-Up As A New Way Of Alignment Of Interests In The Brazilian Private Equity Funds

In the private equity funds, the compensation of the manager is usually made through the management fee and the carried interest. The first consists of a fixed value, calculated based on a percentage over the committed capital or the net worth of the fund, according to whether the fund is in the investment or the divestiture period, serving for the manager to cover his costs with a dedicated team to the fund and its general expenses of functioning. Currently, for the private equity funds raised with Brazilian institutional investors, the average has been 1.7% per year.

The carried interest consists in the participation of the manager in the profits of the fund, being paid to him a percentage of the proceeds of the fund (usually 20%) that exceeds the capital invested by investors plus a multiple defined upon the constitution of the fund - the preferred return/ hurdle rate. This is the minimum return to be achieved by the investors before the carried interest can be paid to the manager, varying, nowadays, around IPCA increased by 10% to 11% per year.

The manager's compensation is a key point for the alignment of interests among managers and investors, since investors do not want to pay large management fees to their managers, in order to avoid leaving them only comfortable with their compensation. Thus, the carried interest emerges as the main tool to align the interests of the parties, for it links the gains of the manager to those of the investors. There is consensus among investors that most of the manager's compensation should come from the carried interest. However, the carried interest shall only be paid after the return to the investor of invested capital and the preferred return, being, therefore, the preferred return the main challenge for the manager to reach his target.

The increase in amounts charged with respect to the preferred return can possibly misalign the interests of investors and managers. The solution to this problem can be found in the North American market itself: the catch-up clause.

Catch-up clauses allow the manager to receive compensation on the values paid to the investors as preferred return, operating the distribution of the proceeds of the fund as follows: (i) first the capital invested is returned to the investors, (ii) then, the preferred return is paid, (iii) next, it is paid to the manager the catch-up, a compensation incident upon the amounts paid with respect to the preferred return, generally, in the...

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