Every concept, endless questions
Each concept is a small financial model. Read how it works, then draw a real interview question from it: forwards, backwards or what-if, with fresh numbers and a worked solution every time.
Forward runs a concept the usual way. Inverse runs it backwards, which is what separates understanding from memorizing.
Fund Economics
5 conceptsCarried interest waterfall (European, whole-fund)
Carry is the GP’s share of fund profit, but it is not paid off the top. The waterfall returns the LPs’ capital first, then a preferred return on it, and only then lets the GP catch up — taking most or all of the next distributions until it holds its full carry share of the profit so far. After the catch-up every dollar splits at the carry rate. Two things follow. Below the hurdle the GP earns nothing, however large the fund. And once the catch-up is complete the hurdle has cost the GP nothing at all: it ends up with exactly carry-percent of total profit, as if the hurdle never existed. The hurdle is a gate, not a discount.
Management fee drag
The management fee is paid out of the LPs’ commitments, so a "$500M fund" never invests $500M. Two percent a year on commitments for five years, then a lower rate on what is actually invested for another five, eats a sizeable slice before a single deal is done. The gross multiple is earned only on what was left to invest; the net multiple the LP quotes is measured on everything they committed. The gap between the two is the fee drag, and it is why a fund has to earn well over 2x gross to show 2x net — before carry takes its share.
DPI, RVPI and TVPI
Three multiples describe a fund mid-life. DPI is cash actually returned per dollar paid in — realized, banked, beyond argument. RVPI is what is still held, per dollar paid in — a valuation, and therefore an opinion. TVPI adds the two: total value, realized and unrealised. Early in a fund TVPI is nearly all RVPI and nearly all opinion; by the end RVPI is zero and TVPI equals DPI. LPs read the split, not just the total: a 2.0x TVPI that is 0.3x DPI is a very different fund from one that is 1.5x DPI, even though the headline is the same.
The J-curve
Plot an LP’s cumulative cash position in a fund and it looks like a J. Money goes out first — capital calls for deals, and management fees on the whole commitment from day one — while nothing comes back, because the companies bought in year one are not sold until year five or six. The curve bottoms out when the last deal is bought, then climbs as exits arrive. Two numbers describe it: how deep the trough is, and how long until the LP is back to even. Fees deepen the trough; earlier or larger distributions shorten it. Neither says anything about the fund’s final return, which is why a young fund’s negative IRR is not a verdict.
The GP commitment
Carry is an option: the GP gets a share of the upside and none of the downside. LPs want the GP to have something to lose, so they require it to invest its own money in the fund — the GP commitment, historically one percent and now often two to five. On that money the GP earns what any LP earns, after fees and after its own carry. In a good fund the commitment is a small part of the GP’s economics next to the carry; in a bad fund it is the only part that moves, and it moves against them. That asymmetry is the point.