By: Manuel Villavicencio
Consulting Director
September 22, 2022
Waterfall automation software can now drastically simplify the headache of waterfall calculations
In the world of Private Equity, distribution waterfalls define the economic relationship between the private equity fund managers (GP) and the investors (LP). It is the fundamental thread that bridges the entire profit cycle of the private equity fund together and, therefore, the most crucial component that a PE fund looks at in terms of fund accounting.
But waterfall calculations are also notoriously complex. Customized LP agreements lead to a wide variety of private equity waterfall structures, and the calculating of distributions becomes even more complicated as you layer on tiers, calculate catch-ups, and try to accommodate other factors that require circular logic and a multitude of if/then assumptions.
Add to this the challenge that the formula behind waterfall calculations will differ between funds and sometimes even among investors within the same fund and it’s easy to see how the eye-watering complexity can lead to errors and enormous headaches for fund managers.
The solution seems obvious: automate the process. But the non-standardization of distribution waterfalls has led some CFOs to swear off even trying to do so.
“I have found that the waterfalls have gotten so complicated that I don’t know how you would ever program all the steps in a system,” one CFO told Private Funds CFO.
As a result, many firms continue modeling waterfalls in Excel – even if that opens the door to more risks and challenges. As another CFO put it, “I would love there to be something other than Excel, but I’ve never seen automated waterfall software that works.”
Challenges of modeling waterfalls in Excel:
- Calculations can be too complex, making it difficult to layer in multiple tiers and accommodate factors that require circular logic.
- Fat-finger risk is high and increases as spreadsheets become more complicated.
- Auditing spreadsheets is extremely difficult, making it challenging to catch and fix mistakes.
- Key-person dependency increases as spreadsheets become increasingly customized and complex.
- Excel doesn’t scale. It might work OK for one fund, but will quickly cause issues as your business grows.
Why waterfall automation software too often fails
The pain and frustration many CFOs express about waterfall automation is understandable. Many of the ‘out-of-box’ solutions currently in the marketplace don’t fulfill their promise, for a number of reasons:
- Systems lack the flexibility to cope with the intricacies and individuality of each LP agreement, forcing teams into an unsuitable workflow.
- Solutions often only support an aspect of the waterfall rather than the entire structure, in which case teams can’t use it to replace their existing system and it only adds complexity.
- Teams try to build their own solution but underestimate the R&D required to both get the project off the ground and then keep it up to date. Plus, with no ability to query, they have to work with imported files, which then have to be adapted to fit the solution.
PE funds need a configurable, automated solution that can cope with dynamic calculations for different workflows—and cash flows—in order to create a risk-averse process and eliminate the need for cumbersome spreadsheets.
What makes Allvue’s waterfall automation solution different
Allvue’s solution to the waterfall distribution is unique because it recognizes the above challenges and takes a different approach.
Far from being left to your own devices, our teams work closely with you to implement your waterfall within our fund accounting software framework. Therefore, any workflow can be accommodated within our proprietary technology.
The real game-changer is the form designer, which auto-generates code that turns an Excel form into a dynamic one. Fitting your workflows into a dynamic template then feeds a portal you can log into to run your report based on the data you select.
Finally, true distribution waterfall automation is a reality
Not only will PE funds benefit from faster, more reliable and accurate workflows, they will also reduce risk and operational expenses while enjoying simplified scalability.
It’s time to move away from manual processing and workarounds and embrace the benefits and cost savings of automating waterfall calculation processing. Discover the power of Allvue’s Fund Accounting software solution.
