Threshold types explained

You can manage your waterfall by adding customized distribution steps from your waterfall view. The first option when you start to add a distribution step will be the Threshold type. Here we explain the different types of thresholds that Diligent Equity has and their use. Each threshold determines the options for further input.

Return of capital

Typically, both LLC and C corp waterfalls start with a return of capital (ROC) phase. When you select the Return of capital threshold there are options to specify dividend calculation and the set of classes that receive the capital.

Diligent Equity calculates the total investment of all classes specified to calculate the threshold.

Note

  • Choose at least one class for each ROC distribution step.

  • This threshold type cannot handle liquidation preferences. Use the Return multiple threshold type instead.

  • You can add classes to the distribution which can help with handling carve-outs.

Use case

Use this threshold when your distribution clauses include returning capital (with or without dividends) for share classes. You can add multiple Return of capital thresholds to define the precedence between different preferred classes. Including Return of capital thresholds is optional, and you can mix them with other threshold types in any order. Example: Start with two ROC steps, add a PPU step, and then another ROC step.

Dividends

  • Select the Add dividend checkbox and enter the yearly dividend percentage if your ROC includes a dividend.

  • By default, the dividend is calculated from the initial date of each allocation. A class-level base date or a uniform base date can also be used. The class-level base date applies to a specific class, while the uniform base date is shared across all classes involved in the allocation step.

  • Dividends are calculated with an exponential formula, on a 365/actual basis.

    • This means the daily dividend is calculated as the 365th root of the yearly dividend percentage and the assumption that a year consists of 365 days. An extra day of dividend is paid out in leap years, which consist of 366 days.

Preferred return

This threshold calculates an interest-type return, requiring a specified yearly interest rate and a base date.

Note

Preferred return only distributes the interest, unlike the IRR threshold, which includes both interest and principal in its calculations.

Use case

Use this threshold when you need to allocate interest earnings without returning the original investment amount.

Return multiple

Specify the multiple number and select the classes that the calculation is based on.

Diligent Equity calculates the total investment for all allocations to the selected classes and multiplies the amount by the multiple specified.

Note

  • You cannot enter negative numbers.

  • Choose at least one class to have a base on which the multiple is calculated.

  • Choose any number of classes for the base of multiple calculation. However, it is important to note that this step calculates the incremental amount by subtracting prior distributions to the classes from the target multiple.

Example: if you have set up a multiplier of 2 on Class A and Class B, and there are 1 million Class A shares invested at a PPU of $10 plus 2 million Class B shares invested at a PPU of $20, the total will amount to 2*(1,000,000*$10 + 2,000,000*$20) = $100,000,000. If classes other than Class A and Class B are participating in the distribution, and the Distribution type is Wide, the final calculated threshold is higher than the $100,000,000 calculated above.

Use case

Use this threshold type when you want a multiple specified in the distribution step. Commonly used when the cap table includes performance interest units that start participating at certain predetermined multiples.

PPU (price per unit)

Set up a threshold tied to a given class reaching a certain PPU (price per unit).

Diligent Equity calculates the difference between the desired PPU and the PPU reached by the same class in the previous step. It then multiplies by the number of shares participating in the distribution to get the total incremental proceeds.

Note

  • Select just one class as the reference class.

  • Narrow distribution is not available.

Use case

Use this threshold type when there are participation thresholds (similar to share option exercise prices) set up for some performance interest units (PIUs). Create a separate share class for each different participation threshold and set up a corresponding threshold relative to the base class.

Dollar amount

Set a threshold based on a specific equity value. This threshold can be defined as either an absolute amount (Narrow distribution) or the total proceeds required to be distributed among selected share classes (Wide distribution).

Note

  • The amount is converted to the default currency of the cap table.

  • If a wide distribution is selected, the actual breakpoint may be higher than the dollar amount entered.

  • The next step in the waterfall will equal the dollar amount settings.

Use case

Use this threshold when you have specific dollar amounts in your distribution settings.

IRR (internal rate of return)

Set an internal rate of return, similar to setting an expected yearly interest rate. The total investment of all selected classes is used in the calculation. Add the yearly interest rate expected and the relevant classes for which the IRR is calculated and specify the IRR base date, which marks the starting point for calculating the IRR.

Diligent Equity calculates the difference between the As of date of the waterfall (effective date) and the IRR base date in days. The IRR rate is then applied for the calculated time period.

Note

  • A class-level or uniform base date can be used. The class-level base date applies to a specific class, while the uniform base date is shared across all classes involved in the allocation step.

  • The IRR amount is calculated with an exponential formula, on a 365/actual basis. This means that the daily interest is calculated as the 365th root of the yearly IRR percentage and that a year is assumed to consist of exactly 365 days. As a consequence, an extra day of interest will be paid out in leap years, which consist of 366 days.

Use case

Use this threshold when you have an IRR type clause in your distribution settings.

Catch up to prior distribution

Set up a threshold where a certain class catches up to a percentage of previously distributed proceeds.

Diligent Equity calculates the percentage of the total incremental distribution calculated for the prior step specified in the settings.

Note

The class selected in the settings is the class that receives distributions in this step, not the class that previously received distributions.

Use case

Use this threshold when there are catch-up clauses in the distribution settings.

Catch up to class return multiple

This is a more complex threshold type. It allows one class of equity to catch up to the return multiple achieved by another class in real-time. Both classes receive proceeds simultaneously during this step, meaning the return multiple of the class being caught up to changes with each additional dollar distributed. This ensures that the two classes progress together toward a balanced return.

Diligent Equity calculates the allocation of proceeds between two classes based on a predefined percentage. A portion of each dollar goes to the class catching up, while the rest goes to the other class. The process continues until both classes have equal return multiples. If the return multiple of the catching-up class is already higher, the calculation yields a negative result, reducing the proceeds. Additionally, if the higher-multiple class receives 50% or more of the proceeds, the catch-up calculation becomes ineffective, preventing the balance from being achieved.

Important

  • The assigned percentage must be over 50%.

  • The Class to catch up to and the Class selected cannot be the same.

Use case

Use this threshold when there is a catch up to multiple clauses in the terms.