Mistakes are a reality in business in general, and in financial modeling in particular. Humans are fallible, and the more times we touch our spreadsheets it seems, the more mistakes we make in them. Tolerance for mistakes varies person by person and situation by situation, but modeling mistakes are generally least tolerable when it comes to calculating profit splits among equity partners. People can get emotional when it comes to profit splits.
Here are four commonly-made mistakes when it comes to modeling waterfalls:
1. Calculating accruals at the wrong rate
- Monthly IRR-based at Annual IRR %/12 instead of (1+Annual IRR %)^(1/12)-1
- Monthly IRR-based at Annual %
- Using IRR when XIRR is stipulated
- Making non-cumulative when it should be cumulative, or vice versa
2. Not observing priority of distributions
- Distributing the Pref pari passu when it is only to be distributed to the investor
3. Misinterpreting the promote
- Is the quoted promote % inclusive of the sponsor’s ownership share or in addition to it?
4. Over-distributing to one of the parties at a higher tier by not netting out prior tier distributions.
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