Preferred Returns calculations?
I know this would be a legal issue, check with your lawyer and all that, but I've got a couple of documents I want to make sure I understand, because someone I know is giving me a different read of what I think is really a pretty simple issue. (I know that I could be completely wrong, of course.)
It seems to me that both of the below scenarios are really the same - cash pays expenses, bills and such, then preferred returns, then excess returns are split according to percentage of ownership. (Seems to me Doc A unnecessarily splits out Managers then Members on the excess, but since it's in proportion to ownership, order doesn't matter, right?) What my friend thinks however, is that this goes expenses, bills, and such, then excess is split by ownership but the preferred return gets paid first. This appears to me non-sensical as the preferred returns are clearly a section followed by a separate section, just the same as the expenses come off the top first, then what's left is shared out in order. Does that make sense? Am I reading this wrong?
Document A:
Except as otherwise provided in this Agreement or required by law, distributions of cash receipts of the Limited Liability Company shall be in the following order:
-To the Asset Manager of the Limited Liability Company his fees as described herein;
-To pay the debts and expenses of the Limited Liability as they become due;
-The establishment of a necessary reserve of funds as determined by the Managers in their sole discretion;
-To [redacted] of a preferred return as described herein;
-To the non-managing Members of the Limited Liability for their preferred return as described herein;
-To the Managers in proportion to their membership interest and finally to the Members in portion to their membership interest.
Document B:
Section 4.02 Cash Receipts. The cash receipts of the Company shall be applied in the following order of priority:
(1) To pay the debts and expenses of the Limited Liability as they become due;
(2) To the Asset Manager of the Limited Liability Company his fees as described herein; then
(3) The establishment of a necessary reserve of funds as determined by the Managers in their sole discretion; then
(4) To the Members of the Limited Liability for their preferred return as described herein;
(5) To the Members in proportion to their membership interest; and
Section 4.03 Preferred Returns. Notwithstanding anything in this Operating Agreement to the contrary, the non-managing Members identified on Exhibit A as “entitled to preferred returns” shall be entitled to an 8% preferred return on their invested capital beginning January, 2016, and each year thereafter. All cash equity preferred returns will be distributed equally amongst the members as described below. Distributions to the Members shall be made at least quarterly, if available
Numerical examples that might make more sense: assume for simplicity $100k cash flow. $200k equity to purchase. Equity ownership is 60%, manager ownership 40%. Preferred return is 10%.
My idea is of $100k, preferred return is $20k. Equity investors get 60% of remaining $80k ($48k), managers get 40% of the remaining $80k ($32K). Equity investor total return (of CF) is $68k.
My friends idea is of $100k, preferred return is still $20k. CF is split equity 60%, managers 40%. Equity investors get $20k first, but of $100k, equity would get only $60k and managers $40k.
In both situations, we agree that managers get nothing until the preferred return is met.
Hopefully this made sense. Thoughts?