Corporate and Project Finance Modeling

Chapter 11Alternative Calculations of Equity Distributions

The final aspect of allocating free cash flow in a financial model relates to the manner in which dividends are paid to equity holders and new equity issues or buybacks are added to a model. Some shareholder agreements may distribute dividends using complex formulas rather than simply allocating common dividends in a proportionate manner to all shareholders. These agreements define the manner in which some investors receive a priority on the cash flow after debt service relative to others, which is analogous to the way in which loan agreements define priorities on free cash flow. Shareholder distribution structures can involve a technique known as a flip where one group of priority or senior shareholders is allocated the majority of dividends until a given internal rate of return (IRR) criterion is met. After achieving the IRR target, the dividend distribution scheme changes and the second investor receives a majority of the dividends. Other dividend structures known as ratchets can allocate a portion of cash flow in excess of a target to management or to developers. In these structures management may receive 10 percent of the excess cash flow after a target IRR of 20 percent is obtained. In acquisition transactions, earn-out provisions can be established whereby a portion of the purchase price is allocated to existing owners, but they are allowed to share in upside profits only after a defined target is obtained.