Distribution: How Money Returns to Investors

A distribution is a payment out of a private fund to the people who put money into it. The payment moves in proportion to commitments, it arrives on a notice rather than on a date the investor picks, and it is applied in an order the fund's documents fixed in advance. Investor 1 of Nilgiri Growth Partners Fund II, invented, holding 20.0 per cent, has received Rs 87,60,00,000 across four payments to the record date.

What is a distribution, and what has already been settled before one ever arrives?

Think about a chit arrangement in a neighbourhood, or a group of cousins who put money together to buy a shop. Somebody keeps the money, somebody decides what it does, and at some point money comes back out. When it comes back out, three separate things are already true before anybody is told anything: it was decided that money would come out, it was decided how much, and the proportion each person gets was settled long before, on the day they each put their money in. The split was never the thing in question, so nobody argues about it at the moment of payment.

A distributionA payment out of a private fund to the people who put money into it. from a private fund is that, made formal and made large. A distribution is a payment out, and the two questions to answer about one separately are how much left the fund and what that payment actually was. Those are not the same question, and a reader who runs them together has misread the statement in front of them. The first is arithmetic and the second is character. Most explanations answer only the arithmetic.

Three things are fixed before any distribution happens at Nilgiri Growth Partners Fund II. The first is that cash exists to pay out: a fund cannot distribute what it has not received, and how a holding turns into cash is covered under realisation. The second is the proportion, fixed at the fund's final close and unmoved since. The third is the order the money is applied in, set in advance by the fund's own documents and covered separately. The manager is left to decide when, and only when.

Who signs the notice, and what does that document have to carry?

An investor in a closed-end private fund does not ask for money and does not receive it on a date of its choosing. The investor receives a distribution noticeThe document telling an investor an amount is being paid and on what date.. The notice arrives, states an amount, states a date and states which obligation the payment is applied against. Receiving that notice is the whole of the investor's involvement. Both directions of cash in a closed-end private fund travel on notices written by the manager. No other structural fact separates a fund interest so sharply from an instrument the holder can sell on a Tuesday at its own whim.

At Nilgiri Growth Partners Fund II the chain runs through named parties. The manager, Nilgiri Alternatives Advisors Private Limited, invented, decides. Farida Contractor, its chief operating officer, invented, signs both the capital call notices and the distribution notices. Kolar Fund Services Private Limited, invented, is the administrator, and it is the party that takes the total amount and works out what each of the thirteen parties in the fund is due. Then the cash moves. Investor 1, a domestic life insurance company, invented, is at the end of that chain and at no point in the middle of it.

The notice itself is a plain document and it has plain work to do. The notice names the fund, names the total being paid, names the amount payable to that one investor, gives the payment date, and says what it is being applied against. The last line matters most of the five. Two payments of identical size can be two completely different things, and the line describing what the payment was applied against is the only place an investor finds out which.

Why is the proportion settled at final close, and why does it never move again?

Six friends buy a taxi together. One puts in half the money, the rest put in a tenth each. The split was decided the day the money went in, so applying it to the week's takings is arithmetic rather than a conversation. Nobody sits down every month to renegotiate it. A private fund does exactly this, and the day the split stops moving is the day of the fund's final close, when the last investor is admitted and the total is known.

The word for it is pro rataIn proportion to commitments, so every investor receives the same share of every payment., and at Nilgiri Growth Partners Fund II it governs both directions. Every capital call goes out pro rata and every distribution comes back pro rata. Investor 1 committed Rs 1,00,00,00,000 of that fund's Rs 5,00,00,00,000 of total commitments, so its proportion is 20.0 per cent, and 20.0 per cent is what it has been paid on every single distribution the fund has ever made. The proportion was settled years earlier, so payment day is only the multiplication. Nothing about an individual investor's share is ever in question at the moment of payment.

Now the trap, and it is the trap on every proportion in finance. Twenty per cent of what? Investor 1's Rs 1,00,00,00,000 is 20.0 per cent of the fund's Rs 5,00,00,00,000 of total commitments, and that total includes the manager's own Rs 10,00,00,000. Against the twelve investors' Rs 4,90,00,00,000 alone, the very same commitment is 20.4 per cent. Same investor, same rupees, two different percentages, and only one of them is the number the fund actually pays on. A share quoted without naming the total it was taken from has said almost nothing, and this is the single most common way a reader of private fund figures gets quietly misled.

One consequence of the proportion falls out immediately and surprises almost everybody the first time. Because investor 1 has paid 20.0 per cent of everything the fund ever drew, received 20.0 per cent of everything the fund ever distributed, and holds 20.0 per cent of everything the fund still has, every ratio that can be built for investor 1 is identical to the same ratio built for the whole fund. Investor 1's total value against what it paid in is 1.50 times at Nilgiri Growth Partners Fund II's record date, the fund's own figure at the same date, and not the product of anything clever investor 1 did. A ratio of two numbers is unchanged when both of them are multiplied by the same fifth.

An investor's own performance statement in a fund like this is not a report on that investor at all, but a report on the fund with a decimal point moved. The identity also shows where to look when the two do differ: if one investor's ratio departs from the fund's, something is not pro rata, and the usual reason is a term in a side letter. At Nilgiri Growth Partners Fund II six side letters exist and none of them moves investor 1's economics, so its figures and the fund's agree exactly.

What has investor 1 actually received, and how do the four payments add up?

Nilgiri Growth Partners Fund II has made four distributions in its life to the record date at the end of its Year 9 Q2, and every one of them was made in the quarter after the cash was received. The payments were Rs 63,00,00,000 at that fund's Year 6 Q4, Rs 2,03,00,00,000 at its Year 7 Q3, Rs 1,50,00,00,000 at its Year 8 Q2 and Rs 22,00,00,000 at its Year 8 Q4, being Rs 4,38,00,00,000 in total. Four payments in thirty-four quarters, and five full years at the start of the fund's life with no payment at all.

Investor 1's 20.0 per cent applied to each of the four gives its own schedule: Rs 12,60,00,000, then Rs 40,60,00,000, then Rs 30,00,00,000, then Rs 4,40,00,000. The four receipts add to Rs 87,60,00,000. The check the other way holds exactly: Rs 87,60,00,000 is 20.0 per cent of the fund's Rs 4,38,00,00,000, to the rupee, with nothing rounded and nothing left over. The reconciliation is the cheapest possible test of whether the proportion an investor thinks it has is the proportion it is actually being paid on, so it is worth running on every statement that arrives.

Now set that Rs 87,60,00,000 against what investor 1 has actually handed over. The fund has drawn Rs 4,80,00,00,000 of its Rs 5,00,00,00,000 of commitments, being 96.0 per cent. Calls are pro rata too, so investor 1 has paid in 96.0 per cent of its own Rs 1,00,00,00,000, or Rs 96,00,00,000. So it has paid Rs 96,00,00,000 and received Rs 87,60,00,000. The difference is Rs 8,40,00,000, and that difference is not a rounding artefact: it is exactly 20.0 per cent of the Rs 42,00,00,000 by which the fund as a whole is still short of returning the capital it called.

Look at that picture for a moment before moving on. The shape it draws is the honest position of a real private fund in its ninth year, and it looks nothing like the story people tell about these vehicles. Four payments have been made. The largest of them was Rs 2,03,00,00,000. And the investor is still, at the record date, a little behind on its own money. Nothing has gone wrong to produce that. The shortfall is simply what the arithmetic says when a fund has sold some of what it holds and not the rest.

Why is every rupee of that Rs 87,60,00,000 return of capital rather than profit?

Here is the part most explanations of this subject skip, and it is the part that decides whether a statement can be read at all. When money arrives from a fund, the amount is one fact and the character of the payment is a completely separate fact. The character of a distribution is what the payment is being applied against, and two payments of identical size can have entirely different characters. The household version of the question makes it plain. A brother borrowed Rs 3,00,000 two years ago and hands back Rs 1,00,000 this month. The lender is not Rs 1,00,000 better off than before the money went out. The lender is Rs 2,00,000 down and moving in the right direction. The rupees arriving are the lender's own rupees coming home.

A private fund records that difference formally. A payment applied against capital the investor has already put in is a return of capitalA distribution repaying capital already called, before any profit is shared.: the investor is getting its own money back, not earning anything on it. A payment applied after all of that capital is home is a share of profit, and it is a different line on a different part of the statement. The order in which a payment is applied to one and then the other is fixed in advance by the fund's own documents, and that ordering is covered separately. The remaining question is where this particular fund currently stands in that order.

Nilgiri Growth Partners Fund II has drawn Rs 4,80,00,00,000 from its investors over seventeen calls and has distributed Rs 4,38,00,00,000 back over four payments. Rs 4,38,00,00,000 is less than Rs 4,80,00,00,000. The fund is Rs 42,00,00,000 short of having returned the capital it called, so every rupee of the Rs 4,38,00,00,000 has been applied against capital, and there is nothing left over for anything else to have been applied against. The fund therefore records all of it as return of capital, and investor 1's Rs 87,60,00,000, being exactly 20.0 per cent of it, carries the same character to the last rupee.

The consequence is uncomfortable and it is true, so say it out loud. Investor 1 has received four payments across nine quarters, one of them Rs 40,60,00,000, and it has not yet made a single rupee of profit from this fund. Its Rs 8,40,00,000 shortfall is the exact measure of that. A reader who sees money arriving and calls it a gain has misread the statement, and it is the most expensive misreading available on a capital account because it feels like good news while it is happening.

One more figure completes the position, and only one. The rest of the arithmetic is covered separately. Distributions against capital paid in for Nilgiri Growth Partners Fund II, at its record date at the end of its Year 9 Q2, is Rs 4,38,00,00,000 over Rs 4,80,00,00,000, or 0.9125. The denominator has to be named every time the figure is quoted: that is distributions measured against paid-in capital and not against commitments, and the same 0.9125 is investor 1's own figure at the same date for exactly the reason set out earlier. A figure below 1.00 there is not a verdict on anybody. The ratio is a sentence about how much of the called capital has come back at one particular date on this fund's clock, and how a private fund's value traces its whole life, year by year, is covered separately. Two points of that shape and nothing more: this fund's distributions against paid-in capital stood at 0.00 at its Year 5 year end and at 0.9125 at its record date.

Does a distribution always arrive as cash?

No, and the alternative has a name worth knowing. A distribution made in specieA distribution made in the asset itself rather than in cash. hands the investor the asset itself rather than rupees. The classic case is a holding that has listed on an exchange: instead of selling the shares and paying out the proceeds, the fund can pay out the shares. The reported value of the distribution is struck on a stated date and appears on the statement like any other. The investor's account has not received money.

Feel the difference with a small example. A contractor finishes a job and is paid in cash, and a contractor finishes the same job and is paid in bags of cement worth the same amount on paper. Both invoices are settled. Only one of them has been paid in something the contractor can use to meet payroll on Friday. The cement has to be stored, valued and sold, and what it eventually fetches is nobody's promise. An in specie distribution puts an institution in exactly that position, with the added complication that some institutions are not permitted to hold the asset at all and must sell it whether the price suits them or not.

Can a distribution be taken back once it has been made?

Sometimes, in some funds, within limits those funds set for themselves. There is a term for it, a recallable distributionA payment the fund may, under some documents, call back and draw again., and what it means is that an amount already paid out can be added back to the pool of capital the fund is allowed to call again later. The words turn up often. Frequency is not the same as a rule.

Whether a distribution can be recalled is a question about one particular fund's documents and never a general feature of private funds. Some sets of documents provide for it and set out precisely which amounts qualify, for how long and up to what total. Others do not provide for it at all, and in those funds a payment made is simply a payment made. The only honest way to answer the question for any given fund is to read that fund's own documents, and anybody who answers it for private funds in general has revealed something about their own confidence rather than about the funds.

What does a rupee received tell the recipient, and what does it refuse to tell them?

The whole mechanism arrives at one document. The capital accountThe running record of what one investor has contributed, received and is owed. is the running record of one investor's position in one fund, and for investor 1 of Nilgiri Growth Partners Fund II, at its record date, it is five numbers on a single sheet. A commitment of Rs 1,00,00,00,000. Capital contributed of Rs 96,00,00,000. Distributions received of Rs 87,60,00,000, all of it return of capital. Unfunded commitment of Rs 4,00,00,000, being Rs 1,00,00,00,000 less the Rs 96,00,00,000 already paid in. And a share of residual valueAn investor's share of what the fund still holds and has not sold. of Rs 56,40,00,000, being 20.0 per cent of the Rs 2,82,00,00,000 the fund still holds.

The fourth line, the unfunded commitment, is where readers most often reach for the wrong number. The fund as a whole has Rs 20,00,00,000 of unfunded commitment, being the Rs 5,00,00,00,000 committed less the Rs 4,80,00,00,000 drawn. Rs 20,00,00,000 is the fund's figure and not investor 1's. Investor 1's own unfunded commitment is its own subtraction, Rs 1,00,00,00,000 less Rs 96,00,00,000, or Rs 4,00,00,000, and it checks the other way as 20.0 per cent of the fund's Rs 20,00,00,000. Any investor-level figure has to be derived from that investor's own commitment, and lifting the fund's number onto one investor's statement overstates the position by five times here.

So what does a rupee received actually tell the person receiving it? A rupee received establishes that cash reached the fund and left it again. A payment made cannot be re-estimated later, and no valuation can say as much. The receipt is genuinely the strongest fact available. A distribution is the only line on a private fund statement that has already been tested by somebody actually paying.

And then three things it does not establish, each of which people read into it anyway. The receipt does not establish that the payment was profit. The character of the payment is a separate line, and on this statement that line says return of capital. The receipt does not establish that the investor's obligations are finished either. Rs 4,00,00,000 remains callable from investor 1 for the fee and expenses of the six quarters that remain in this fund's contracted ten-year term. And it establishes nothing at all about the Rs 56,40,00,000 still sitting in unsold holdings, a valuation of five companies, one of them written down, none of them sold to anybody.

How does an investor's treasury actually use a distribution notice?

The mechanism stops being theory at an institution's treasury desk. An institution holding a private fund position runs a small, dull, repeated procedure every time a notice lands, and the procedure exists because each step of it has burned somebody.

First, reconcile the notice against the proportion. Take the fund-level total on the notice, apply the proportion the institution believes it has, and check the rupee figure the notice actually states. Rs 2,03,00,00,000 at 20.0 per cent is Rs 40,60,00,000. If that check fails, something is wrong with the notice or with what the institution thinks it committed, and either is worth finding out before the cash arrives rather than after. Second, read the character line. Capital and profit land in completely different places in a treasury's own books and, in many institutions, in front of completely different committees, so the treasury needs to know which of the two the payment is.

Third, and this is the step that matters most, do not release the unfunded commitment. Investor 1's Rs 4,00,00,000 is still callable at the record date, and money arriving from the fund does not reduce that obligation by one rupee. Only the fund's own documents can make a repaid amount callable again, and that is the recall question, settled for one fund alone. A treasury that sees Rs 87,60,00,000 come in and quietly redeploys the Rs 4,00,00,000 it was holding against future calls has to find that money again at short notice when the next notice arrives. A fund in its ninth year still has a fee and expenses to pay, so the next notice will arrive.

Fourth, keep the residual value in the estimate column. An analyst building the institution's own view of this position should be able to say, in one sentence, how much of the Rs 1,44,00,00,000 of total value has been received in cash and how much is a valuation. Here it is Rs 87,60,00,000 against Rs 56,40,00,000, and how a fund splits what has come back from what is still an estimate, and how those unsold holdings are valued at all, are both covered separately. The point for the treasury is simply never to let the two sit in one column with one heading.

One last framing, and it belongs to somebody else's book. Andrew Ang, in Asset Management, 2014, treats the fact that an investor cannot choose its own timing as a property of the asset that has to be paid for rather than an inconvenience to be worked around. Every mechanism above is that property in its concrete form: notices the investor does not write, dates it does not pick, amounts it does not set, and a proportion fixed years before any of it. Whether that is a trade worth making is a question for each particular institution.