A reserve for late claims keeps the fund alive and the LPs' cash idle. Both have a price, and it belongs next to the chance of a recall.
Hold back the fund's known wind-down costs for as long as it must stay alive, plus a reserve for contingent claims sized against what it costs the LPs to have cash sitting in the fund. On an illustrative fund with $84.0m left after its last exit, wind-down costs are $0.50m if it can dissolve in six months and $1.025m if it must stay alive two years to cover an indemnity window. Reserving the full $6.0m indemnity cap then costs LPs $1.352m, 22.5 per cent of the amount held, to remove a 25 per cent chance of a later recall.
Worked in full in The Private Equity Fund Controller Playbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The final distribution is the controller's last real decision on a fund, and it is usually made under pressure from both sides. LPs want the cash and a clean final DPI. The GP wants to avoid the embarrassment of recalling money after it has said goodbye. The limited partnership agreement typically allows the GP to retain reserves for liabilities and expenses, and many agreements also allow distributions to be recalled under a giveback clause. Between the two, the reserve is a sizing question with a price on each answer.
| Input | Value |
|---|---|
| Cash available | 84.0 |
| Paid-in capital / distributions to date | 480.0 / 760.0 |
| Administrator, a year / audit and tax return, per year-end | 0.150 / 0.180 and 0.120 |
| Legal and dissolution / other costs | 0.090 / 0.035 |
| Indemnity window and cap | 2 years, 6.0 |
| Claims: none / 1.5 / 6.0 | 75% / 15% / 10% |
| Interest earned on cash held / LPs' opportunity cost | 4% / 12% |
Dissolve in 0.5 years: 0.075 admin + 0.180 audit + 0.120 tax + 0.090 + 0.035 = 0.500
Stay alive 2.0 years: 0.300 + 0.360 + 0.240 + 0.090 + 0.035 = 1.025
Holding any contingent reserve keeps the fund, its audit and its tax filings alive for the indemnity window. That adds 0.525 before a dollar of reserve is counted.
Opportunity cost = reserve × [1 − ((1 + cash rate) ÷ (1 + LP rate))years]
= reserve × [1 − (1.04 ÷ 1.12)²] = reserve × 13.78%
In Excel: =Reserve*(1-((1+4%)/(1+12%))^2)
Expected claim = 15% × 1.5 + 10% × 6.0 = 0.825
For each reserve size: probability of a recall = probability the claim exceeds the reserve; expected recall = Σ probability × (claim − reserve)
| Contingent reserve | Final distribution | DPI at final | Price of reserve | Chance of a recall | Expected recall |
|---|---|---|---|---|---|
| 0.0 | 83.500 | 1.757 | 0.000 | 25% | 0.825 |
| 1.5 | 81.475 | 1.753 | 0.732 | 10% | 0.450 |
| 3.0 | 79.975 | 1.750 | 0.938 | 10% | 0.300 |
| 6.0 | 76.975 | 1.744 | 1.352 | 0% | 0.000 |
Distributions to date give a DPI of 1.583; the final distribution adds 0.174 with no reserve and 0.160 with the full one. The difference is temporary: any unused reserve is distributed when the window closes, so once claims are paid the expected DPI ends between 1.754 and 1.756 whichever option is chosen. What is not temporary is the price. The reserve is not a cost because claims are paid either way; it is a cost because it holds LP money at 4 per cent for two years and keeps a fund running that could have closed.
Look at where the price comes from. Moving from no reserve to 1.5 costs 0.732, of which 0.525 is simply the cost of keeping the fund alive, and cuts the chance of a recall by 15 points. Once the fund is alive anyway, going from 1.5 to the full 6.0 costs only 0.620 more, 13.8 cents per dollar held, and removes the last 10 points. That is why a partial reserve is often the worst of both: it pays the fixed cost of staying open and still leaves the GP exposed to the claim that matters.
| LP opportunity cost | Price of full reserve |
|---|---|
| 8% | 0.961 |
| 12% | 1.352 |
| 16% | 1.702 |
Reserving only the expected claim, 0.825, would cost 0.639, but it is not a real option: claims arrive whole, so a reserve at the expected value is either too much or far too little. The giveback clause is the alternative. A cap of 25 per cent of the final distribution would allow 20.88 to be recalled, well above the 6.0 cap on the indemnity, so the LPs' past distributions can stand behind the claim. Whether that is acceptable depends on the clause's window and caps, worked through in how much an LP can be made to return under a giveback clause, and on whether the GP is willing to make that call.
Sizing the reserve as the maximum exposure plus a margin, and treating it as free because the cash comes back. It does come back, but two years late and after paying for a fund that could have dissolved: here 1.352 of value for a 6.0 reserve. The opposite mistake is to budget the wind-down costs for a six-month dissolution and then hold a contingent reserve that keeps the fund open for two years; the budget is short by 0.525 before any claim. The reserve and the running costs have to be sized together. On exits with escrow, the controller should also check what the escrow receivable already covers, as in the realised and unrealised gain on a fund exit, so the fund does not reserve twice for the same claim.
Budget the wind-down for the life the reserve imposes, price each reserve at its opportunity cost to the LPs, and put the chance of a recall beside it. Here the choice is between 0.000 and a 25 per cent chance of recalling, or 1.352 for none, with little sense in between. The distribution mechanics, recallable treatment and capital accounts behind a final distribution are built in the free workbooks for The Private Equity Fund Controller Playbook.
Cash the GP keeps back from the final distribution to pay the fund's remaining costs and any late liabilities, such as indemnity claims from the buyer of a portfolio company. Unused amounts are distributed when the risk lapses. In the illustrative fund a full reserve of $6.0m plus $1.025m of running costs cuts the final distribution from $83.500m to $76.975m.
The return they forgo while the cash sits in the fund, plus the costs of keeping the fund alive. With cash earning 4 per cent and LPs valuing money at 12 per cent, each dollar held for two years costs 13.78 cents, and the longer life adds $0.525m of audit, tax and administration: $1.352m in all for a $6.0m reserve.
Often, if its LPA has a giveback clause with a window and caps that reach the final distribution. Illustratively, a cap of 25 per cent of an $83.500m final distribution allows $20.88m to be recalled, enough for a $6.0m claim. The trade-off is a 25 per cent chance of having to ask LPs for money after the fund has wound up.
This article is one calculation from The Private Equity Fund Controller Playbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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