Distribution waterfall

In private equity investing, distribution waterfall is a method by which the capital gained by the fund is allocated between the limited partners (LPs) and the general partner (GP).[1]


In a private equity fund, the general partner manages the committed capital of the limited partners. The GP usually commits some amount to the fund, usually 1 to 2% of the commitment. When distributing the capital back to the investor, hopefully with an added value, the general partner will allocate this amount based on a waterfall structure previously agreed in the Limited Partnership Agreement.

A waterfall structure can be pictured as a set of buckets or phases. Each bucket contains its own allocation method. When the bucket is full, the capital flows into the next bucket. The first buckets are usually entirely allocated to the LPs, while buckets further away from the source are more advantageous to the GP. This structure is designed to encourage the general partner to maximize the return of the fund.

Typical distribution waterfalls[2]

Waterfalls usually consists of the following phases:


Before the waterfall, the distributed amount is allocated across the partners of the funds. The partners include both GP and LP. The amount distributed to the GP is kept by the GP, while the amount distributed to each LP will then go through the waterfall and be redistributed between the GP and the LP.

Various Allocations

Return of Capital

The first step of the waterfall is to return to the LP at least the amount it was called. We find here a lot of variations on what exactly has to be return. This usually includes the capital called for investments, plus some expenses and fees.

Various Return of Capital

Preferred Return (or Hurdle)

Once the capital is returned, 100% will still be distributed to the LP until a specific IRR is reached. Regardless of whether the waterfall is global or deal-by-deal, this preferred return is always calculated on every cashflows.

The main variations here are in what is included in the payment cashflows. As contribution, the GP may choose to consider only the capital called for investment, or may include the capital called for fees and expenses. For the distribution, the amount previously distributed as carried interest may be excluded.

Various Preferred Return


Catchup is a bucket where strongly favorable to the GP. The rationale of a catchup is to give to the GP all or a majority of the gain, until the share of the profit received by the GP equals the carried interest

The catchup is defined by two elements: an allocation (usually 80% for the GP, 20% for the LP), and a target (in relation to the carried interest).

Various Catchup

Carried Interest

Carried interest is a simple allocation of the remaining amount between LP and GP

Multihurdle waterfall

A GP may decide to define many hurdle rates, each linked to a specific allocation. In this case, the higher hurdles are linked to allocations more favorable to the general partner. An example of hurdle would look like:

Hurdle Carried Interest
Preferred return: 8% 10% / 90%
Hurdle 1: 11% 20% / 80%
Hurdle 2: 15% 25% / 75%

European vs American waterfall

The European waterfall, or global waterfall, means that the hurdle threshold is calculated at fund level.[3][4] The American waterfall, or deal-by-deal waterfall, calculates the hurdle thresholds for each deal. The American waterfall is more favorable to the GP than the European waterfall:

To mitigate the effect of a deal-by-deal waterfall and to make it more attractive to LPs, private equity funds using an American waterfall may include a clawback clause in their LPAs.[5]

Clawback clause

When liquidating the fund, if the LPs were distributed less than the agreed preferred return, they claw back the missing amount from the carried interest distributed to the GP.[5][6] The clawback clause is triggered at the very end of the fund, at a time where the General Partner may have already put the clawback amount to other use.

In August 2010, Blackstone Group returned $3 million in carried interest to the limited partner of a fund as part of a clawback provision.[7]

See also


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