Glossary · Fund economics

What is a distribution waterfall?

A distribution waterfall is the order a fund pays out proceeds: investors’ capital, then the preferred return, then the manager’s catch-up, then the split of what remains.

In practice

The waterfall is written into the LPA’s distribution provisions, and it applies each time the fund distributes after an exit, not just at the end. Terms vary on whether the return test runs across the whole fund or deal by deal, and on whether the catch-up is full, partial or absent. Often confused with the carry percentage, which is only the last tier.

An example

Round numbers, not a real fund

Say a fund has $130 million to distribute on $100 million invested, with an 8% hurdle. Investors get their $100 million, then the hurdle amount, and only then can the manager earn carry.

Why it matters

It decides who gets paid first, and so when a manager’s carry actually starts.

A definition, not advice; where usage varies the entry says so. Something wrong? Tell the desk.

Related terms

European waterfallA European, or whole-fund, waterfall pays the manager carry only after investors have received all their paid-in capital, plus the preferred return, across the entire fund.
American waterfallAn American, or deal-by-deal, waterfall lets the manager earn carry on each sale as it happens, usually after investors recover that deal’s cost and a share of fees.
Hurdle rateA hurdle rate, or preferred return, is the minimum yearly return, often 8%, that investors must receive before the manager can start earning carried interest.
GP catch-upThe catch-up is the part of a fund’s waterfall, after the hurdle, where the manager takes most or all distributions until it holds its full share of the profit.
Carried interestCarried interest is the share of a fund’s profits, typically 20%, that the manager earns after investors get their money back and clear the preferred return.

The terms, in the news each morning.

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