Distribution Waterfall

A distribution waterfall defines who is paid what, and in which order, when a closed-ended fund distributes proceeds. A typical structure has four tiers: return of contributed capital to limited partners; a preferred return at the hurdle rate; a general partner catch-up; and a split of remaining profits, commonly 80/20, with the GP share being carried interest.

Waterfalls are either European (whole-of-fund), where carry is paid only after investors have received all contributed capital plus the preferred return, or American (deal-by-deal), where carry can be paid on individual realized investments, usually with escrow and clawback protections.

Operational pitfalls include misreading the LPA definitions of contributed capital (for example whether fees count), compounding the preferred return incorrectly, ignoring recycled distributions, and tracking clawback exposure poorly. Waterfalls should be modeled at investor level and reconciled to each capital account.

Example

LPs contributed $10M and the fund distributes $13M ($3M profit). Tier 1: $10M return of capital to LPs. Tier 2: 8% preferred return, $0.8M to LPs. Tier 3: full GP catch-up of $0.2M, so the GP has 20% of the $1.0M of profit distributed so far. Tier 4: remaining $2.0M split 80/20, $1.6M to LPs and $0.4M to the GP. Total GP carry = $0.6M, exactly 20% of the $3M profit.