Waterfall
A waterfall is the distribution framework defining how profits are allocated between LPs and the GP, including preferred return and carry.
Definition
A waterfall specifies the order and proportions by which distributions are paid to LPs and the GP. It typically outlines return of capital, preferred return, catch-up provisions, and the carried interest split. Waterfalls are central to fund economics and incentive alignment. Allocator Context Allocators analyze waterfall structures to understand expected net outcomes under different scenarios. They also assess whether the structure is consistent with market standards and whether it prevents situations where the GP is overcompensated before LPs have received adequate returns. Decision Authority Waterfall terms are reviewed by investment teams, legal counsel, and often require approval for exceptions or nonstandard mechanics. Large LPs may negotiate customized terms via side letters or parallel arrangements. Why It Matters for Fundraising A manager that can clearly explain the waterfall and provide transparent fee and carry examples reduces late-stage friction. Confusion here commonly delays closes. Key Takeaways Waterfall defines distribution order and economics Structure determines alignment and net returns Nonstandard mechanics raise diligence burden Clear communication accelerates approvals