Waterfall
A waterfall is the distribution framework that determines how cash flows are split between LPs and the GP, including return of capital, preferred return, catch-up, and carry.
Allocator relevance: Defines net outcomes—small changes in waterfall mechanics can materially change LP returns and alignment.
Expanded Definition
Waterfalls set the order of distributions: typically return of capital → preferred return → catch-up → carried interest splits. Variations include deal-by-deal vs whole-fund waterfalls, European vs American styles, and different clawback protections. The waterfall interacts with fees, recycling, and subscription line usage, all of which affect timing and economics.
Allocators model waterfalls to understand expected net performance under different scenarios and to test alignment of interests.
How It Works in Practice
Distributions occur as exits happen. The fund administrator calculates allocations per the LPA and side letters. Over time, clawback may apply if early carry is overpaid relative to final outcomes.
Decision Authority and Governance
Governance is contractual (LPA) and operational (administrator accuracy, audit). LPAC may be involved in disputes or conflict situations affecting distributions.
Common Misconceptions
- Waterfalls are standardized across funds.
- Preferred return guarantees fairness.
- Clawback is automatic and frictionless.
Key Takeaways
- Waterfall mechanics determine net alignment.
- Model outcomes, don’t trust headlines.
- Clawback enforceability matters.