Distribution waterfall
The order in which a fund's proceeds are paid out to LPs and the GP.
In a whole-fund waterfall, sometimes called European, LPs get all their contributions plus the hurdle back before the GP takes carry. In a deal-by-deal waterfall, sometimes called American, the GP can take carry earlier on each realised investment, which is why clawbacks matter.
A typical whole-fund waterfall has four steps: return of all contributed capital to LPs, the preferred return to LPs, the GP catch-up, and then a split such as 80 percent to LPs and 20 percent to the GP. Deal-by-deal waterfalls apply similar steps to each investment as it is sold.
Some funds use hybrids, such as deal-by-deal carry held in escrow or paid only once the fund has returned a set multiple of capital. The waterfall interacts with fees, expenses and the clawback, so LPs model it closely during diligence.
Worked example
A $100M fund invests $50M in each of two companies. Company A sells early for $80M. Under a deal-by-deal waterfall the GP could take 20 percent of the $30M gain, $6M, straight away. Under a whole-fund waterfall the GP takes nothing yet, because LPs have not received their full $100M plus the hurdle. If Company B later returns only $20M, the fund breaks even and the whole-fund GP never earns carry.
Common questions about distribution waterfall
What is the difference between a European and an American waterfall?
A European, or whole-fund, waterfall pays carry only after LPs receive all contributed capital and the preferred return. An American, or deal-by-deal, waterfall lets the GP take carry on each profitable investment as it is sold, protected for LPs by a clawback.
Which waterfall do LPs prefer?
Most institutional LPs prefer a whole-fund waterfall because carry is paid only when the fund as a whole is in profit. Deal-by-deal structures remain common in US buyout funds but usually come with stronger clawback protection.