What is a distribution waterfall in private equity?

The contractual order in which a fund's cash flows are split between limited partners and the general partner: return of capital to LPs, then the preferred return, then a GP catch-up, then the carry split (commonly 80/20).

What is the difference between a European and American waterfall?

A European (whole-fund) waterfall returns all paid-in capital and the preferred return to LPs across the entire fund before the GP earns carry. An American (deal-by-deal) waterfall lets the GP earn carry on each exited deal sooner, which is why GPs prefer it. A clawback lets LPs recover carry overpaid if later deals underperform.

What is the GP catch-up?

After LPs receive their preferred return, the catch-up gives the GP a run of distributions (often 100%) until the GP has earned its carry percentage of the profit distributed above the return of capital. With a full catch-up, the GP ends at its carry rate of total profit.

Distribution Waterfall - How PE Fund Profits Are Split

A distribution waterfall is the order in which a fund's cash flows are split between its limited partners and the general partner. It runs in tiers, and each tier must be satisfied before the next one pays. The standard order is: return of capital to LPs, then the preferred return, then a GP catch-up, then the carried interest split, commonly 80% to LPs and 20% to the GP.

Why it matters

The waterfall is how the alignment between LPs and the GP is actually enforced. It puts LPs first: the GP earns its carry only after investors have their capital back and a minimum return. The shape of the waterfall, and especially whether it is whole-fund or deal-by-deal, decides how soon the GP sees carry and how much risk LPs carry along the way.

The four tiers

1. Return of capital. LPs receive their paid-in capital back. 2. Preferred return. LPs receive a minimum annual return, most commonly 8%, before the GP shares in profits. 3. GP catch-up. The GP then receives a run of distributions (often 100%) until it has earned its carry percentage of the profit above the return of capital. 4. Carry split. Everything beyond the catch-up splits at the carry rate, typically 80/20.

Worked example

Where the profit goes

A fund returns $250M on $100M of paid-in capital, a $150M profit, with an 8% preferred return over five years and 20% carry. LPs first take back their $100M and roughly $47M of preferred return. The GP then catches up about $12M, and the remaining roughly $91M splits 80/20. With a full catch-up the GP ends with $30M, exactly 20% of the $150M profit, and LPs receive $220M. Adjust the inputs in the calculator below.

European vs. American

In a European (whole-fund) waterfall, the GP earns no carry until LPs have been returned all invested capital across the entire fund. In an American (deal-by-deal) waterfall, the GP can earn carry on each exited deal sooner, which is why GPs prefer it. A clawback provision lets LPs recover carry that was overpaid if later deals underperform. The cash actually returned through the waterfall is what shows up in DPI.

The common mistake

Modeling a "waterfall" that is really just a flat 80/20 split. Dropping the preferred return or the catch-up changes who gets paid and when, and overstates the GP's early economics. A correct model runs all four tiers in order.