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 thegeneral 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 interestsplit, 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 inDPI.

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.