Definition
Distribution Waterfall
A distribution waterfall is the order in which a fund's proceeds are split between LPs and the GP.
Proceeds typically flow in tiers: first, return of LP capital; second, the preferred return (hurdle); third, a GP catch-up; and finally, the remaining profits split (commonly 80/20) between LPs and the GP as carried interest. The structure ensures LPs are made whole before the GP earns most of its carry.
Waterfalls can be 'European' (carry only after the whole fund clears the hurdle) or 'American' (deal-by-deal). The choice materially affects when the GP receives carry and is a key negotiation point with LPs.
Related terms
- Carried InterestCarried interest, or carry, is the share of a fund's profits that the general partner keeps as performance pay, typically around 20% and only after investors clear a minimum hurdle return.
- Hurdle Rate (PE)A hurdle rate, or preferred return, is the minimum annual return that limited partners (LPs) must earn on their capital before the fund manager (GP) becomes entitled to any share of the profits, known as carried interest.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.