Distribution Waterfall

The waterfall is set out in the fund's legal agreement. Money flows down through a series of tiers, with each tier filled before the next receives anything.

A typical private equity waterfall has four tiers. First, investors receive back their invested capital. Second, investors receive their preferred return, often 8% a year. Third, a catch-up gives the manager a large share of further profits until it has received its agreed share, often 20%, of total profits. Fourth, remaining profits are split, typically 80% to investors and 20% to the manager.

For example, if a fund's total profit after returning capital is 100,000,000 and the full catch-up is reached, the manager receives about 20,000,000 and investors about 80,000,000.

Waterfalls may be European, also called whole-fund, where the manager receives carried interest only after investors get back all their capital across the whole fund, or American, also called deal-by-deal, where carry can be paid on individual successful investments earlier. European waterfalls are generally more protective of investors.