Distribution Waterfall
Financial Mechanisms
In Short
A distribution waterfall is the method outlined in the LPA that dictates how profits from a fund's investments are allocated between investors (LPs) and the manager (GP). It ensures LPs receive their initial capital and a preferred return before the GP earns performance fees.
detailed Definition
A distribution waterfall is the framework that governs how investment proceeds are allocated among stakeholders in a private equity, venture capital, or real estate fund. It establishes the sequence and proportion in which returns flow to Limited Partners (LPs) and the General Partner (GP), and is a central feature of the Limited Partnership Agreement (LPA).
Waterfall structures are designed to align incentives and ensure that LPs are compensated before the GP participates in the upside. While structures vary across funds, most follow a common sequence:
• Return of Capital: LPs receive back their contributed capital before any profits are shared.
• Preferred Return (Hurdle): LPs are then paid a preferred annual return—typically 7–9%—on their invested capital.
• Catch-Up: Once the preferred return is met, the GP may receive a larger portion of the next profits—often 100%—until the profit split aligns with the agreed terms.
• Carried Interest: After the catch-up, remaining profits are shared according to the carried interest structure—commonly 80% to LPs and 20% to the GP.
The distribution waterfall provides a clear, pre-agreed formula for value-sharing that underpins transparency, trust, and performance alignment throughout the life of the fund.
Important Information
CapGain does not make investment recommendations and no communication, through this website or otherwise should be construed as a recommendation of any security. Alternative investments in private placements are highly illiquid, speculative, and involve a high degree of risk. Past performance is not indicative of future results. Investors may not get back their money originally invested and those who cannot afford to lose their entire investment should not invest. Prior to investing, carefully consider the respective fund documentation for details about potential risks, charges, and expenses. The value of an investment may go down as well as up. An investment in a private equity ("PE") fund or investment vehicle is not the same as a deposit with a banking institution. Investors receive illiquid and/or restricted membership interests that may be subject to holding period requirements and/or liquidity concerns. Investors who cannot hold an investment for the long term (at least 10 years) should not invest. In the most sensible investment strategy for PE investing, PE should only be part of your overall investment portfolio. The PE portion of your portfolio may include a balanced portfolio of different PE funds.
The CapGain platform may be accessed by certain international investors globally, including ‘Professional Investors’ (as defined by the DFSA) in the UAE, on a cross-border basis after appropriate checks and confirmation of their status. CapGain’s products are not suitable for retail investors in the UAE.