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Sponsors organize and operate private equity funds to generate profits for themselves and their investors. The two primary ways in which fund sponsors are compensated for their efforts are through a management fee and a carried interest, or performance, fee. This second type of compensation, carried interest, is made possible through a technical and heavily negotiated provision in a fund’s limited partnership or operating agreement: the distribution waterfall. This practice note provides a general overview of what distribution waterfalls are in the context of private equity funds; identifies basic types of distribution waterfalls, their general operation, and mechanics by way of example; and suggests related topics for consideration when drafting, reviewing, and negotiating distribution waterfall provisions.
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