Don’t Go Chasing Waterfalls … Without Consulting Practical Guidance!

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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Related Content

• “American” Style Waterfall Clause (Private Equity Fund)
  Review this example of an American style (often called a “deal-by-deal” or “investment-by-investment”) waterfall that calculates carried interest based on individual liquidity events.

• “European” Style Waterfall Clause (Private Equity Fund)
  Review this European style (or “total return”) waterfall, in which investors must receive 100% of their capital contributions plus a preferred return before the investment manager receives any carried interest. 

• Limited Partnership Agreement Drafting for a Private Equity Fund
  Read this practice note that provides guidance on drafting the distribution waterfall in the context of the larger limited partnership agreement and its composite provisions.

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