Definition
What is Waterfall Distribution?
The sequential order in which fund proceeds are paid out to investors and the General Partner per the partnership agreement.
A waterfall is the contractual order specified in a Limited Partnership Agreement (LPA) for distributing fund cash flows. The "waterfall" metaphor captures the cascade: each tier must be fully satisfied before any cash flows to the next tier.
Standard four-tier waterfall (PE/VC):
1. Return of capital (ROC) — LPs receive 100% of distributions until they have received an amount equal to their total contributed capital.
2. Preferred return ("hurdle") — LPs receive 100% of distributions until they have received an 8% per annum compounded return on contributed capital. This is the LP's reward for taking the risk before the GP earns anything beyond base fees.
3. GP catch-up — once the hurdle is met, the GP receives 100% (sometimes 80%) of further distributions until the GP has received an aggregate amount equal to 20% of all profits above the original LP capital. This is the "catch-up" — letting the GP catch up to its 20% promote on the entire profit pool.
4. Final split — beyond the catch-up, all further distributions split 80% to LPs / 20% to GP. This is the steady-state carried interest.
Variations: - No catch-up waterfall — LP receives 80% of post-hurdle profits, GP receives 20%, without a catch-up tier. Less GP-favourable, used in some pension-fund-anchored funds. - Tiered carry — carry percentage increases at higher return tiers (e.g. 20% up to 2x money multiple, 25% above 2x). Aligned with outperformance. - Clawback — at fund wind-up, if total LP returns fall below the hurdle, the GP must return previously-distributed carry. Without clawback, GPs collecting early wins can walk away if later losses cancel them.
Worked example: LP commits NZ$10M. Fund returns NZ$25M over 7 years (2.5x MOIC). - Tier 1: LP receives NZ$10M (return of capital). - Tier 2: LP receives NZ$5.86M (8% × 7 years on NZ$10M). - Remaining profit pool: NZ$25M - NZ$15.86M = NZ$9.14M. - Tier 3 (catch-up): GP receives the lesser of (a) the remaining pool or (b) the amount needed to bring GP share to 20% of total profits above ROC = 20% of NZ$15M = NZ$3M. GP receives NZ$3M. - Tier 4: Remaining NZ$6.14M splits 80/20 — LP NZ$4.91M, GP NZ$1.23M. - LP total: NZ$10M + NZ$5.86M + NZ$4.91M = NZ$20.77M (2.08x net). - GP total: NZ$3M + NZ$1.23M = NZ$4.23M.
All numeric examples here are illustrative; real fund mechanics depend on the specific LPA wording.
Related Terms
Carried Interest
The General Partner's share of fund profits above a hurdle rate — typically 20% — that aligns the manager's incentives with the limited partners'.
GP / LP Structure
The General Partner / Limited Partner structure used in NZ Limited Partnerships, where the GP manages and bears unlimited liability while LPs are passive with capped liability.
Limited Partnership (LP)
A fund structure where investors are limited partners with flow-through taxation and liability limited to their investment.
Private Equity (PE)
Investment in established private companies through buyouts, growth capital, or restructuring.
Educational Content Disclaimer
This glossary provides general educational information only and does not constitute financial, legal, or tax advice. Definitions and explanations are simplified for educational purposes and may not cover all aspects or nuances of each term.
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