Photo: Arnar Valdimarsson
A reader has just been hired by a fund-of-funds and asks: "what does my boss mean when he talks about a European distribution waterfall?"
Simply, the waterfall refers to the sequence in which proceeds from the sale of a portfolio company are distributed. European private equity funds don't usually pay carry to the fund manager until all capital that has been drawn down has first been returned to the investors.
- All drawn down capital is repaid to the LPs (cash that was called for realised and unrealised investments, management fees, other expenses of the fund), then
- The investors are paid a preferred return on all drawn down capital. This hurdle rate is typically an 8% IRR. And only then,
- The manager starts to get a 20% share of the remaining proceeds (usually with a catch up).
An American waterfall is more GP friendly. Most American private equity managers begin to receive a share of the profits (carry) as soon as they have returned the drawn down capital and paid a preferred return on the fund's realised investments. They don't have to return capital on investments that still remain unrealised within the fund . . . this difference can bring forward carry payments by many years.
Hope this helps. Enjoy your new job!