What it is
A waterfall is the order in which distributable cash is paid out. In a European (whole-fund) waterfall, LPs get back all contributed capital across the fund plus the pref before the GP receives any carry. In a deal-by-deal (American) waterfall, each property is run through the waterfall separately, so the GP can earn carry on an early winner before later deals are known.
How it works
Worked example (illustrative only; ignores fees, expenses and timing). An LP puts $100,000 into Deal A and $100,000 into Deal B. Deal A is sold after one year for total distributable cash to that LP of $150,000. Deal B later returns only $80,000.| Step (Deal A) | LP | GP |
|---|---|---|
| 1. Return of capital | $100,000 | – |
| 2. 8% preferred return | $8,000 | – |
| 3. Remaining $42,000 split 80/20 | $33,600 | $8,400 |
| Total | $141,600 | $8,400 |
Under a pure deal-by-deal waterfall the GP keeps $8,400 from Deal A even though Deal B lost $20,000. Across both deals the LP contributed $200,000, received $221,600, and fund-level profit is $30,000, so 20% of total profit would be only $6,000. Under a European waterfall the GP would have been paid nothing until the LP had $200,000 back plus the pref. This gap is why a clawback is essential in deal-by-deal funds (see Carried Interest & Clawback).
Good for LPs vs. watch out for
✓ Good for LPs
- European waterfall, or deal-by-deal with a fund-level clawback
- Losses on realized deals counted before carry on later deals
- Escrow/holdback of carry to fund the clawback
- Clear, worked examples in the PPM
⚠ Watch out for
- Deal-by-deal carry with no clawback, or clawback with no security
- Clawback only tested at the very end of a long fund life
- Clawback reduced by “taxes paid” with no cap
- Waterfall defined only in prose with no examples
How Story Samurai Investments handles it
The template uses a deal-by-deal waterfall: (a) return of capital and allocable fees/expenses, (b) 8% pref, (c) catch-up [PLACEHOLDER – if any], (d) 80% LP / 20% GP (LPA §5.2). To protect LPs from the gap shown above, it adds a fund-level clawback tested at final liquidation and at [PLACEHOLDER – interim test dates], secured by escrow of [PLACEHOLDER – e.g. 25–30%] of each carry distribution (LPA §5.3–5.4). The PPM includes the same $100,000 worked example (PPM §6).
Based on our template documents (TEMPLATE, DRAFT FOR ATTORNEY REVIEW, NOT FOR USE). The final Limited Partnership Agreement controls.
Where to find it in the documents
- LPA §5.1–5.4
- PPM §1, §6
- Risk Factors #9