Section II
The Distribution Waterfall
The order in which every dollar is paid out, and the tier where the sponsor's share changes.
The waterfall is the part of a syndication that decides what you actually receive, and it is the part least likely to be explained in the marketing deck. It is an ordered list: money arrives at the top, fills the first obligation completely, and only then flows to the next. Return of capital, preferred return, a catch-up, then one or more splits that shift in the sponsor's favor as performance improves. Every term in that list has more than one common definition, and the differences are not cosmetic. A preferred return that compounds and one that does not can differ by a fifth of the total over a five-year hold. A hurdle measured on internal rate of return rewards a sponsor for selling early; one measured on equity multiple does not. This section defines each tier, shows the arithmetic on hypothetical numbers, and points at the clauses where the definitions hide.
All 11 articles in this section
- 01WaterfallPillarHow the Distribution Waterfall Works, Tier by TierThe waterfall is an ordered list, not a formula. Each tier fills completely before the next receives anything, and the order is where the money is.
- 02WaterfallReturn of Capital: Why Tier Order Decides EverythingThe tier that repays your principal can sit first in the waterfall or last. Moving it changes whether the sponsor earns a promote on profit or on your own money.
- 03WaterfallPreferred Return: Cumulative, Compounding, and Why the Difference Is MoneyFour one-word choices inside a definition decide what "8% preferred" is worth. All four produce the same phrase in the marketing material.
- 04WaterfallThe GP Catch-Up and How It Eats the Next DollarThe tier that pays the sponsor while appearing to pay nobody. It converts a preferred return from a permanent priority into a question of timing.
- 05WaterfallThe Promote: What the Sponsor Earns Above the HurdleA disproportionate share of profit, earned on capital the sponsor did not contribute. It is the central incentive and the most negotiable number in a deal.
- 06WaterfallHurdle Rates: IRR Hurdles vs Equity Multiple HurdlesThe measure a hurdle uses decides what the sponsor is rewarded for. One pays for speed, the other for total dollars, and they disagree where it matters.
- 07WaterfallA Worked 8% Pref / 70-30 / 50-50 Waterfall, Line by LineOne hypothetical deal, five tiers, every intermediate figure printed. The arithmetic is ordinary; what it shows is how much of the outcome the tier order decides.
- 08WaterfallEuropean vs American Waterfall: Whole-Fund or Deal-by-DealOne structure pays the sponsor only after every investor is whole across the whole program. The other pays deal by deal and relies on a clawback.
- 09WaterfallClawback Provisions: When Early Distributions Were Too GoodA true-up that requires the sponsor to give back promote it should not have received. Its value depends entirely on who owes it and whether anything secures it.
- 10WaterfallIRR, Equity Multiple and Cash-on-Cash: Three Numbers, Three QuestionsEach measure answers a different question and none answers the others. Quoted alone, any one of them can make an ordinary deal look like a good one.
- 11WaterfallRefinance and Capital Event Distributions vs Operating Cash FlowA distribution funded by new debt is not profit. Whether your agreement treats it as one decides whether a sponsor earns a promote on borrowed money.