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The  Distribution Waterfall, in a Private Equity or Real Estate Fund, describes the way by which the capital gained by the fund is allocated between the Limited Partner and the General Partner.

In a Private Equity Fund, the General Partner manages the commited capital of the Limited Partners. The General Partner usually commit some amount to the fund, usually 1 to 2 % of the commitment. When distributing the capital back to the investor, hopefully with an added value, the general partner will allocate this amount based on a previously agreed waterfall structure.

A waterfall structure can be pictured as a set of buckets or phases. Each bucket contains its own allocation method. When the bucket is full, the capital flows into the next bucket. The first buckets are usually entirely allocated to the Limited Partners, while buckets farther away from the source are more advantageous to the General Partner. This structure is design to incentivize the General Partner in maximizing the return of the fund.

Typical Distribution Waterfall
A standard distribution waterfall is defined by a hurdle rate, a catchup rate and a carried interest rate.
 * Recovery Phase : As long as the called capital hasn't been fully returned to the Limited Partner, the whole distributed amount is allocated to the Limited Partners.


 * Hurdle Phase : The LPA may specify a hurdle rate (typically 8%). The hurdle rate is an IRR that needs to be reached to the Limited Partners before the General Partner get allocated.
 * Catchup Phase : Above the Hurdle Rate, the LPA defines a catchup rate (typically 50%). In this case 50% of the next distributions will be allocated to the General Partner, until the General Partner commitment reaches an IRR equal to the hurdle rate.
 * Carried Interest Phase : Above the Catchup phase, every proceeds will be distributed based on the carried interest rate (typically 20%). This means that the General Partner will receive 20% of the distributed amount, while the Limited Partners will share the remaining 80%.

Multi hurdle Waterfall
A general Partner may decide to defines many hurdle rate, each linked to a specific allocation. In this case, the higher hurdles are linked to allocations more favorable to the General Partner.

An example of hurdle would look like :

European vs American Waterfall
An European Waterfall, or global waterfall, means that the hurdle threshold a calculated at fund level. An american waterfall, or deal-by-deal waterfall calculates the hurdle thresholds for each deal. The American Waterfall favorizes the General Partner over the Limited Partner as :
 * A deal by deal waterfall distributes carried interest faster. With an European Waterfall, the first distributed amount are usually used to return the capital called for other deals. In a deal by deal waterfall, the first deal may return some carried interest if its IRR is above one of the hurdle rate.
 * If the GP buys into a company that bankrupts. The bad performance will need to be compensated by very positive deals before the GP may reach the hurdles. In a deal by deal waterfall, the bad performances of a single company do not leak over the performances of the others.