What Is a Fee Waterfall?

A fee waterfall is the sequence written into a fund's LPA that determines how distributions get split between the GP and the LPs as a fund realizes gains. It's called a waterfall because cash flows through a series of tiers in order, and each tier has to fill up before the next one applies.

A typical structure runs through stages like these:

• Return of capital — LPs get their invested capital back first

• Preferred return (the hurdle) — LPs then receive a minimum return, often 8 percent annually, before the GP participates in profit

• GP catch-up — the GP receives a larger share of distributions until it reaches its target carry percentage

• Carried interest split — remaining profits split according to the agreed carry, commonly 80/20 in favor of LPs

Waterfalls also come in two structural types: European (fund-level), where the GP doesn't receive carry until the whole fund has returned capital and the hurdle, and American (deal-by-deal), where carry can be paid out on individual realized deals before the full fund has cleared its hurdle. The difference matters significantly for how early a GP gets paid relative to LP capital being fully returned.

Why this matters for LP reporting

The waterfall terms live in the LPA and any side letters, and they rarely match a GP's own generic reporting template exactly. Confirming that a distribution was calculated correctly means checking the actual cash split against the specific hurdle, catch-up, and carry terms your side letter negotiated, not just accepting the number on the notice.

This is the core of what capital account reconciliation actually involves. Read more about Capital Account Reconciliation →