Fund Structure
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Quick Answer
The sequential distribution structure that determines the order in which fund profits are allocated between LPs and the GP, including the return of capital, preferred return, and carried interest.
A Carry Waterfall (or distribution waterfall) is the contractual mechanism in a fund's Limited Partnership Agreement that dictates the precise order in which fund proceeds are distributed between limited partners (LPs) and the general partner (GP). A typical waterfall has four tiers: (1) return of contributed capital to LPs, (2) preferred return (usually 8% annually) to LPs, (3) GP catch-up where the GP receives distributions until they reach their carried interest percentage, and (4) carried interest split (typically 80/20 between LPs and GP). The two main types are American (deal-by-deal) and European (whole-fund) waterfalls, each creating different incentive structures and timing of GP payouts.
In Practice
A fund returns capital as follows: First, LPs receive back their $100 million in committed capital. Then LPs receive 8% preferred return ($8 million per year of the investment period). Then the GP receives a catch-up until carried interest reaches 20% of total profits. Finally, remaining profits split 80/20 between LPs and GP. On a $300 million total distribution, the GP might earn $36 million in carry after LPs receive their capital plus preferred return.
Why It Matters
The waterfall structure fundamentally determines when and how much the GP gets paid. LPs should scrutinize waterfall terms during fund due diligence because differences between American and European structures can mean millions of dollars in timing and total GP compensation, affecting alignment of interests.
VC Beast Take
The carry waterfall is where fund economics get real. Most emerging GPs underestimate how long it takes to hit catch-up, especially in today's extended exit timeline. We're seeing more creative structures emerge - some funds are experimenting with deal-by-deal carry or reduced hurdle rates to accelerate GP economics. The traditional 8% preferred return assumes 5-7 year fund cycles, but when exits stretch to 10+ years, LPs compound at that rate for much longer than originally modeled.
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A Carry Waterfall (or distribution waterfall) is the contractual mechanism in a fund's Limited Partnership Agreement that dictates the precise order in which fund proceeds are distributed between limited partners (LPs) and the general partner (GP).
Understanding Carry Waterfall is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Carry Waterfall falls under the fund-structure category in venture capital. This area covers concepts related to how venture capital funds are organized, managed, and governed.
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