Fund Structure
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Quick Answer
The contractual sequence governing how fund proceeds flow from exits to LPs and the GP, specifying the order of capital return, preferred return, catch-up, and profit sharing.
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Open the Waterfall CalculatorWhere this shows up in fund operations:
Fund Accounting SoftwareA Distribution Waterfall is the contractual structure in a fund's Limited Partnership Agreement that specifies the exact sequence in which proceeds from portfolio company exits and other realizations are distributed between limited partners and the general partner. The standard four-tier waterfall flows as follows: Tier 1 (Return of Capital) — LPs receive back their total contributed capital; Tier 2 (Preferred Return) — LPs receive a preferred return (typically 8% per annum) on their contributed capital; Tier 3 (GP Catch-Up) — the GP receives an accelerated share of distributions until their cumulative receipts equal their target carry percentage of total profits; Tier 4 (Carried Interest Split) — remaining profits are split according to the agreed ratio (typically 80% LP / 20% GP). The waterfall can be structured on a deal-by-deal (American) or whole-fund (European) basis, with significant implications for when the GP receives carry.
In Practice
A fund distributes $400 million from exits. Waterfall: Tier 1 — $200 million returns LP capital. Tier 2 — $48 million preferred return (8% over 3 years average). Tier 3 — GP catch-up of $62 million until GP holds 20% of total $200 million profit. Tier 4 — remaining $90 million splits 80/20 ($72 million to LPs, $18 million to GP). Total: LPs receive $320 million (1.6x), GP receives $80 million in carry.
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Why It Matters
The distribution waterfall is the most important economic provision in the LPA for determining how profits are shared. Small differences in waterfall structure—preferred return rate, catch-up percentage, American vs. European—can swing millions of dollars between LPs and the GP. Both parties should understand the waterfall mechanics thoroughly before committing.
VC Beast Take
Distribution waterfalls are where the real economics of VC funds hide in plain sight. Most LPs don't fully grasp how catch-up provisions and carry calculations work until they see their first distribution statement. We've noticed newer fund managers sometimes propose overly aggressive waterfall terms that backfire during fundraising—experienced LPs can spot unfavorable terms immediately and it signals inexperience more than ambition.
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What is a clawback provision in venture capital?
A clawback provision requires GPs to return previously paid carried interest to LPs if the fund ultimately underperforms — ensuring GPs don't keep carry from early winners if later losses bring overall fund returns below the hurdle.
What is a distribution waterfall?
A distribution waterfall is the contractual order in which proceeds from a VC fund are allocated between GPs and LPs. It determines who gets paid first, in what order, and under what conditions — protecting LPs and ensuring GPs only earn carry on genuine profits.
What is a distribution waterfall?
A distribution waterfall is the sequence of rules that determines how and when money flows from a VC fund back to GPs and LPs when portfolio companies exit.
This concept is especially relevant for these venture capital roles:
A Distribution Waterfall is the contractual structure in a fund's Limited Partnership Agreement that specifies the exact sequence in which proceeds from portfolio company exits and other realizations are distributed between limited partners and the general partner.
Understanding Distribution Waterfall is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Distribution 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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