How Waterfall Distributions Work: American vs European

The distribution waterfall determines how fund profits flow from exits back to investors, prioritizing LP returns before the GP earns carried interest.

The 4-Tier American Waterfall

In a standard US-style venture fund, the American (deal-by-deal) waterfall is structured in four tiers:

1. Tier 1 – Return of Capital

All contributed LP capital must be returned before any carry is paid. This includes management fees and expenses if the fund is structured as a return-of-capital waterfall rather than a deal-by-deal profit waterfall.

1. Tier 2 – Preferred Return (Hurdle)

LPs receive a preferred return (often 8% per year, non-compounded or compounded depending on the LPA) on their contributed capital. Until this hurdle is met, 100% of distributions go to LPs.

1. Tier 3 – GP Catch-Up

After the LPs have received their capital and preferred return, distributions shift to the GP until the GP has "caught up" to the agreed carry percentage on all profits to that point. In a typical 20% carry structure, this means the GP receives most or all of the next dollars until their share of total profits equals 20%.