Guide

Distribution waterfall: how to run the European and American models, worked to the dollar

Updated October 20, 2026Checked against our editorial standards6 min read

Quick answer

A distribution waterfall runs in four tiers: return of contributed capital to LPs, then the preferred return, then the GP catch-up, then the remaining split at the carry rate. The European model, standard in venture capital, runs all four tiers across the entire fund before carry is paid. The American model runs them per exit, letting carry flow sooner but requiring a clawback if later deals underperform. Both produce the same carry when every exit clears the hurdle.

Before you start

Three documents before you model the first number: the LPA's distribution and waterfall clause, the schedule of contributed capital with each drawdown date, and the amount of proceeds you are distributing.

The LPA's distribution clause tells you the model. It names the four tiers, the preferred return rate and how it compounds, the catch-up percentage, the carry rate, and whether the waterfall runs per deal or across the whole fund. These are negotiated at closing and fixed for the fund's life. The words matter: "contributed capital" might mean invested cost only, or it might include organisational expenses and management fees paid by the fund. That definition changes every tier that follows.

The schedule of contributed capital tells you the denominators for the preferred return calculation. The preferred return accrues from the date capital was actually drawn, not from the fund's closing date. A drawdown 18 months after closing has a shorter accrual period than the first one, and each LP's schedule is different.

The four tiers of a distribution waterfall

Each tier must be exhausted before the next begins. The GP receives nothing until Tier 3, and only after LPs have their capital and preferred return back.

1Tier 1: return contributed capitalLPs receive 100% until all drawn-down capital is returned
2Tier 2: preferred returnLPs receive the hurdle rate accrued from each drawdown date to the distribution date
3Tier 3: GP catch-upGP receives 100% until GP's share equals carry% / (1 − carry%) × preferred return paid
4Tier 4: residual splitRemaining proceeds split at the carry rate, typically 80% LP and 20% GP

Figure 1

The GP Ledger

Step 1. Build the capital schedule

Pull the fund's ledger and list every drawdown: the date, the LP, the amount called. You need the period from each drawdown date to the current distribution date in years or fractions of a year. If the fund used a subscription credit line before calling capital, use the date the LP was actually called, not the date the fund first borrowed against the line.

Confirm the total contributed capital: the sum of all capital ever drawn from LPs. If prior distributions have already returned some capital, subtract those amounts from the Tier 1 amount. A prior notice that returned $2,000,000 of capital means the Tier 1 hurdle for this distribution is reduced by $2,000,000.

Step 2. Compute the preferred return

The preferred return accrues on each tranche of capital from its drawdown date. For a fund with a single drawdown and an 8% compounded hurdle:

Preferred return = contributed capital × ((1.08)^years − 1)

A $10,000,000 fund with all capital drawn on one date, holding for five years:

$10,000,000 × ((1.08)^5 − 1) = $10,000,000 × 0.46933 = $4,693,280

For a fund with multiple drawdowns, compute the accrual for each tranche and sum them. A call drawn 2.5 years before the distribution accrues for 2.5 years; a later call drawn 1.5 years before accrues for 1.5 years.

If the LPA uses simple interest instead of compounded:

Preferred return = contributed capital × rate × years

At 8% simple over five years: $10,000,000 × 0.08 × 5 = $4,000,000. The gap between compounded and simple ($693,280 on this example) grows with time and is worth confirming in the LPA before the first model runs.

Step 3. Run Tiers 1 and 2

Allocate proceeds in order. For a $10,000,000 fund returning $25,000,000 in a single final exit after five years:

Tier	Recipient	Amount	Remaining
1: return of capital	LPs	$10,000,000	$15,000,000
2: preferred return (8% compounded, 5 years)	LPs	$4,693,280	$10,306,720

After these two tiers, the LP has received $14,693,280: everything it invested plus the full compounded preferred return. The GP has received nothing.

Step 4. Compute the catch-up and run Tiers 3 and 4

The catch-up target formula:

GP catch-up = preferred return paid × carry% / (1 − carry%)

At 20% carry: $4,693,280 × 0.20 / 0.80 = $4,693,280 × 0.25 = $1,173,320

The GP receives 100% of distributions in Tier 3 until it reaches $1,173,320. At that point the GP holds exactly 20% of all profits distributed since the return of capital. The residual then splits 80/20.

Tier	Recipient	Amount	Remaining
3: GP catch-up	GP	$1,173,320	$9,133,400
4a: 80% residual	LPs	$7,306,720
4b: 20% residual	GP	$1,826,680	$0

Final totals: LPs receive $22,000,000; GP receives $3,000,000; total $25,000,000.

The check: GP carry ($3,000,000) equals 20% of total profit above contributed capital ($15,000,000). If it does not, the catch-up target was computed incorrectly.

European vs American: the dollar contrast

European vs American: which model the LPA uses determines when carry can first be paid

The models produce the same carry when every deal clears the hurdle. The difference only appears when one exit underperforms.

Q1Does the LPA run the waterfall per deal or across the whole fund?This clause is fixed at closing

Whole-of-fund (European)Carry waits until all LP capital and the preferred return are back across every exit; no carry is paid if the fund blended below the hurdle

Deal-by-deal (American)Carry flows per profitable exit; GP receives cash faster but owes a clawback if later deals bring the blended return below the hurdle

Figure 2

The GP Ledger

The difference becomes concrete when a fund has one strong exit and one loss. Use the same $10,000,000 fund with a four-year hold and an 8% simple hurdle, two exits:

Deal A: $3,000,000 invested, $9,000,000 returned
Deal B: $7,000,000 invested, $4,000,000 returned
Preferred return rate: 8% simple, four-year hold

American (deal-by-deal) waterfall, Deal A:

Tier	Recipient	Amount
1: Deal A capital back	LPs	$3,000,000
2: Preferred return ($3M × 8% × 4)	LPs	$960,000
3: GP catch-up ($960K × 25%)	GP	$240,000
4a: 80% of $4,800,000	LPs	$3,840,000
4b: 20% of $4,800,000	GP	$960,000

Deal A totals: LPs $7,800,000; GP $1,200,000.

Deal B returns only $4,000,000 on $7,000,000 invested. LP capital back: $4,000,000. No preferred return clears, no carry.

American total: LPs $11,800,000; GP $1,200,000.

European (whole-of-fund) waterfall, both exits pooled:

Tier	Recipient	Amount
1: All LP capital back	LPs	$10,000,000
2: Preferred return target ($10M × 8% × 4 = $3,200,000); available: $3,000,000	LPs	$3,000,000
Carry (hurdle not fully met)	GP	$0

European total: LPs $13,000,000; GP $0.

The LP recovers $1,200,000 more under the European model. The GP received $1,200,000 under the American model but holds a clawback obligation for the same amount at the fund's wind-down.

What goes wrong

Using the fund closing date instead of each drawdown date. The preferred return accrues from when capital was actually called. A call made a year after the closing accrues for one fewer year than the first call; the difference compounds.
Wrong definition of contributed capital. Check whether the LPA includes management fees and organisational expenses paid by the fund in the contributed capital base. This is the most common source of discrepancies between the GP's model and the LP's rebuild.
Running the catch-up as a percentage of each dollar in instead of as a fixed target. The catch-up is a one-time amount. After the GP reaches the target, distributions shift to the residual split.
Skipping the independent rebuild. Run the waterfall in the fund's system of record and rebuild it separately. If the two disagree by even one dollar, find the cause before the notice goes out. A corrective notice after the fact damages LP confidence.
Confusing the carry accrual with cash carry. The quarterly financial statements show an accrual of carry at fair value. That accrual is not a payment and does not change until a distribution clears the waterfall and cash moves.

Frequently asked questions

What is the difference between a European and an American waterfall?

A European (whole-of-fund) waterfall withholds all carry until limited partners have received their contributed capital and preferred return across every exit the fund makes. An American (deal-by-deal) waterfall runs the same four tiers per exit, so the GP can receive carry from a profitable deal before the fund has fully returned LP capital. The European model is the institutional standard in venture capital; the American model persists in buyout and is typically paired with a clawback escrow.

What does the preferred return compound at, and does it matter?

The LPA specifies both the rate and the compounding convention. Most venture LPAs use 8% per annum compounded annually from each drawdown date to the distribution date. The compounding convention matters: 8% compounded annually over five years returns $4,693 on every $10,000 invested; 8% simple interest over the same period returns $4,000. Always model from the actual drawdown dates, not from the fund's first closing date, and confirm whether the LPA says compounded or simple.

How does the GP catch-up work?

After the LP has received its capital and preferred return, the GP receives 100% of subsequent distributions until the GP has received an amount equal to the carry rate divided by one minus the carry rate, multiplied by the preferred return just paid. At 20% carry, the catch-up target is 25% of the preferred return paid. After the catch-up is reached, the residual splits at the stated carry rate. The purpose is to give the GP 20% of all profits above contributed capital, not just 20% of what comes in after the hurdle.

Can carried interest accrue before a distribution is made?

Yes. Most funds accrue carried interest in the quarterly financial statements as if the fund liquidated at current fair values, recording it as a reallocation between LP and GP capital accounts. That accrual does not move cash. Cash carry is paid only when a distribution runs the waterfall and the LP capital accounts confirm the hurdle was cleared. The accrual lets LPs see how much of the NAV the GP's carry claim already covers each quarter.

What is a clawback and when does it apply?

A clawback requires the GP to return carry already paid if, at wind-down, the GP has received more than the agreed percentage of total fund profits. It most often applies in American waterfalls, where carry from early profitable exits can exceed the GP's earned share once later deals are counted. European waterfalls rarely trigger a clawback because carry is not paid until the whole-of-fund hurdle is cleared. GPs receiving carry under an American model commonly hold a portion in escrow for this reason.

Sources

ILPA Capital Call and Distribution Templateilpa.org/industry-guidance/templates-standards-model-documents/ilpa-templates-hub/ilpa-capital-call-distribution-template/
ILPA Suggested Guidance, September 2025 (PDF)ilpa.org/wp-content/uploads/2025/09/ILPA-Suggested-Guidance-2025-Final.pdf

Terms used in this article

Distribution waterfall A distribution waterfall is the sequence in which a fund's proceeds are allocated between limited partners and the general partner, typically return of contributed capital first, then a preferred return to LPs, then a catch-up to the GP, then the remaining profit split at the carried interest rate.
Carried interest Carried interest is the general partner's share of a fund's profits, typically 20%, paid through the distribution waterfall only after limited partners have received their contributed capital and, usually, a preferred return.
Hurdle rate (preferred return) The hurdle rate, also called the preferred return, is the annual return, commonly 8%, that limited partners must receive on their contributed capital before the general partner is entitled to carried interest in the distribution waterfall.
Catch-up Catch-up is the tier of a distribution waterfall, paid after limited partners have received their capital and preferred return, in which the general partner receives all or most of the next proceeds until it has received its agreed percentage of total profit.
Clawback Clawback is a provision in the limited partnership agreement that obliges the general partner to return carried interest already distributed to it if, measured over the life of the fund, it has received more than its agreed share of net profit or limited partners have not received their capital and preferred return in full.
DPI (distributions to paid-in capital) DPI, distributions to paid-in capital, is the total cash and stock distributed to limited partners divided by the total capital they have contributed.
Capital account A capital account is the running balance of a single partner's economic interest in a fund: contributions in, allocations of income, gains and losses, less distributions out.

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