Distribution Waterfall

Who gets paid first

When a private equity or venture fund exits an investment and cash comes in, that money does not get split casually. It cascades down a pre-agreed sequence of tiers — like water down a series of ledges — which is why it's called a waterfall. Each tier must be filled before the next gets a drop.

In India this matters for anyone investing in an Alternative Investment Fund (AIF) registered with SEBI, whether Category I, II or III. The waterfall, buried in the fund's contribution agreement, decides how much of the upside the manager keeps versus how much reaches you.

The four classic tiers

A standard waterfall runs roughly like this:

1. Return of capital — LPs get back every rupee they put in, before the GP sees a paisa of profit. 2. Preferred return (the hurdle) — LPs earn a minimum return, commonly set around 8%, on that capital. 3. GP catch-up — once LPs have their hurdle, the GP draws a larger share of subsequent profits until the overall split realigns to the agreed ratio. 4. Carried interest split — everything beyond is shared, typically around 80% to LPs and 20% to the GP.

That 20% is the famous "carry" — the manager's real payday.

European vs American — read the fine print

The single most important question for an Indian LP: is the waterfall European or American?

In a European (whole-fund) waterfall, the GP earns carry only after the *entire* fund has returned all capital plus the hurdle. In an American (deal-by-deal) waterfall, carry can start flowing after each individual exit — far friendlier to the GP, riskier for you, because the manager may pocket carry on winners before the losers are tallied.

My view: for AIF investors, the deal-by-deal structure deserves real scrutiny, ideally paired with a clawback clause so you can recover excess carry if later deals sour. Don't let a glossy IRR distract you — the waterfall is where the actual rupee split is decided, and a generous-looking fund with an aggressive American waterfall can quietly cost you a chunk of your gains.