Carried Interest WaterfallCopy Anchor Link

Carried Interest WaterfallCopy Anchor Link

The waterfall is the mechanical rule that releases the GP's carried interest — roughly 20% of net profits — only after the limited partners are made whole. The order of payments, not the headline percentage, is where most of the alignment actually lives. ^[reports/Fund structuring tax jurisdictions.md]

The feesCopy Anchor Link

The management fee is the ManCo's annuity, charged on committed capital during the investment period and stepped down to invested capital afterward — 82% of venture funds use a post-investment-period step-down. ^[reports/Fund structuring tax jurisdictions.md] PE funds raised in 2025 charged the lowest average management fee ever recorded, 1.61%, down from the 2% norm, while private credit diverged — direct-lending funds raised in 2025 charged a mean 1.42% / median 1.50%, roughly matching 2005–2025 long-term averages after a post-pandemic trough near 1.0%. ^[reports/Fund structuring tax jurisdictions.md] The 2018 textbook anchors the baseline at roughly 2% of committed capital until the end of a 4-to-5-year investment period.

Fee offsets have moved from a historical 50% to an ILPA-endorsed 100% baseline on transaction fees (80% on monitoring fees) — the textbook notes GPs sometimes receive deal and monitoring fees from portfolio companies and LPs insist on applying them to reduce the management fee or splitting them. ^[reports/Fund structuring tax jurisdictions.md] The GP commits roughly 1–3% of capital (5–10% for wealthy managers), and LPs increasingly demand the commitment be cash-funded rather than waived through the fee. ^[reports/Fund structuring tax jurisdictions.md]

Whole-fund vs deal-by-dealCopy Anchor Link

The European (whole-fund) waterfall returns all capital and preferred return before the GP shares anything — ILPA's best practice. The American (deal-by-deal) waterfall pays carry per realized deal, accelerating GP pay at LP risk unless tempered by escrow and clawback. ^[reports/Fund structuring tax jurisdictions.md] Preferred returns are typically 5–10% payable annually and subordinated to the return of capital.

A whole-fund waterfall with an 8% hurdle and 100% catch-up on a $100M fund that exits at $180M:

^[reports/Fund structuring tax jurisdictions.md]

Catch-up math: solve X where X = 20% × ($8M + X), giving X = $2M. Total profit is $80M, and GP carry of $16M is exactly 20% of it. ^[reports/Fund structuring tax jurisdictions.md]

Clawback recovers overpaid carry. ILPA best practice is whole-fund clawback computed gross of taxes, backed by escrow of 30%+ of carry and joint-and-several GP liability, with the obligation surviving fund termination. ^[reports/Fund structuring tax jurisdictions.md]

Subscription lines and expensesCopy Anchor Link

Capital is called over a 3–5 year investment period, with recycling re-deploying realized proceeds. Subscription lines (credit secured by uncalled commitments, SOFR + 150–300 bps) smooth calls; ILPA caps them at ≤180 days outstanding with a clean-down convention and demands dual IRR reporting, and a sub-line outstanding more than 90 days at year-end can itself create UBTI for tax-exempt LPs. ^[reports/Fund structuring tax jurisdictions.md]

Expense allocation is where the sharpest LP/GP fights now sit: formation costs (~$250K, LP-borne), broken-deal costs, and related-party expenses all face scrutiny. ^[reports/Fund structuring tax jurisdictions.md]

Hurdles and the hedge-fund comparisonCopy Anchor Link

Hedge funds compressed separately — to roughly 1.4% management / 16.4% incentive by 2023, a ~40% decade decline — though that 2023-vintage figure is not directly comparable to the 2025 PE fee. ^[reports/Fund structuring tax jurisdictions.md] Hedge funds typically add a high-water mark so incentive fees accrue only on new profits above the prior peak. ^[reports/Fund structuring tax jurisdictions.md]

The CFA volume distinguishes the two hurdle forms precisely: a hard hurdle pays the performance fee only on returns in excess of the hurdle rate, while a soft hurdle lets the manager catch up the fee on the entire return once the hurdle is exceeded — the catch-up clause. The LP receives 100% of cash distributions until it earns the hurdle, then the GP receives 100% until the profit split reaches 80/20, then the remainder splits 80/20.

The hurdle rate itself is a cost-of-capital question — the preferred return is the LPs' opportunity cost, the minimum the manager must clear before sharing a dollar, which is why an 8% preferred is a stand-in for the equity risk of the underlying pool. See capital-allocation for the parallel logic of what return a business must clear before capital is committed at all.

SourcesCopy Anchor Link

• textbooks/markdown/banking-valuation-training-pdfs__Chapter-19---Organization--Compensation--R_2018_Investment-Banks--Hedge-Fund.md
• textbooks/markdown/investment-textbooks-pdfs__CFA LV1 2025 - Volume 08 - Alternative Investments.md