A fund that returns $170,000,000 on $100,000,000 of contributed capital, after an 8 per cent preferred return and a 100 per cent catch-up, pays the general partner $17,200,000 — 24.6 per cent of the $70,000,000 of profit, not 20 per cent. The overshoot is not an error. It follows from paying the preferred return as a priority distribution to limited partners and then catching the general partner up to a share of all profit above capital.
The waterfall, step by step
The example is stripped down so the mechanics are visible. Limited partners contribute $100,000,000 at inception. The fund distributes $170,000,000 in a single liquidation at the end of year 5. The preferred return is 8 per cent per year, simple, on unreturned contributed capital. The catch-up is 100 per cent. The promote is 20 per cent. The general partner commitment is ignored. Every dollar moves once, so nothing in the result depends on timing.
Four steps then run in order, and each one consumes what the step before it left.
European-style waterfall: $170,000,000 distributed on $100,000,000 of capital.
Step
Amount
Total distributions at the end of the fund
$170,000,000
Return of capital to limited partners
$100,000,000
Profit above capital
$70,000,000
Preferred return, 8 per cent for 5 years
$40,000,000
Remaining after the preferred return
$30,000,000
Catch-up to the general partner
$14,000,000
Remaining after the catch-up
$16,000,000
Residual split 80/20 — limited partners
$12,800,000
Residual split 80/20 — general partner
$3,200,000
General partner total carry
$17,200,000
The limited partners end with $152,800,000 — $100,000,000 of capital, $40,000,000 of preferred return and $12,800,000 of residual. After the preferred return they had already received $140,000,000. The two final totals sum back to $170,000,000, which is the only check that matters when a waterfall is being tested.
Why the general partner clears 24.6 per cent
The catch-up target is set as 20 per cent of profit above the return of capital: 20 per cent of $70,000,000, which is $14,000,000. The general partner has received nothing at that point, so the whole $14,000,000 is paid out of the $30,000,000 left after the preferred return.
Then the residual split runs. The $16,000,000 still on the table is divided 80/20, and the general partner takes another $3,200,000. That second payment sits on top of a catch-up that had already been calculated to reach 20 per cent of all profit.
The general partner receives $17,200,000 of $70,000,000 of profit. That is 24.6 per cent, not 20 per cent. The overshoot is not a drafting mistake and it is not a rounding artefact. It is the arithmetic of paying the preferred return as a priority distribution to limited partners while leaving it inside the base on which the general partner is caught up.
Three readings, three answers
The phrase “20 per cent promote” does not settle the question, because it does not say what the 20 per cent is 20 per cent of. Three defensible readings of the same three words produce three different cheques out of the same $70,000,000.
Same fund, same $70,000,000 of profit, three definitions of the promote.
Reading of “a 20 per cent promote”
To the GP ($m)
Catch-up to 20 per cent of all profit above capital, then an 80/20 residual split
17.2
General partner takes 20 per cent of total profit and no more
14.0
Promote applies only to the profit left after the preferred return
6.0
The widest reading pays $17.2 million. The narrowest pays $6.0 million. Nothing in the term sheet headline distinguishes them, and a limited partner model that assumes one while the document says another will misprice the fund by more than the entire residual split.
What to settle before the document is signed
Four definitions do the work. Each one should be answered in the fund documents in a way an auditor could apply without asking a question.
Is the promote 20 per cent of profit after return of capital and after the preferred return, or 20 per cent of profit above capital only?
Does the catch-up aim at 20 per cent of all profit, or only at profit above the preferred return?
Is the preferred return simple or compounded, and is it struck on contributed capital or on unreturned capital?
Is the waterfall struck at fund level or deal by deal, and what clawback backs it?
The last question is the one that survives a good market. A fund buys five assets. Two outperform and are sold in year 3, and under a deal-by-deal waterfall the general partner earns carry on those sales immediately. The remaining three run into leasing trouble and are sold at breakeven. The final fund return is mediocre, but the carry has already been taken. A fund-level waterfall makes that impossible; a clawback makes it recoverable, which is not the same thing and is worth less.
Run the four steps above on a live fund before the next close, and run them again under each of the three readings. If the three answers are close together, the drafting is tight. If they span $6.0 million to $17.2 million, the promote has not been negotiated yet — only its headline rate has.
The workbooks behind this article
Every figure above is a live formula in the free companion files for
Real Estate Fund Management. Each workbook ends with a Checks sheet
setting the printed figure beside the computed one. No account and no email address.
At what wealth does a family office pay?A five-person office costs the same $2,442,000 at $100m as at $2bn. Against a tiered multi-family schedule the two curves cross exactly once.
Does an undrawn revolver count as liquidity?67.4567 per cent of the headroom, and it leaves at a fall in annual revenue of 8.4127 per cent — not the 13.3333 per cent the board deck implies.
Does supply chain finance count as debt?66,049,315 released, and leverage of 2.7622× or 3.1362× depending on which balance the test is asked of — the second is a breach at today's EBITDA.
Does the fulcrum move with enterprise value?A worked capital structure at three enterprise values. The break migrates from the first lien to the subordinated notes without a single document changing.
How many companies does a reserve pool defend?Holding pro rata to the Series D costs $14.76m per company. A $40m reserve defends 2.71 of forty — and 61 per cent of the cost is the last round.
How much room a 1.15x downside actually leaves79 basis points of margin. The leverage covenant fails first, five basis points before the coverage covenant the chapter reports on, and 4.6 per cent of EBITDA is the whole cushion.
How the GP catch-up is actually solvedMost write-ups state the catch-up formula then hardcode the answer. Set it as a solve and it moves on its own when the carry rate does.
How do you set a minimum cash balance?Three components, 124,596,281 in total — and the double count that turns a margin of 27,403,719 into an apparent shortfall of -3,988,281.
Is a 2/10 net 60 discount worth taking?An annualised 14.8980 per cent against a revolver at 4.50 per cent — worth 5,471,890 a year, and 0.3132 turns of reported leverage.
Should corporate debt be fixed or floating?78.1818 per cent of gross debt fixed, and a net floating exposure after cash of -608,000.00 — the proportion, not the instrument.
Six ways to state the same fund's return7.12 per cent, 18.04 per cent, or 1.323 times the public market — one fund, one set of flows. The eleven-point gap is the valuation, and it is not cash.
The IRR at which a closed-ended fund merely tiesA drawdown fund advertising 13.25 per cent ties an evergreen netting 8.64. On committed rather than called capital, 78.7 per cent of the edge vanishes.
The month a remediation trigger has to be armed byMonth 8, on a one-year window and a 14-week hiring lead time. The date is 12W − L/4.33 and holds for any portfolio size — the book only changes the euros.
Two routes to the same NAVFive findings in one quarter-end close, and not one of them was a modelling error. Every one was a control that did not exist.
What a CBAM certificate buffer costs to holdCarry and protection are both linear in the buffer, so the break-even probability is identical at 5 per cent and at 30 — and 2027 costs exactly twice 2026.
What a clawback actually collateralises24 million recovers 13.20 net of tax and 7.20 is escrowed. The rule is e ≥ 1 − t, and every euro won on the tax clause lands uncollateralised.
What a co-investment programme actually saves37 basis points, and a 22.8 per cent total-loss rate erases it. At the usual per-deal cap a single failure is 37 per cent of the annual cohort.
What a diligence exercise actually recoversEighteen basis points is only the part that reaches the yield. Three of the four instruments never do, and the exercise is worth thirty-one.
What a follow-on reserve is actually worth0.019 turns under plain dilution, 0.285 under pay-to-play. The optimum is a property of the shareholders’ agreement, not of the portfolio.
What a lease mark-to-market is actually worth5,788,000 becomes 807,365 once the over-market stream, the expiry dates and the cost of re-letting are priced — and nothing at all below a 43.7 per cent renewal rate.
What a minimum payment actually does£81.53 leaves the account and £20.46 reaches the debt. On minimums alone the set clears in 258 months and repays 1.78 times what was borrowed.
What a month of delay costs in an enforcement463,000 euros of present value a month. No single error about enforcement, and no pair of errors, moves the indifference point from 58.7 cents to the 72 on the table.
What a pro rata cheque actually costsDefending costs 1.25 times the initial cheque across two rounds, not more in each — and below a 521 exit the follow-on dollars come back worth less than they cost.
What a subscription line does to the IRR20 per cent becomes 38.41 on the same asset while the multiple falls. Two dollars of interest buys 18.4 points, and the longer the line runs the cheaper each point gets.
What one point of fees actually costsOne point on the annual charge turns 738,846 into 567,961 over forty years — 23 per cent of the pot, and 2.43 of wealth lost per 1 of fee.
When the promote stops clearingCarried interest is not proportional to performance near the hurdle. It is a step function, and $2m of headroom is what stands between a promote and none.
Why a secondaries bid-ask gap has no zoneThe seller’s floor and the buyer’s ceiling are one formula at two rates. At equal required returns the zone is exactly zero — here it is 11.02 points apart.
Why refining a due diligence rubric makes it weakerThree of twelve managers carry a terminal flaw and the average approves all three. Splitting eight domains into sixteen makes it easier to hide, not harder.