Calculating Waterfall Distributions When the General Partner Has Committed Capital

General Partners (GPs) in private equity funds generally commit one to five percent of their fund’s total commitment. As such, GPs also receive their share of distributable proceeds in addition to the carried interest.   

The basic terms of the waterfall in private equity are dictated by the Limited Partnership Agreement (LPA) and generally include: 

1. Return of capital
2. Preferred return for Limited Partners
3. GP catch-up
4. Carried interest, aka promote 

How Does GP Capital Commitment Affect the Waterfall?  

When GPs invest their own capital, the waterfall calculation becomes more complex. Some common questions that arise include:  

1. When will the GP receive their capital back?
2. Does the GP also receive preferred returns?
3. How will the GP’s commitment impact the GP catch-up and carried interest?  

The specific answers to these questions depend on the individual LPA. A close examination of the agreement’s terms is crucial for understanding how a GP’s capital commitment interacts with the waterfall structure.  

The following section provides an illustrative example of how a typical LPA might handle the distribution of proceeds to the General Partner.  

Example of GP Waterfall Distribution  

Most LPAs explicitly state how the General Partner should receive their share of distributable proceeds. Below is a condensed abstract from an LPA.  

Section 1.1 

Distributable cash shall be apportioned to the Partners in proportion to their respective Pro Rata Percentage. The amount apportioned to the General Partners shall be distributed to the General Partner. The amount apportioned to each other Limited Partner shall be further distributed by the Partnership to the General Partner and such Limited Partners as follows: 

1. First, to Limited Partners until distributions to such Limited Partner equal the Limited Partner’s capital contributions.
2. Second, to Limited Partners until distributions to such Limited Partner equal the Preferred Return
3. Third, 100% to the General Partner until distributions to the General Partner equals 20% of all distributions made pursuant to Section B and Section C. 
4. Thereafter, 80% to Limited Partners and 20% to the General Partner. 

Let’s look at a simple example to illustrate the mechanics of the waterfall with the following assumptions: 

The other limited partners (LPs) and the General Partner contributed $1,000 on January 1, 202X. The distributable proceeds on December 31, 202X is $3,000. The Preferred Return is 8%. There have been no prior distributions since inception. At the time of distribution on December 31, 202X, distributable proceeds will be allocated as follows: 

Based on the LPA, the first step is to allocate the total distributable proceeds of $3,000 to all the partners based on their ownership percentage. The GP is a 10% investor entitled to $300 of the $3,000 distributable proceeds. The remaining 90%, or $2,700, is the remaining distributable proceeds for the other LPs. The GP will not participate in Section 1.1A or 1.1B because the GP has already received its capital and share of the investment fund’s return.  

Let’s continue and allocate the remaining $2,700 of distributable proceeds for Sections A through D.  

Here’s the breakdown and rationale for each step: 

• Section 1.1A – The Partnership returns the $900 capital contributions to the other LPs.
• Section 1.1B – The Partnership distributes $72 of preferred return to the other LPs. In this example, the preferred return is an 8% return on the $900 contribution for one year.
• Section 1.1C – The Partnership distributes $18 of GP catch-up to the GP, representing 20% of the total distributions from Section 1.1B and 1.1C.  
• Section 1.1D—The remaining distributable proceeds are $1,710. The GP’s carried interest is 20% of that amount, which equals $342. The remaining 80%, or $1,368, is allocated to the other LPs. 

The GP receives $660 of the $3,000 distributable proceeds. The $660 consists of $300 for the GP’s 10% ownership interest plus $360 for the GP catch-up and carried interest.  

Stay Compliant with a Clear understanding of the LPA  

The above example presents a common methodology to allocate distributable proceeds to the GP when the GP has committed capital to the fund. It allocates distributable proceeds based on percentage ownership. The amount apportioned to the General Partners is distributed to the General Partner. The remaining distributable proceeds flow through the rest of the waterfall per Sections A through D of the LPA.  

The LPA dictates how distributable proceeds are allocated to all partners. Understanding and accurately applying the LPA terms to the waterfall calculation is crucial for fund managers to make sure there is a compliant and fair distribution process.