Deal-by-deal distribution waterfall

When a fund sells a portfolio company, the cheque does not go to whoever asks first. It runs down a fixed ladder written into the contribution agreement, and each rung is paid in full before the next one gets anything.

Under a deal-by-deal waterfall that ladder is walked after every exit, not once at the end of the fund's life. The attraction for the manager is obvious: carried interest arrives years earlier. The risk for the investor is equally obvious — carry has been paid on the winners before anyone knows how the losers will turn out, which is why the clawback and the high-water mark exist.

Table 6.1 of the workbook sets the illustrative order:

If there is no catch-up clause, rung 5 is skipped entirely and residual proceeds are shared straight after rung 4.

Two safeguards ride on top. The high-water mark is applied at the time of each exit for funds on this waterfall, so no carry is paid on a NAV the fund has already been paid on. The clawback lets investors recover carry taken on early successful exits to offset losses on later failed ones — losses computed as capital committed less sale proceeds, with the hurdle return deliberately excluded from that computation. A clawback is only as good as the manager's balance sheet, which is the other reason some funds simply defer all carry to the end of the tenure.

Example 6.5. XYZ Fund: committed capital Rs 50 crore, tenure 3 years, NAV at end of year 3 Rs 70 crore, hurdle 10 per cent, incentive fee 20 per cent of total profits.

• Total profit = 70 − 50 = Rs 20 crore
• Manager's pre-agreed share = 20% × 20 = Rs 4 crore
• Hurdle return = 50 × 1.10³ − 50 = Rs 16.55 crore
• Residual after capital and hurdle = 20 − 16.55 = Rs 3.45 crore

Scenario A — no catch-up clause:

Scenario B — catch-up rate of 100 per cent:

The residual is not enough to reach Rs 4 crore, so the manager takes all of it and the investors take nothing beyond their hurdle. The manager's pay-out goes from Rs 69 lakh to Rs 3.45 crore — a five-fold difference produced by one clause.

Chapter 6, section 6.3 and Table 6.1, with Example 6.5 and the clawback discussion in section 6.3.2. Expect an ordering question ("which is paid first?"), a catch-up computation of exactly the Example 6.5 shape, and the Chapter 6 sample question on what a clawback provision actually does — the answer is that investors recover the manager's incentive fee from earlier deals against losses in later ones.

• Expenses, taxes and statutory dues come before investors get their capital back, not after. Reserves, at the manager's discretion, rank ahead of investors too.
• No catch-up clause means rung 5 disappears — the residual is simply shared in the agreed ratio. It does not mean the manager gets nothing.
• A 100 per cent catch-up does not mean the manager keeps everything; it means the manager takes 100 per cent of the residual until it reaches its agreed share of total profits. If the residual runs out first, as in Scenario B, the manager stops short.
• Clawback runs from the manager to the investors. The Chapter 6 sample question offers the reverse as a distractor.
• The hurdle is excluded when computing clawback losses, even though it is the investors' opportunity cost. The workbook flags this as deliberate.
• Deal-by-deal is the reason the high-water mark is applied at exit for Category I and II funds. On a whole-fund waterfall the question does not arise until the end.