What's the difference between an American and European waterfall in private equity?

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AcadiFi · Accepted Answer

American ('deal-by-deal') and European ('whole-fund' or 'fund-as-a-whole') waterfalls differ in WHEN the GP can start earning carry. European is much more LP-friendly. European waterfall: GP earns carry only after ALL invested capital AND the preferred return have been returned to LPs for the ENTIRE fund. You can close 10 deals at huge profits, but until LPs have received back their full $1B committed plus 8% preferred, the GP sees zero carry. American waterfall: GP earns carry on a deal-by-deal basis. Each exit has its own mini-waterfall. If Kinsman Private Equity exits deal #3 at 3x, the GP can take carry from that deal's profit, even though 12 other deals are still at cost or marked down. ```mermaid flowchart TD A[Fund starts] --> B{Waterfall?} B -->|European| C[Return all capital
+ pref first] B -->|American| D[Per-deal
waterfall] C --> E[GP carry at
end of fund] D --> F[GP carry on
every winner] F --> G[Clawback
risk] ``` The risk with American: GP takes carry on early winners, then later deals flop. The LP ends up NOT having received full return plus preferred, yet GP already pocketed carry. CLAWBACK provisions exist to force GPs to return over-distributed carry, but clawbacks can be difficult to enforce if GPs have distributed to individual partners who've already paid tax and spent the money. US funds have historically favored American waterfalls; European funds favored the whole-fund approach. Over the past decade, large institutional LPs have pushed aggressively for European structures, and most new institutional-quality funds now use European or hybrid waterfalls (sometimes called 'modified American' with a partial-fund return threshold before per-deal carry is allowed).

What's the difference between an American and European waterfall in private equity?

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