Waterfall

The Distribution Waterfall defines the order in which fund proceeds (from realisations of portfolio investments) are split between LPs and the GP. The waterfall is the most economically consequential clause in the Contribution Agreement.

The classic 4-tier waterfall:

1. Return of Capital — 100% to LPs until they have received an amount equal to their contributed capital (including capital paid for fees and expenses, depending on definition). 2. Preferred Return / Hurdle — 100% to LPs until they have earned a specified IRR (commonly 8%) on their contributed capital. 3. GP Catch-up — 100% (or 80/20) to GP until GP has received 20% of cumulative profits distributed in steps 2 + 3. This 'catches up' the GP to its 20% share of profits. 4. 80/20 Carry Split — 80% to LPs, 20% to GP, on all remaining distributions.

Two structural variants:

• European Waterfall (fund-as-a-whole) — carry is distributed only after all LPs have received their entire contributed capital + preferred return across the whole fund. LP-friendly; common in Indian AIFs.
• American Waterfall (deal-by-deal) — carry is computed and distributed per investment as it realises, subject to interim catch-ups and clawback at fund termination. GP-friendly; common in US PE.

Most Indian AIFs adopt the European model or a hybrid European with deal-by-deal recycling, reflecting LP preferences in the Indian market.

Clawback:

A mechanism whereby the GP returns previously-received carry to the fund if cumulative LP returns at fund termination fall short of the hurdle + capital return promise. Crucial in American waterfalls; less material in European waterfalls (where carry only flows after the whole fund is in the money).

Indian-context notes:

• SEBI's carry unitisation rules (2023 onwards) require carry to flow through units of the AIF held by the manager / key personnel, not as a cash fee. The waterfall mechanics interact with unitisation — the 'carry units' have economic rights matching the carry tier of the waterfall.
• Tax timing — for Cat I and Cat II AIFs (pass-through), waterfall distributions to LPs are reported in Form 64C with the character of income preserved (LTCG, STCG, dividend, interest). This means a single waterfall distribution to an LP may carry multiple income streams with different tax treatments.
• GIFT City IFSC AIFs can be structured with more flexibility on waterfall mechanics, particularly for offshore feeders.

Pitfall: Misalignment between the legal waterfall in the Contribution Agreement, the economic model in the PPM, and the GP's spreadsheet that actually computes distributions. Reconcile these every quarter — Kapitalyze's Fund OS automates the waterfall computation against legal documents.