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CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt

A private equity fund has a deal-by-deal (American) waterfall. Compared with a whole-of-fund (European) waterfall, the American waterfall most likely:

A deal-by-deal waterfall pays carried interest earlier, on individual profitable deals, so later losses may leave the general partner overpaid. Limited partners therefore bear more risk and rely on clawback provisions. The European whole-of-fund approach instead returns all contributed capital first.

  1. Adelays all carried interest until limited partners have received all contributed capital back
  2. Bexposes limited partners to greater risk that the general partner receives excess carry, making clawbacks more importantCorrect
  3. Celiminates the need for a clawback provision because carry is paid only at fund end

Explanation

Under the American waterfall, carry is paid on early profitable deals before later losses are known, so the GP may be overpaid. A clawback is therefore especially important. The first option describes the European waterfall, and the third is reversed.

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