How to use the distribution waterfall calculator
- Enter the cash to distribute, the investor capital and the years the capital was invested.
- Set the preferred return per year and whether it is simple or compounding yearly.
- Set the sponsor catch-up share (0 for none) and the sponsor share of profits above the preferred return. In advanced options you can add a second split after a total cash level.
- Read what the investor and sponsor each receive and the table that shows the cash at every tier.
Formula
Tier 1: return of capital to the investor, up to the capital contributed
Tier 2: preferred return = capital x rate x years (simple), or capital x ((1 + rate)^years - 1)
Tier 3: catch-up tier size = sponsor share x preferred return / (catch-up share - sponsor share)
Tier 4: remaining cash split by the sponsor share, then by the second share past the threshold
In the catch-up tier the sponsor receives the catch-up share of each dollar, until the sponsor holds its profit share of the preferred return plus the catch-up cash.
$2,000,000 distributed on $1,000,000 of capital
Investors put in $1,000,000 four years ago with an 8% simple preferred return, so the preference due is $320,000. The sponsor receives 20% of profits above that, with no catch-up and no second split. Tier 1 pays $1,000,000, tier 2 pays $320,000, and the remaining $680,000 is split 80/20: $544,000 to the investor and $136,000 to the sponsor.
The investor receives $1,864,000 (1.864x) and the sponsor $136,000, which is 13.6% of the total profit. With a 100% catch-up the sponsor first takes 20% x $320,000 / (100% - 20%) = $80,000 and then 20% of the remaining $600,000, which is $120,000. The sponsor ends with $200,000, exactly 20% of the $1,000,000 profit, and the investor receives $1,800,000.
How a waterfall works
A waterfall pays out cash in steps, and each step must be filled before the next one starts. The usual order is return of capital, then a preferred return that rewards the investor for waiting, then a split of what remains between the investor and the sponsor who runs the project. The sponsor share above the preferred return is often called the promote or carried interest.
A catch-up lets the sponsor receive a larger share of the cash right after the preferred return until its total matches its profit share. Without it, the sponsor only shares in profits above the preference. See the example above for how this changes the split.
Keeping the version simple
This version uses one preferred return, fixed tiers and cash amounts. It does not model hurdles that depend on the investor reaching a target IRR, because those depend on the timing of every cash flow. For that kind of test, find the investor IRR with the XIRR Calculator on the cash flows you expect.
Agreements differ on how the preferred return compounds, whether capital comes back first, and what happens to fees and clawbacks. Use this page to understand the mechanics and to check your own spreadsheet. For an exit with several classes of stock, use the Liquidation Preference Calculator.
Assumptions and limits
- All cash is distributed once. There are no interim distributions and no change in capital.
- The preferred return runs for the full number of years entered, as a simple or yearly compounding rate.
- The catch-up share must be larger than the sponsor profit share, or the sponsor can never catch up.
- Fees, taxes, clawbacks and hurdles based on an IRR are not modeled, and the page is not legal or investment advice.
Frequently asked questions
What is a preferred return?
It is a return the investor receives first, before the sponsor shares in profits. If the preferred rate is 8% and capital is invested for four years, a simple version due is 32% of the capital, or $320,000 on $1,000,000.
What does catch-up mean?
After the preferred return is paid, the sponsor receives a larger share of the next dollars until it has received its agreed percentage of all profit so far. A 100% catch-up gives the sponsor every dollar in that tier.
What happens if cash is less than the capital?
The investor receives all of it in tier 1, and nothing goes to the later tiers. The investor then has a loss, and the sponsor receives nothing from the distribution.
Why does the second split use total cash?
It is a simple way to model a higher sponsor share once a certain amount has been paid out. Set it to 0 to use only one split.