Question

The normal waterfall distribution in a venture capital fund is:

	A.	Fees first, return of capital to LPs second, capital gains distribution to LPs and GP third.
	B.	Return of capital to LPs first, fees second, capital gains distribution to LPs and GP third.
	C.	Fees first, return of capital to LPs second, capital gain to LPs third, carried interest to GP fourth
	D.	Capital gains distribution to LPs and GP first, return of capital to LPs second, fees third.

Answer 1

Ans C.

In a In a private equity/ VC fund, the general partner manages the capital, while LP, the limited partners provide the major chunk of capital. The GP provides a very small, 1 to 2% of the capital. The distribution of capital back to LP is through a water fall distribution process in which,

1. First step involves payment of fees to GP
2. The next step of the waterfall is to returning the capital to the LP .
3. After the capital is distributed, all of returns will still be distributed to the LP until a specific Internal Rate of Return (IRR) is reached. This is the preferred return and is always calculated on every cashflow.
4. In this step, called catch up, the GP gets all or a majority of the gain, until the GPs share of the profit earned equals the carried interest (a % of the total return, e.g., 18%). The catchup has two components: an allocation and a target (in relation to the carried interest).