Fund Accounting 101: Distribution Waterfalls — PHXA

2 min readApr 1, 2021

Distribution waterfalls, the method by which the capital gained by a fund is allocated between the limited partners (LPs) and the general partner (GP), is a critical consideration in setting up an investment fund. Simplicity is key. How investment returns are allotted to investors and management must be easy for investors to understand, practical for fund accounting to execute and perceived by all parties as representing equitable compensation for management performance and investor risk as both parties are involved in creating the investment return. The waterfall structure must be thoroughly understood in all its permutations by the fund accounting provider from the outset. If the structure is too complex, it can cost significant money down the road.

Waterfalls are structured as a set of buckets or phases in the distribution of incoming capital as delineated in the Limited Partnership Agreement (LPA) or LLC Operating Agreement. Each bucket represents a tranche of income from portfolio investments and contains its own allocation method. When the first bucket is full, additional incoming capital flows into the next bucket and a new allocation method applies. The early buckets are typically allocated largely to the LPs, while later buckets favor the GP. This structure encourages the GP to maximize the return of the fund.

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Fund Accounting 101: Distribution Waterfalls — PHXA

Written by PhoenixAmerican