A waterfall is the step-by-step rule for splitting cash among stakeholders — whether distributing fund proceeds to LPs and GPs or allocating sale proceeds on a cap table.

How it works

Two main contexts:

Fund waterfall (LP/GP):

1. Return LP contributed capital (return of capital)
2. Pay LP preferred return (hurdle, if any)
3. Split profits — typically 80% LP / 20% GP carry, with catch-up mechanics
4. Clawback provisions may apply if early distributions overpaid GP

Exit waterfall (company):

1. Pay transaction fees and debt
2. Satisfy liquidation preferences by series
3. Participating preferred may take additional share
4. Remaining to common and option holders

Documents define American vs European carry waterfalls, deal-by-deal vs whole-fund, and escrow timing. Spreadsheet models test multiple exit prices — essential before board votes on sale.

Why it matters

• Founders: Your personal outcome depends on exit waterfall, not headline valuation. Model preferences and participation at $50M, $100M, $200M exit.
• LPs / GPs: Waterfall language in the LPA sets carry timing and clawback — core economic negotiation in fund formation.

Common mistake

Using last-round post-money as proxy for common proceeds. Waterfall math with stacked preferences often zeros common at moderate exit values.

Related ideas

See also liquidation waterfall, waterfall chart, and catch-up.