Whole-fund or deal by deal is the decision that sets every other economic term.

A waterfall calculates the manager's share on one of two units. On the whole fund, the register receives all of its capital and the hurdle on all of it before the manager receives anything; the share is then calculated on the fund's total gain. On each deal, the register receives its capital and the hurdle on that investment, and the manager's share on that investment is paid on realisation; the fund's other investments are corrected for later by escrow and clawback. The rate of the share, the hurdle and the catch-up are negotiated after the unit, and managers negotiate them as though they were the economics. They are the economics of a unit already chosen, and the unit decides the timing of the manager's receipts, the need for a clawback, the price of every side letter that touches carry, the valuation of a continuation, and the manager's own incentive on each position. A register that negotiates the rate without first fixing the unit has negotiated a number whose meaning the unit will set.

This note sets out the two units and what each does, the timing of receipts, the clawback's dependence on the unit, the incentive each creates, the hybrid forms, the effect on side letters, on the continuation vehicle, on the interim test and on the manager's internal arrangements, the lender's reading, a comparison, a worked waterfall as a type, cases, what each party holds, the sequence, questions, terms and what to read.

The two units

Whole-fund: every distribution goes first to the register until contributed capital, across all positions, is returned; then to the register until the hurdle on all of it is met; then to the manager, by catch-up, until the manager has its share of the gain to date; then in the agreed split. The manager's share is calculated once, on the fund's entire account, and is paid only when the account is in credit by enough.

Deal by deal: each position's proceeds go first to the register until that position's contributed capital, plus an allocation of charges and of losses on positions already realised at a loss, is returned; then to the register until the hurdle on that amount is met; then to the manager by catch-up; then in the split. The manager's share on each position is paid at its realisation, and the positions still held may later lose, which the clawback corrects.

The first unit is the register's preference and the second is the manager's, and each has a reason. The register wants to be whole before the manager is paid. The manager wants to be paid when it performs, not at the end of a decade.

Timing

On a ten-year fund whose first exits come in year four and whose last in year ten, a whole-fund waterfall pays the manager carry when cumulative distributions exceed cumulative contributions plus the hurdle, which on most funds is in the second half of the life; a deal-by-deal waterfall pays carry at the first profitable exit. The difference is years, and the manager's principals, who are paid from the carry, feel the years. The timing is the unit's first consequence and the one the manager negotiates hardest.

Why the rate is negotiated first

The rate is a number and the unit is a mechanism, and numbers are negotiated because they can be compared. A register that has seen ten memoranda knows the range of carry rates and hurdle rates and negotiates within it; it has seen ten waterfall clauses too, but the clauses are long and the register's counsel reads them after the commercial terms are agreed. The manager's counsel drafts the unit into the first draft, and the first draft's unit becomes the document's unless the register's counsel reads it and the register reopens the commercial terms to change it. By then the rate has been agreed on the unit in the draft, and changing the unit changes what the rate means. The order is inverted because the unit is in the draft and the rate is in the term sheet, and a register that puts the unit in the term sheet has fixed the order.

The arithmetic of the difference

Take a fund that draws its commitments over four years, realises positions from year four to year ten, and produces a total gain above the hurdle across its life. On a whole-fund unit the manager receives its share of that total gain when cumulative distributions have returned cumulative capital and hurdle, which on a typical profile is around the sixth or seventh year, and the share is computed once. On a deal-by-deal unit the manager receives a share of each position's gain from year four, and if the later positions lose, the sum of the shares exceeds the whole-fund share by the carry on gains the losses erased. The excess is the clawback amount, and the arithmetic of the two units differs by the losses' timing: a fund whose losses come first and gains later has no excess under either unit, and a fund whose gains come first and losses later has the full excess under deal by deal. The unit's consequence is a function of the order of outcomes, which nobody knows at the first close.

The loss carry-forward

A deal-by-deal waterfall with a loss carry-forward adds to each position's hurdle base the losses realised on prior positions, so that the manager earns carry on a position only after the register has recovered that position's capital and the capital it lost before. The carry-forward moves the deal-by-deal unit toward the whole-fund, because it nets realised losses into later carry, and it leaves unrealised losses unnetted, which the clawback catches. A document with a loss carry-forward and a realised-and-unrealised test is a deal-by-deal document that behaves like a whole-fund one until the last position, and the administrator's computation carries each position's base with its allocations.

The clawback's dependence

A whole-fund waterfall with no interim distribution needs no clawback, because the manager is paid once at the end on a closed account. A deal-by-deal waterfall needs a clawback, an escrow and a guarantee, because the manager is paid on open positions. The whole apparatus of clawback, escrow percentage, net-of-tax computation, principals' guarantees and interim tests is the price of the deal-by-deal unit, and a register that accepts the unit accepts the apparatus. A whole-fund waterfall with an interim distribution is between the two, and needs the apparatus in proportion to how early it pays.

The incentive

The unit sets what the manager is paid for. On a whole-fund unit the manager is paid for the fund's total gain, and a position that loses reduces the carry on the positions that won; the manager's incentive is the portfolio. On a deal-by-deal unit the manager is paid for each position's gain, subject to the clawback at the end; the manager's incentive is each position, and a position that loses after the manager was paid on another is a clawback risk the manager may discount. The register reads the unit for the incentive it creates, and a register that wants the manager to care about the last position chooses the unit that pays on the last position.

The catch-up under each unit

The catch-up, by which the manager receives all or most distributions after the hurdle until it holds its share of the gain to date, is computed on the unit. On a whole-fund unit the catch-up runs once, on the cumulative account, and the manager's share after it is of the whole gain. On a deal-by-deal unit the catch-up runs at each realisation on that position's gain, and the manager's catch-up on an early position is cash the clawback may later recover. A full catch-up under a deal-by-deal unit pays the manager the most, earliest; a partial catch-up under a whole-fund unit pays the least, latest. The catch-up's percentage is negotiated after the unit for the same reason the rate is, and its value depends on the unit the same way.

The hurdle's base under each unit

The hurdle runs on contributed capital from its contribution dates. On a whole-fund unit the base is every contribution, including those that funded charges and costs, and the hurdle on the whole is the register's first claim. On a deal-by-deal unit the base is the position's cost plus an allocation of charges, costs and prior realised losses, and the allocation method is the document's. A method that allocates charges by cost, by time held or by value is each a different hurdle base, and the manager's counsel chooses the one that produces the smallest. The register reads the allocation method as part of the unit, because it is the unit's arithmetic.

The fund with few positions

A fund with four positions has a waterfall whose unit matters more than a fund with forty, because each position is a quarter of the account and a loss on one is a quarter of the register's capital. A deal-by-deal unit on a concentrated fund pays the manager a quarter of its carry at each exit and makes the clawback a large number; a whole-fund unit on the same fund pays nothing until three positions have returned the capital and hurdle on four. Concentrated strategies, such as development platforms holding a few large projects, lean to whole-fund units with strict interim tests, because the register's exposure to the order of outcomes is too large to leave to a clawback.

Hybrid forms

Most documents settle between the two. A whole-fund waterfall with an interim distribution once a test is met pays the manager earlier than pure whole-fund and later than deal by deal. A deal-by-deal waterfall with a loss carry-forward, so that each position's hurdle includes losses on prior realised positions, pays later than pure deal by deal. A deal-by-deal waterfall with a realised-and-unrealised test, so that carry is paid only if the unrealised positions are marked above cost, is closer to whole-fund. Each hybrid is a point between the two, and the document names the point by its mechanics rather than by a label.

Side letters

Every side-letter term that touches carry is priced by the unit. A reduced carry rate for an anchor is worth more on a deal-by-deal unit, because it applies earlier; a better hurdle base is worth more on a whole-fund unit, because the hurdle is on everything. A most-favoured-nation clause that reaches carry terms reaches terms whose value depends on the unit, and a manager that prices each concession across the register prices it on the unit the document fixed. A letter negotiated before the unit was fixed is a letter whose price nobody knew.

The continuation vehicle

A continuation vehicle that buys the fund's remaining positions crystallises the fund's account, and the manager's carry on the sale is computed on the unit. On a whole-fund unit the sale completes the account and the carry is the whole-life share; on a deal-by-deal unit the sale is the last realisation, the carry on it is computed, and the clawback computation runs. The manager's roll of its carry into the continuation vehicle, as the conflict's mitigation, is a roll of the carry the unit produced, and the fairness opinion the continuation needs reads the unit for what the manager is giving up.

The interim test

The interim test that gates an early distribution under a whole-fund waterfall is the unit's hybrid mechanism, and its strictness sets where between the two units the document sits. A test on the proportion of capital returned, a test on the remaining positions' value against capital at risk, or both, are the usual forms, and the escrow percentage is set with the test in view. A document with a loose test and a small escrow is a deal-by-deal document under a whole-fund name.

The manager's internal arrangements

The manager's principals share the carry under internal arrangements the register does not see, and those arrangements are drafted to the unit. A deal-by-deal unit pays the principals by position, and a principal that leaves after a profitable exit has been paid; the internal vesting and the guarantee to the register hold it. A whole-fund unit pays the principals at the end, and the internal arrangements carry the principals through a decade. The manager's ability to retain its people is a function of the unit, which is the manager's real reason for its preference, and the register reads it as such.

The lender's reading

A lender to the fund's positions reads the unit for when cash leaves the fund to the manager, because cash distributed as carry is cash not available to the lender. A deal-by-deal unit distributes carry at each exit, and the lender's covenants on distributions read the waterfall for the carry's timing. A lender to the manager reads the unit for when its borrower's income arrives, and prices a whole-fund manager's facility on a decade's wait.

By consequence · by unit	Whole-fund	Deal by deal	The hybrid
When carry is paid	At the end, or on an interim test	At each profitable exit	Between, by the test
Clawback needed	No, unless interim distributions	Yes, with escrow and guarantee	In proportion to the early payment
Manager's incentive	The portfolio	Each position, discounted by clawback risk	Between
Side-letter price of a carry term	On the whole account	From the first exit	By the unit's point
Continuation sale	Completes the account	Last realisation, then clawback	As the test provides
Manager's retention of principals	Hard over a decade	Easier, by position	Between
Lender's reading	Carry late, cash stays	Carry early, cash leaves	By the test

A waterfall, as a type

A fund fixes a whole-fund waterfall with an interim distribution once a stated proportion of contributed capital is returned and the remaining positions' value, by the appointed valuer, exceeds a multiple of capital at risk; an escrow of a stated percentage of each interim distribution, net of tax; and several guarantees. The rate, hurdle and catch-up are then negotiated on that unit. The anchor's reduced carry rate is priced on the unit and excluded from the reach as tied to status. In year five the test is met and carry is distributed with the escrow funded. In year eight the fund sells its remaining positions to a continuation vehicle, the account completes, the whole-life computation runs, and the escrow is applied to the excess the later losses produced. The manager's principals were paid in year five under internal arrangements that vested by the fund's account, and the departed principal's guarantee held.

The structure paper's page

The structure paper carries a page on the waterfall's unit: the unit named, the reasons for it on both sides, the interim test and its inputs, the escrow and guarantees sized to it, the letters priced on it, the internal arrangements drafted to it, the continuation vehicle's treatment, and the administrator's computation in outline. The page is written before the term sheet so that the term sheet names the unit, and it is the page the register's counsel reads before the rate is discussed.

The onshore vehicles and the unit

A fund holding through onshore vehicles receives distributions as the onshore vehicles pay them, and the waterfall's unit is applied at the fund on what the fund receives. A deal-by-deal unit treats each onshore vehicle's proceeds as a position's realisation when the cash reaches the fund, and proceeds held onshore pending approval are unrealised until then. A whole-fund unit accumulates what reaches the fund. The onshore timing is the waterfall's timing under either unit, and the administrator's computation records each receipt's date.

The second fund's reading

A manager's second fund is read against the first fund's unit and what it produced. A first fund on a deal-by-deal unit whose clawback was computed and paid from escrow shows the apparatus worked; one whose clawback was computed and not recovered shows it did not, and the second fund's register asks for a whole-fund unit. A first fund on a whole-fund unit whose principals stayed shows the manager can carry its people through the wait, and the second fund's register accepts an interim test because the manager has shown it will not empty the escrow. The unit chosen for the second fund is the first fund's record, read by the next anchor.

Four cases, as types

A register negotiates a low carry rate and accepts a deal-by-deal unit without reading it. The manager is paid at the first exit, the fund's last three positions lose, the clawback is computed at the end against a manager with no assets, and the register's low rate was paid early on gains the fund did not keep.

A manager accepts a whole-fund unit to win the anchor and cannot retain its principals through the decade. The team leaves in year six, the key-person clause triggers, and the register holds a fund whose manager has no one to manage it.

A document names a whole-fund waterfall and provides an interim test so loose, and an escrow so small, that carry is paid at the second exit. The register believed it held a whole-fund document and holds a deal-by-deal one.

A document fixes the unit first, sets the interim test and escrow to it, prices the anchor's letter on it, and negotiates the rate last. The manager's receipts, the register's protection and the principals' retention are each what the unit implied.

What each party holds

The manager holds the unit it proposed and the internal arrangements drafted to it.

The register holds the unit it accepted and the apparatus that goes with it.

Counsel holds the waterfall clause, the interim test, the escrow and the letters priced on the unit.

The administrator holds the computation on the unit at each distribution and at the end.

The committee holds the reading of each computation and of each interim release.

The lender holds its covenants on distributions, read against the unit.

Where it surfaces

It surfaces at the term sheet, if the unit is in it, and at the first draft, if it is not. It surfaces at the anchor's letter, when a carry term is priced and the price depends on the unit. It surfaces at the first exit, when the administrator asks whether carry is due and the answer is the unit's. It surfaces at the manager's principals, when the first profitable exit pays nothing under a whole-fund unit and a principal asks when it will. It surfaces at the interim test, when the valuer's mark of the unsold positions is the input and the committee reads it. It surfaces at the continuation sale, when the fairness opinion reads the manager's carry on the unit. And it surfaces at the fund's end, when the register learns whether the carry it paid was the carry the fund earned.

The cost of getting it wrong

A register that accepted a deal-by-deal unit without the apparatus has paid carry it cannot recover. A manager that accepted a whole-fund unit without arrangements to retain its people through the wait has lost the people. A register that accepted a whole-fund name with a deal-by-deal test has believed in a protection it did not hold. Each cost was set at the unit's choice, which was made in a draft nobody read as the decision it was. The cost of getting it right is a term sheet that names the unit, a clause drafted to it, an apparatus sized to it and a rate negotiated on it, in that order.

The committee's reading

The committee reads every carry computation for the unit's application: which positions' proceeds, which capital returned, which hurdle base, which allocations of charges and losses. On a deal-by-deal unit it reads the allocation of charges and prior losses to each position's base, because the allocation is where the manager's counsel can move the carry; on a whole-fund unit it reads the cumulative account. It reads the interim test's inputs, the valuer's report and the escrow's funding, and it reads the continuation vehicle's fairness opinion for the unit's crystallisation. A committee that understands the unit reads the computation in an hour; one that does not reads a number.

A timeline, as a type

At the term sheet the unit is named: whole-fund with an interim distribution on a test. At the first draft the clause carries the unit, the test, the escrow percentage and the guarantees. At the first close the anchor's reduced carry rate is priced on the unit, the manager's internal arrangements vest by the fund's account, and the lender's covenants read the test for the carry's timing. In year four the first exit pays nothing to the manager, and the principals knew. In year six the test is met, carry is distributed, the escrow is funded, and the committee reads the computation and the valuer's report. In year nine the remaining positions are sold to a continuation vehicle; the fairness opinion reads the manager's whole-life share; the account completes; the escrow is released because the whole-life computation shows no excess. The register received what the unit promised, and the manager was paid what the unit implied.

The disclosure the regime expects

Each regime expects the memorandum to describe the waterfall so that a prospective holder can compute the manager's share on an illustrative account, and a description that names the rate and hurdle and leaves the unit to the constitution is a description the regulator reads as incomplete. The memorandum names the unit, the interim test, the escrow and the clawback in the same paragraph as the rate, and the constitution carries the clause the paragraph summarises. A holder that asks for an illustrative computation on two scenarios, gains first and losses first, is asking the question the unit answers, and a manager with the structure paper's page answers it from the page.

The sequence

1. The unit is chosen first, with the register's protection and the manager's retention both in view.
2. The interim test, the escrow percentage and the guarantees are set to the unit's early payment.
3. The rate, hurdle and catch-up are negotiated on the unit.
4. The side letters that touch carry are priced on the unit and excluded from the reach where they are tied to status.
5. The manager's internal arrangements are drafted to the unit.
6. The continuation vehicle's terms and the fairness opinion read the unit at the fund's end.

Questions a manager asks

Which unit do regimes expect. Neither; each regime expects disclosure of the waterfall and a computation the administrator can run, and the unit is commercial.

Can the unit change mid-life. Only by amendment with the register's consent, which it gives for a price, because the unit is the register's protection.

What interim test is usual. A proportion of capital returned and a value multiple on the remaining positions, both by the appointed valuer; the numbers are the negotiation.

Does the unit affect the hurdle rate. The hurdle's base differs: on the whole fund it is all contributed capital; by deal it is that position's capital plus allocations. The rate is the same number with a different base.

How do co-investments fit. A co-investment vehicle holds one position, so its carry is deal by deal by construction, and its document says so.

What about a fund with one position. A single-asset fund has no difference between the units, and the clawback question does not arise.

Terms used

Whole-fund waterfall: carry calculated on the fund's entire account, paid when the account is in credit.

Deal-by-deal waterfall: carry calculated on each position, paid at its realisation, corrected by clawback.

Interim distribution: carry paid under a whole-fund waterfall before the end, on a test.

Loss carry-forward: a deal-by-deal term adding prior realised losses to each position's hurdle base.

Unit: the account on which the waterfall calculates, the fund or the position.

Hybrid: a waterfall between the two units, named by its mechanics.

What to read

The constitution's waterfall, interim test and clawback provisions; the side letters that touch carry; the manager's internal carry arrangements for their vesting; the continuation vehicle's terms. On this site, the economics and continuation rooms under Structures and the worked structure on seed terms.