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- 🛠️ Investment Fund Key Terms, Part 17
🎉 Happy Friday, funds family!
Today, we have Part 17 in our many-part series walking through each term in an investment fund term sheet in detail.
Here’s the index of each article in this series (so far):
This week focuses on GP Catch-Up Provisions.
But first..
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If the preferred return (discussed in Part 16) is the LP’s “head start,” then the catch-up provision is the GP’s sprint to get back to its intended share of profits.
A catch-up is the mechanism that allows the GP to receive priority distributions for a short phase after the LP has received its preferred return.
➡️ What Is a Catch-Up?
A catch-up is the bridge between the preferred return (LP-friendly) and the final profit split (e.g., 80/20).
The standard formulation looks something like:
“After the Limited Partners have received (i) a return of capital and (ii) the preferred return, the General Partner shall receive 100% of additional distributions until it has received 20% of all profits distributed by the Fund.”
In plain English: The GP gets all of the cash flow for a moment to “catch up” to its carried interest percentage.
➡️ Why Do Catch-Ups Exist?
Without a catch-up, it’s a mathematical certainty that the GP will end up with less than its intended carry percentage (e.g., the 20% in an 80/20 waterfall). This is because the LPs got their referred return (which constitutes the first distribution of profits).
Note that not all waterfalls have GP catchups. More LP-favorable waterfalls have a pref but no catch-up. However, in institutional funds, catch-ups are quite common.
➡️ Key Components of a GP Catch-Up Provision
Here are the major levers:
🔸 Catch-Up Percentage: This is the percentage of profits the GP gets after the preferred return until the GP is “caught up” to the target carry percentage. The GP often receives 100% of distributions during the catch-up. However, more LP-friendly deals use a partial catch-up (e.g., 50/50).
🔸 Target Carry Percentage: The GP stops receiving 100% once it has received its full carry percentage (e.g., 20%) of all profits distributed to date. If the ultimate profit split is 70/30, the GP would get the catch-up until it receives 30% of the profits, for example.
🔸 Deal-by-Deal vs. Fund-Level: In an American waterfall, each deal has its own miniature catch-up. In a European waterfall, the catch-up applies only after the entire fund has satisfied the pref across all deals.
➡️ Simple Example
Assume:
🔸 LP invested $1,000,000 two years ago
🔸 Pref = 8% simple
🔸 GP carry = 20%
After return of capital and the $160,000 preferred return, the next phase looks like:
GP receives 100% of distributions until the GP has received 20% of all profits distributed to both parties. In this case, that would be $40,000 (20% of $160k + $40k).
After the GP “catches up” to 20% of the profits, the waterfall reaches the final 80/20 profit split.
🗓️ Next up in Part 18: American vs. European Waterfalls
Thanks for reading, everyone.
Have a great weekend! 🙌
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