Choose Your Splash Zone: Waterfall Models

Fund1 Frank here 👋🏼
Grab your floaties, because today we’re diving into every emerging fund manager’s favorite Wednesday morning topic: waterfalls. That’s right — not Niagara, not Victoria — but the spicy debate between European vs. American models. Same carry, same pref, same GP/LP drama… just a question of who gets soaked first.

The Basics

There are two main waterfall models for private funds: European & American. Both have the same terms, but differ in timing of who gets paid out, when. Here’s the low down.

European (a.k.a. Whole Fund Waterfall):

• GPs don’t touch carry until LPs have gotten all their money back plus pref.

• Think of it as dessert after dinner — no skipping straight to cake.

• Safer for LPs, slower for GPs.

American (a.k.a. Deal-by-Deal Waterfall):

• Carry is paid deal by deal as soon as exits happen.

• You close a company, you get your slice.

• Feels great early… but often comes with “clawback” hangovers if the fund underperforms.

Again, in both, the LPs and GPs are entitled to be paid out the same amount, but the European waterfall makes GPs wait to get the piece they’re owed.

Why LPs Case for European?

Because history. Before clawbacks were standard, LPs got wrecked by early carry cowboys. GPs rode off into the sunset, and LPs were left counting pennies in the saloon.
Cue the sheriff riding into town with this adjusted model. No can do cowboy.

When the American Model Actually Does Make Sense

• Small fund math: Early carry can literally keep the lights on. Management fees on a $20M fund don’t pay for much staff (or rent). For Fund I GPs, a big exit in Year 4 is less about yachts in Ibiza and more about finally affording an analyst and a working printer.

• Accessibility: For GPs coming from lower-income backgrounds, early access to carry can make the difference between building a sustainable firm… or washing out.

• Clawback as compromise: You get deal-by-deal carry, but if you don’t clear the pref overall, LPs can claw it back. (Messy in practice, but it’s the standard middle ground.)

The Trade-Offs

• European: GP-unfriendly, LP-favored. Works once you’re Fund III+ and management fees stack enough to cover operations.

• American: GP-friendly in Fund I, especially for small/micro funds. But higher risk of LP side-eye.

Frank’s Hot Take 🔥

If you’re Fund I with a $20M vehicle, don’t feel bad about negotiating American with a clawback. You’re not being greedy; you’re trying to build a business.
But… if you’re on Fund III and still arguing for American waterfalls? Yeah, LPs are going to look at you like, “bro, you’ve got three sets of fees compounding and you still need your dessert before dinner?”

TL;DR

• European = LPs eat first.

• American = Everyone eats at the same time, but you might have to give back dessert later.

• Use American + clawback as a bridge for Fund I / smaller funds.

• By Fund III, European is the standard — unless you’re trying to end your LP relationships early.

Till next time,
-Fund1 Frank
Currently negotiating with my niece about why dessert comes last — apparently, she’s an American waterfall maximalist.