The same deals, the same total profit, two calculation orders — and a $9M promise to repay that is only as good as the entity that made it.
On the same ten deals, with the same total profit, the American calculation pays the general partner earlier and leaves a $9M clawback — sixteen percent of everything already banked. Whether that $9M is worth $9M depends on facts that have nothing to do with the waterfall.
European and American waterfalls are not two different economic deals. Run to the end of a fund's life, on the same cash flows, they can produce the same total carried interest. What differs is the order of calculation, and therefore the timing — and timing is where the disputes are.
| Convention | How carried interest is computed |
|---|---|
| European (whole-of-fund) | All contributed capital across every investment is returned first, then the preferred return on it, and only then does the general partner participate. Carry is calculated once, on the fund. |
| American (deal-by-deal) | Each realisation runs its own waterfall. Capital and preferred return attributable to that deal are satisfied, and the general partner takes its share of that deal's profit immediately. |
In a fund where every investment succeeds, the two converge. In a fund where the winners exit before the losers — which is the normal sequence, because good assets are easier to sell — the American calculation pays carried interest on gains that later losses will erase.
The $500M fund: ten investments of $50M, seven at 1.8x, three at 0.7x, $735M of proceeds and $235M of profit. Under the American calculation the general partner receives carry as the seven winners are realised. Then the three losers come in at 0.7x and the fund's total profit turns out to be lower than the sum of the profits already shared.
The correction is the clawback: $9M, equal to 16 percent of everything the general partner had already been paid.
Note what the clawback is not. It is not a penalty and not a dispute. It is the arithmetic working correctly: the deal-by-deal order overpaid, and the provision exists to unwind the overpayment. The question is only whether the money comes back.
Carried interest is received by individuals who pay tax on it. Most clawback provisions are therefore capped at the after-tax amount received, on the reasonable ground that the recipients never had the gross. A $9M gross clawback can be a materially smaller net obligation, and the limited partners bear the difference.
The obligation sits with the carry vehicle and, behind it, with individuals — some of whom may have left the firm, and some of whom will have spent the money years earlier. A joint and several guarantee among the carry recipients is far stronger than a several-only one, and the difference is a drafting point in a document most investors read once.
Clawbacks are typically trued up at the end of the fund's life — often ten years or more after the payments they reverse. A promise to repay $9M in year twelve, unsecured, from a vehicle that may by then hold nothing, is not the same asset as $9M.
The headline carry rate is the least informative number in the fee section. Two funds at “20 and 8” can differ by hundreds of basis points of net return on the strength of the calculation order, the preferred return's compounding, and the fee basis after the investment period.
The measurement that settles it is the gross-to-net bridge: what the assets earned, and what the investor received, with every deduction between them named. On one worked fund that bridge runs from 2.15x gross to 1.78x net — roughly 200 basis points of compound annual return handed over across management fees, fund expenses and carried interest.
Two hundred basis points is more than most allocators will move on any other decision in the portfolio. It is worth reading the waterfall for.
Every figure above is a live formula in the companion files for Private Equity Real Estate. Change one input and the rest of the sheet answers. They are free, and they need no account and no email address.