European vs American waterfall and the cost of a late loss

What is the difference between a European and an American waterfall?

A European waterfall tests carried interest against the whole fund, so the general partner (GP) is paid only after the limited partners (LPs) have received all contributed capital and their preferred return. An American waterfall tests deals as they sell, so the GP can be paid when the first deal sells, and the LPs carry the risk of a later loss until a clawback repays them.

Both sit on the distribution side of a fund’s capital calls and distributions, and both commonly use the same tiers: return of capital, the preferred return (also called the hurdle), a GP catch-up, then the carry split, written here as 80/20, meaning 80% to the LPs and 20% to the GP. What differs is the pot each tier is measured against. Early-stage venture funds have generally not had a preferred return, Cooley notes, and a whole-fund waterfall can still owe a clawback at liquidation, particularly where the fund has early winners. Jordan Silber of Cooley says the difference is mostly about timing and the risk of overdistribution, which means carry paid that the fund later cannot support (Cooley, June 2026).

CMS, a law firm, wrote in May 2024 that the two labels refer to where each style had traditionally been pre-eminent, that those geographic distinctions have become increasingly blurred, and that hybrids exist, such as a waterfall applied cumulatively to realised investments only, so that a later realised loss that takes the fund below its hurdle must be made up before more carry is paid (CMS, May 2024).

How much carry does each waterfall pay as the three deals sell?

In our illustrative fund the deal-by-deal waterfall pays the GP $9.00 million of carry in years 3 and 4, and the whole-fund waterfall pays none: the LPs have not had their capital and preferred return back when Deals A and B sell, and Deal C’s $5 million, a $35 million loss, leaves them short at the end. Every input below is an Unmatched Capital example input, not a real fund, and the amounts are in US dollars only for illustration: the arithmetic is the same in any currency.

Example input	Value
Fund size, contributed in one payment at the start	$100 million
Deal A	$30 million invested, sold in year 3 for $54 million
Deal B	$30 million invested, sold in year 4 for $51 million
Deal C, the last deal	$40 million invested, sold in year 6 for $5 million
Preferred return (hurdle)	8% a year, compounded annually
Carried interest	20%, with a 100% catch-up (how the catch-up works)
American waterfall	Each deal tested on its own, with no escrow and no carry-forward of losses
Fees, expenses, GP commitment and tax	None

Carry and clawback, $ million (example input)	American (deal-by-deal)	European (whole-fund)
Carry paid when Deal A sells, year 3	4.80	0.00
Carry paid when Deal B sells, year 4	4.20	0.00
Carry paid when Deal C sells, year 6	0.00	0.00
Total carry paid	9.00	0.00
Carry the GP has earned on the whole fund at the end	0.00	0.00
Clawback owed	9.00	0.00
Received by the LPs before any clawback	101.00	110.00
Received by the LPs after the clawback	110.00	110.00

These are Unmatched Capital’s calculations. The 8% hurdle sits inside the 7% to 9% IRR base hurdle that CMS describes. Deal A earns $24.00 million of profit against its own hurdle of $7.79 million; the 100% catch-up pays the GP $1.95 million and ends once profit reaches $9.74 million, so the GP takes 20%: $4.80 million. Deal B earns $21.00 million against a $10.81 million hurdle; its $2.70 million catch-up ends at $13.51 million, so the GP takes $4.20 million. Both payments follow the agreement as written, and the GP has done nothing wrong when it receives them.

The whole-fund waterfall pays the GP nothing at any point. The LPs’ balance, which is contributed capital plus 8% compounded, less what they have received, stands at $125.97 million in year 3 and $71.97 million after Deal A’s $54 million. It grows to $77.73 million by year 4 and falls to $26.73 million after Deal B’s $51 million, then grows to $31.18 million by year 6, when Deal C returns $5 million. The fund finishes with $10.00 million of profit on $100 million over six years, so the carry it has earned is zero.

CMS says a whole-fund waterfall typically does not pay carry until the late-stage disposals, which back-ends the GP’s entitlement to the end of the fund’s life (CMS, May 2024). In our example the back-ending protects the LPs, because the bad deal is the late one: the whole-fund structure never pays the GP, so there is nothing to recover. Its cost falls on a GP whose fund finishes above the hurdle, which waits for carry that a deal-by-deal GP would already hold.

What does a clawback return when the last deal loses?

A clawback makes the GP repay carry above what the whole fund earned, which here is all $9.00 million, but what the LPs recover depends on the escrow, the tax terms and who stands behind the repayment. Alter Domus, a fund administrator, describes example terms that cap repayment at the lesser of the excess carry or 100% of the carry received, so $9.00 million is also the most that could be owed (Alter Domus, October 2025). The same terms have the GP repay on an after-tax basis, which the last three rows of the table below model.

The table gives four versions of the same $9.00 million. The tax rate and escrow share are example inputs, and every row assumes the carry recipients can pay what they owe. The last row is a best case: it assumes tax was paid only on the 70% of carry released from escrow, so the recipients owe $6.30 million gross and repay $5.04 million after tax. If tax was paid on all $9.00 million when it was allocated, an after-tax clawback returns $7.20 million with or without the escrow, which changes only how much must be collected from the recipients.

Clawback terms (example input)	Held in escrow, $m	Repaid by carry recipients, $m	LPs recover, $m	LPs short, $m
Gross of tax, no escrow	0.00	9.00	9.00	0.00
Net of 20% tax paid on all carry when allocated, no escrow	0.00	7.20	7.20	1.80
Net of 20% tax paid on all carry when allocated, 30% escrow	2.70	4.50	7.20	1.80
Net of 20% tax, 30% escrow never taxed (best case)	2.70	5.04	7.74	1.26

The escrow rows show an arithmetic limit: an escrow holds a share of the carry paid, 30% here, so it covers a clawback in full only if the clawback is no more than that share. Ropes & Gray says escrows often retain 20% to 30% of carry distributions and are typically more common in deal-by-deal funds (Ropes & Gray, December 2025), and Osborne Clarke reports that the ILPA Principles suggest 30% (Osborne Clarke, February 2020). A late loss that pulls the fund below its hurdle makes the clawback 100% of the carry, which is the case in our example.

The size of the clawback depends on how badly Deal C goes. The next table changes only what Deal C returns.

Deal C sells for, $m (example input)	Fund profit, $m	American carry paid, $m	Whole-fund carry earned, $m	Clawback, $m
5	10	9.00	0.00	9.00
30	35	9.00	0.00	9.00
40 (its cost)	45	9.00	8.82	0.18
50	55	9.00	11.00	0.00

On this formula the clawback is the full $9.00 million until Deal C returns $31.18 million, the LPs’ remaining balance in year 6, and almost nil at Deal C’s cost. The last row shows the GP’s side of the trade. At $50 million, which is above Deal C’s cost but below its own hurdle of $63.47 million, this pure deal-by-deal waterfall pays the GP $2.00 million less than the whole-fund waterfall, which counts the fund’s profit as a whole; the gap is largest, $4.70 million, when Deal C sells at its own hurdle (Unmatched Capital’s calculations). A hybrid of the kind CMS describes can fix that.

Where do interim clawbacks, escrow and net-of-tax terms fall short?

Each safeguard either secures only part of the carry, tests it before the loss may be known, or depends on the carry recipients’ ability to pay, which leaves a gap in a deal-by-deal fund.

Torys, a law firm, summarised ILPA Principles 3.0 in March 2020 as asking that unrealised investments in a deal-by-deal waterfall be valued at the lower of cost or market, and that interim clawbacks be triggered at defined intervals and on specific events (Torys, March 2020), so a test depends on the valuations behind it. In our fund, a test at the end of year 5 with Deal C carried at its $40 million cost finds nothing to repay, but a $30 million mark puts $7.87 million back in play (Unmatched Capital’s calculation, assuming a hypothetical sale at the mark).

The figures also rest on a formula: our tables rerun the whole-fund waterfall from the start, as if the LPs had received Deals A and B in full. Henry Riffe of the law firm Robinson, Bradshaw & Hinson calls a hypothetical single distribution at liquidation the more common drafting, using actual distribution dates for time-based hurdles (Private Fund Insights, August 2026). Measured on what the LPs actually received, our reading of it, the clawback stays $9.00 million until Deal C returns $33.12 million, is $2.12 million at its cost, and is $9.00 million at the year-5 $30 million mark (Unmatched Capital’s calculations).

Net-of-tax repayment leaves a gap equal to the tax allowance the agreement deducts. Dechert reported in October 2019 that ILPA Principles 3.0 recommend a clawback gross of taxes, and expected most GPs to push back (Dechert, October 2019), while Cooley says many agreements use an after-tax clawback, sometimes with assumptions about tax rates and tax benefits, so the allowance need not equal the tax actually paid: $1.80 million here at an example 20% rate.

Cooley says that if the clawback arises at liquidation the fund and GP may have little or no remaining assets, and that the issue is more commonly addressed through undertakings or guarantees by the carry recipients (Cooley, June 2026). The 2019 ILPA model LPA suggested a joint and several personal guarantee of 100% of the obligation as an alternative to escrow, and Osborne Clarke said joint and several liability for the return of carry is very rare (Osborne Clarke, February 2020). Dechert reports that the 2020 update requires the GP to procure personal guarantees from the carry recipients.

Dechert, writing from the manager’s side in September 2020, argued that having both an escrow (which it reports ILPA suggests at 30% of carried interest distributions) and personal guarantees is in many situations overkill, that annual interim clawbacks are excessive, and that ILPA’s deal-by-deal model LPA would often give the same timing and amount of distributions as a whole-fund waterfall (Dechert, September 2020). Its reason is that ILPA’s version requires so much to be returned first: the capital invested in the deals sold, unrealised losses and all fund expenses, including management fees. Unmatched Capital’s reading is the converse: the less a deal-by-deal waterfall returns first, as in our example, the earlier carry is paid and the more the LPs’ protection rests on escrow and on the carry recipients’ ability to repay.

Which waterfall do funds use today?

Law-firm sources differ on which waterfall is standard, and each describes a different year, region or sample. In Cooley’s 2026 survey of private fund terms, approximately 90% of funds reviewed used a European waterfall and the remainder used some form of deal-by-deal waterfall, but the page states no sample size or fund types (Cooley, June 2026). Cooley adds that deal-by-deal waterfalls are more common in parts of the private equity market than in early-stage venture capital, which in Unmatched Capital’s reading suggests the 90% overstates the share for buyout funds.

Katten wrote in November 2019 that a deal-by-deal waterfall was still generally the US market standard, while whole-fund was more common in Europe (Katten, November 2019). Ropes & Gray, in December 2025, calls all-capital-first the typical formulation for EU funds and deal-by-deal the typical one for US funds.

Tax law can also steer the choice. Luxembourg’s parliament adopted a reform on 22 January 2026 that removes the previous full capital recovery precondition for its carried interest regime, so deal-by-deal waterfalls can benefit from the preferential regime, provided the other statutory conditions are met. Baker McKenzie adds that the regime covers Luxembourg and foreign funds, and that escrow and clawback mechanics remain commercial arrangements (Baker McKenzie, January 2026). The bill was formally adopted once the Conseil d’État waived the second constitutional vote on 3 February 2026, and the regime applies to income realised from 1 January 2026 (Mourant, February 2026). Unmatched Capital’s reading is that it widens the choice for managers whose carry is taxed in Luxembourg and moves more of the LPs’ protection onto the escrow and clawback terms above.

ILPA, the investor body, recommends the whole-fund model. Torys’s 2020 summary records Principles 3.0 as saying a whole-of-fund model is best practice and, for other models, an escrow of 30% of carry or more. ILPA published Principles 3.0 in June 2019, as its own site says (ILPA), and describes nearly 600 member institutions, about 60% of them US-based and 40% in Europe, Canada and the rest of the world (ILPA), so its whole-fund recommendation comes mostly from investors in the market Katten described in 2019 as deal-by-deal. Apart from those facts, the ILPA points on this page are as the law firms named report them. ILPA also published a deal-by-deal version of its model LPA in 2020, according to Dechert.

No source read for this page measures how many funds hold carry in escrow, require guarantees or test clawbacks at interim dates. How common those protections are today is unmeasured here, so an LP should read each fund’s own terms rather than assume either waterfall.

What should an LP or an emerging manager ask for?

An LP comparing fund terms should size the exposure first: all carry paid before the fund’s final reckoning is what a clawback may need to return, capped in Alter Domus’s example terms at 100% of the carry received, and the question is how much of it is secured. In our fund that is $9.00 million on $100 million; with after-tax repayment at an example 20% the LPs recover $7.20 million, or $7.74 million if the escrowed 30% was never taxed. Even a full gross clawback arrives late: $9.00 million in year 6 replaces $4.80 million in year 3 and $4.20 million in year 4, which at the 8% hurdle rate are worth $10.95 million by year 6, so the LPs are $1.95 million behind (Unmatched Capital’s calculation).

Before signing, check five terms:

1. Whether the waterfall is whole-fund, deal-by-deal or a hybrid, and what must be returned before carry is paid: losses on earlier deals, write-downs and fees.
2. How much carry is held back: the escrow share, and whether it is a percentage of each distribution or of the potential clawback. Ropes & Gray says escrows often retain 20% to 30% of carry distributions (Ropes & Gray, December 2025).
3. Who stands behind the repayment: the GP entity only, or the individual carry recipients by guarantee, and whether LPs can enforce it directly.
4. Whether repayment is gross or after tax, and by when.
5. When the clawback is tested, and how unrealised investments are valued on those dates.

An emerging manager choosing a structure faces the same table from the other side. Deal-by-deal pays earlier when early deals win, but an escrow holds back part of that carry and the clawback terms put the rest at risk, and in our example it paid the GP less than whole-fund when the last deal ended above cost. On Dechert’s reading, a deal-by-deal waterfall that returns earlier capital, write-downs and fees first will often give the same timing and amount as whole-fund. In Unmatched Capital’s reading, a manager therefore pays for early carry either by returning more to investors first or by putting security behind what is paid early. Dechert adds that escrow and personal guarantees would rarely be implemented together. Where a carry tax regime depends on the waterfall, as Luxembourg’s did, check it before choosing. A manager should model its own fund’s deals under both waterfalls before choosing. This page is general information, not legal or investment advice.