lev-os Modeling Carried Interest Mechanics
Builds carry waterfall models with preferred return hurdles, catch-up provisions, and clawback mechanics across deal-by-deal and whole-fund structures.
When To Use
- Modeling GP carry economics during fund formation or LPA negotiation
- Comparing European (whole-fund) vs. American (deal-by-deal) waterfall structures
- Analyzing the impact of preferred return hurdles, catch-up splits, and tiered carry rates
- Stress-testing clawback exposure under different portfolio performance scenarios
- Evaluating GP/LP alignment across varying fund return profiles
- Preparing carry allocation exhibits for side letter or advisory committee discussions
Inputs To Gather
- Fund terms: committed capital, GP commitment percentage, management fee rate and offset mechanics
- Waterfall structure: European (whole-fund) or American (deal-by-deal), or hybrid
- Preferred return: hurdle rate (typically 7–9% IRR), compounding method (simple, compound, or continuous), and whether it is cumulative [VERIFY against LPA]
- Catch-up provision: GP catch-up percentage (commonly 100% or 80/20), and whether catch-up is full or partial
- Carry split tiers: standard 80/20, any tiered escalation thresholds (e.g., 80/20 below 2x MOIC, 70/30 above)
- Clawback terms: interim clawback triggers, true-up frequency, escrow/holdback percentage (typically 20–50% of carry), and any tax-distribution gross-up [VERIFY]
- Deal-level assumptions (for deal-by-deal): projected entry/exit values, hold periods, and recycling provisions
- Fee offsets: whether management fees reduce contributed capital for waterfall purposes
Workflow
Confirm waterfall type and key terms
- Identify European vs. American vs. hybrid structure from LPA or term sheet
- Map each tier: return of capital → preferred return → GP catch-up → carried interest split
- Note any netting or aggregation provisions for deal-by-deal structures
Build the capital account framework
- Track LP and GP contributed capital, cumulative distributions, and unrealized value per period
- For whole-fund: aggregate all investments into a single waterfall calculation
- For deal-by-deal: model each investment's waterfall independently, then aggregate for clawback analysis
Model the preferred return hurdle
- Apply the stated hurdle rate to LP contributed capital (net of any fee offsets)
- Calculate accrued preferred return per period using the specified compounding convention
- Determine the cumulative preferred return shortfall or surplus at each distribution event
Apply catch-up and carry tiers
- Once LP preferred return is satisfied, allocate distributions to GP catch-up until the GP has received its pro-rata carry share of all profits to that point
- After catch-up is complete, split remaining distributions per the stated carry ratio (e.g., 80/20)
- For tiered structures, apply escalating carry percentages at each MOIC or IRR threshold
Model clawback and escrow mechanics
- Calculate the GP's cumulative carry received vs. the carry the GP would be entitled to if the fund were liquidated at current values
- Identify interim clawback triggers (if any) and end-of-fund clawback obligations
- Model the escrow reserve—carry withheld from GP distributions and released upon fund wind-down or true-up
- Account for tax-distribution gross-up provisions that reduce the effective clawback amount [VERIFY against LPA]
Run scenario and sensitivity analysis
- Vary portfolio returns (e.g., 0.5x–3.0x gross MOIC) to map carry across outcomes
- Test the impact of loss investments on deal-by-deal carry vs. whole-fund carry
- Stress-test clawback exposure: model a scenario where early exits are profitable but later exits are at loss
- Compare GP economics across structures (side-by-side European vs. American output)
Produce final model and documentation
- Generate a waterfall schedule showing distributions at each tier per period
- Summarize GP carry, LP net returns, and clawback exposure at each scenario level
- Document all assumptions, including hurdle compounding method, fee treatment, and recycling rules
Output
- Waterfall distribution schedule: period-by-period allocation across return of capital, preferred return, catch-up, and carry tiers
- GP carry summary: total carry earned, carry as percentage of profits, effective carry rate across return scenarios
- Clawback analysis: maximum clawback exposure, escrow adequacy, and net-of-tax clawback obligation
- Scenario matrix: GP carry and LP net multiples/IRRs across a range of gross fund returns (table or chart)
- Structure comparison (if applicable): side-by-side economics of European vs. American waterfall under identical assumptions
Quality Checks
- Verify that LP preferred return is fully satisfied before any carry is allocated—no leakage into catch-up prematurely
- Confirm catch-up math: after catch-up, GP's cumulative share of total profits should equal the stated carry percentage
- Ensure clawback calculation nets to zero at fund wind-down—GP's total carry equals the stated percentage of total fund profits above the hurdle
- Cross-check: under a whole-fund model with uniform returns, deal-by-deal and whole-fund carry should converge
- Validate that GP commitment is treated correctly (carried alongside or excluded from carry base) [VERIFY against LPA]
- Confirm management fee offset treatment matches LPA terms—100% offset, 80% offset, or no offset
- Flag any interim distribution assumptions that could trigger premature clawback obligations