Equity waterfall: preferred return, catch-up, promote
How the levered cash is split between investors and sponsor.
By Surojit Chakraverti, founder of L3VLUP and an investor running a long-short healthcare and technology equities strategy.
On this subject: equity waterfall: preferred return, catch-up, promote.Updated 30 September 2026
What it does
The split of levered cash between the investors and the sponsor. Tier one pays investors a compounding preferred return and their capital through one hurdle balance that accrues and is paid down. Tier two pays the sponsor until its promote share of all profit distributed so far is reached, the catch-up that first-time models omit. Tier three splits the rest. Run period by period across the hold, because the timing of distributions drives both IRRs.
Where it lives
The same schedule in each model that carries it, with the rows to open. Open a model in the browser, go to the sheet, and click the lines.
- Assumptions, rows 34–36: Sponsor co-investment, % of equity, Preferred return to investors, % a year, compounding, Promote to the sponsor above the hurdle
- Waterfall, rows 6–8: Levered cash flow, Equity contributed, Cash to distribute
- Waterfall, rows 11–16: Hurdle balance, opening (capital plus accrued preferred return), Preferred return accrued, Paid to investors, Hurdle balance, closing…
- Waterfall, rows 19–21: Sponsor entitled to, cumulative: promote share of all profit so far, Catch-up paid to date, opening, Paid to the sponsor
- Waterfall, rows 24–26: Remaining cash, To investors, To the sponsor
- Waterfall, rows 29–36: Investors (including the sponsor’s co-investment), Sponsor promote, Third-party investor cash flow, Sponsor cash flow: co-investment plus promote…
What a reviewer looks for
- No catch-up, so the sponsor’s promote is understated above the hurdle.
- A terminal-only waterfall that ignores the timing of interim distributions.
- The sponsor’s co-investment mixed into the promote.
Learn it, then build it
Build · Lab · ~12 min
Exit Waterfall Lab
Run a liquidation waterfall at any exit value, say where a preferred holder chooses to convert, and explain what a 1x non-participating preference actually costs the founders.
Read · Guide · 13 min
Real Estate Financial Modelling: Why Corporate Finance Mechanics Break Here
Vocabulary: Promote (Real Estate), Preferred Return (Hurdle Rate), GP Catch-Up.