1. What is a distribution waterfall in a Luxembourg SPV?

A distribution waterfall is the contractual mechanism that determines how proceeds received by an investment vehicle are allocated between its investors and the persons entitled to carried interest. For a Luxembourg special limited partnership (société en commandite spéciale, or SCSp), it is defined in the limited partnership agreement (LPA): when investors recover their capital, whether they receive a preferred return, when carried interest becomes payable and how the remaining profit is divided.

Consider an SCSp that invests in a venture capital company. Investors contribute EUR 1 million; five years later the SPV receives EUR 3 million from selling its shares. The investment has produced EUR 2 million above contributed capital before any further costs, taxes or reserves, but investors do not automatically receive EUR 3 million. If the LPA provides for 20% carried interest on qualifying profit, part of the proceeds goes to the carry holder; if it also provides for a preferred return, a catch-up or distribution reserves, those provisions change the sequence and timing of payments.

Two different waterfalls may apply to the same exit

1. The portfolio-company exit waterfall determines how the proceeds of selling or liquidating the company are shared among its shareholders and security holders. Liquidation preferences, convertible instruments, seniority and participation rights decide how much the SPV receives.
2. The SPV distribution waterfall determines how the proceeds actually received by the Luxembourg vehicle are divided among its limited partners and the carry holder.

These are separate calculations. An SPV holding preferred shares may receive EUR 2 million from a EUR 20 million company sale; its carry is calculated on its own contractual economics, not on the company's sale price. The calculation also depends on whether the SPV receives cash, listed shares, escrowed consideration or future earn-out payments.

2. How the SCSp governs carried interest

The SCSp suits contractual distribution arrangements because the Law of 10 August 1915 on commercial companies leaves the partners wide freedom to define their economic rights: the LPA may provide for differentiated allocations of profits and distributions. Luxembourg law prescribes no standard 20% carry, 8% hurdle or catch-up mechanism for an ordinary SCSp. These are commercial terms, not statutory percentages, and the LPA must translate them into enforceable, calculable provisions.

In an SCSp syndicate the parties are typically:

• Limited partners: the investors providing most of the capital.
• General partner: the entity representing the partnership and acting for it under the LPA.
• AIFM, where applicable: the entity responsible for regulated portfolio and risk management.
• Carry holder: the sponsor, syndicate lead, investment professionals or a separate carry vehicle entitled to an agreed share of qualifying profit.

The carry holder does not have to be the corporate GP, and in practice carry is commonly held outside it to manage municipal business tax risk under Article 14(4) of the Luxembourg Income Tax Law. The legal form is covered in our guide to the Luxembourg SCSp.

3. The four tiers of a typical waterfall

A conventional private equity waterfall has four successive tiers. Not every Luxembourg SPV uses all four; single-asset syndicates often use a simpler two-tier arrangement.

Tier 1: return of capital

The first tier returns the investors' contributed capital, and the LPA must define what counts as capital: the amount used to acquire the investment; that amount plus establishment expenses; all capital contributed, including fees, operating costs and reserves; or, in a multi-asset vehicle, the capital attributable to the realised investment. The choice drives the carry.

An SPV that raises EUR 1 million and spends EUR 40,000 on set-up and operating costs has EUR 960,000 available to invest. If the LPA requires all EUR 1 million to be returned before carry, the first EUR 1 million of distributable proceeds belongs to investors. Calculating carry against the EUR 960,000 acquisition cost alone, ignoring expenses funded by investors, is wrong unless the agreement expressly provides that basis.

Tier 2: preferred return or hurdle

A preferred return gives investors priority over the carry holder up to a contractual return threshold. The commonly illustrated rate is 8% a year, but it is negotiable. The LPA specifies the rate; simple or compound accrual; the start date; whether it applies to all contributed capital or only invested capital; how distributions reduce the outstanding balance; and how later calls and partially returned capital are treated.

On EUR 1 million outstanding for exactly two years, an 8% simple preferred return is EUR 1,000,000 × 8% × 2 = EUR 160,000; compounded annually it is EUR 1,000,000 × (1.08² − 1) = EUR 166,400. The same headline rate produces a EUR 6,400 difference. Real calculations use the LPA's day-count and compounding conventions and the actual dates of each contribution and distribution. A preferred return is a priority in the allocation of available proceeds, not a guaranteed return.

Tier 3: catch-up

Under a 100% catch-up, all distributions in this tier go to the carry holder until it has received the agreed carry percentage of cumulative profit. With 20% carry, the catch-up needed is the preferred return × 20% ÷ 80%: on a EUR 160,000 preferred return, EUR 40,000. The formula assumes a full catch-up and no earlier distributions that change the calculation. The catch-up does not add carry on top of the agreed percentage; it brings the carry holder up to the contractual sharing ratio.

Tier 4: residual split

Once the earlier tiers are satisfied, the remaining profit is divided as the LPA provides, conventionally 80% to the limited partners and 20% to the carry holder; 85/15 and 90/10 are also common, and ratios can vary by investor class or performance threshold. Where the LPA requires a cumulative waterfall, the sequence is recalculated cumulatively at each distribution rather than restarted.

4. Example 1: 20% carry and no hurdle

The structure most often used in single-asset syndicates. Assumptions: EUR 1,000,000 contributed; EUR 1,800,000 of exit proceeds available for distribution; no preferred return; 20% carry on profit after full return of contributed capital; no other expenses, taxes, reserves or earlier distributions; no co-investment by the carry holder.

The gross multiple before carry is 1.80x; the net LP multiple after carry is 1.64x. With one terminal exit this is operationally simple. Complexity arrives with multiple closings, additional contributions, partial exits, different investor entitlements or special distributions.

5. Example 2: 8% preferred return, 100% catch-up and 20% carry

Same SPV, now with an 8% simple preferred return, a 100% catch-up and a final 80/20 split. Holding period exactly two years, no interim cash flows, no other costs.

The final result is identical to Example 1. The preferred return and catch-up change the sequence of payments and whether the carry holder is paid when proceeds are insufficient to complete the waterfall, and they affect when carry crystallises if the SPV makes interim distributions. With a full catch-up and enough proceeds, the carry holder ends with the same 20% of profit as under a simple 80/20 split; the two structures are not equivalent at every point of the investment's life.

If the exit is only EUR 1.2 million

Return of capital takes EUR 1,000,000 and the preferred return EUR 160,000, leaving EUR 40,000, all of which goes to the carry holder under the 100% catch-up. LPs receive EUR 1,160,000 and the carry holder EUR 40,000, which is 20% of the EUR 200,000 total profit, because the remaining cash is just enough to complete the catch-up. Without a catch-up the result changes, as the next example shows.

6. Example 3: hard hurdle vs soft hurdle

Under a hard hurdle, the carry holder participates only in profit above the preferred-return threshold. Under a soft hurdle with full catch-up, once the hurdle is met and the catch-up completed, the carry holder participates in the whole profit. Using the EUR 1.2 million exit (capital EUR 1,000,000, profit EUR 200,000, preferred return EUR 160,000, carry 20%):

The difference between the two hurdle designs is EUR 32,000 in this example. An LPA that says only "8% hurdle and 20% carry" leaves the most valuable question open: which profit is subject to carry, and whether the hurdle is a priority allocation, an absolute threshold or part of a catch-up mechanism.

7. Example 4: how SPV costs reduce investor returns and carry

Syndicate costs include formation and documentation, GP and AIFM fees, investor onboarding, bank charges, accounting, tax filings and liquidation. Some are charged outside commitments, others funded from them; the waterfall follows the agreed treatment. Assumptions: EUR 1,000,000 contributed; EUR 40,000 of SPV expenses paid from contributions; EUR 960,000 invested; exit proceeds EUR 1,920,000 (2.0x on invested capital); 20% carry after full return of contributions; no preferred return, no further costs or taxes.

The deal returned 2.0x; investors receive 1.736x after costs and carry. The investment ratio, the share of contributions actually invested in the company, is 96%, an important disclosure in small syndicates where fixed costs are a material share of commitments.

The same cost must not be deducted twice. If the EUR 40,000 has already reduced the amount invested and the waterfall returns the full EUR 1 million contributed, deducting it again from distributable profit understates the carry base. Conversely, using EUR 960,000 as the capital base without protecting the EUR 40,000 of contributed expenses favours the carry holder over investors. The LPA, the fee schedule and the accounting records must use the same definitions.

Allocating the distribution between three investors

A pro rata split works because all three invested on the same terms. With different closings or contribution dates, side letters, carry-free tickets or partial participation, the calculation runs at investor or class level.

8. Example 5: partial exits, overpaid carry and clawback

A single-asset SPV does not always exit in one transaction: the company may be sold in stages, the SPV may sell part of its stake in a secondary, or receive liquidity through a recapitalisation. Assume EUR 1,000,000 invested, no fees, taxes or preferred return, 20% carry, and an LPA that pays carry on each realised tranche after recovering the cost allocated to it. The holding is split into Tranche A (cost EUR 600,000) and Tranche B (cost EUR 400,000).

First exit. Tranche A is sold for EUR 1,400,000: profit EUR 800,000, carry EUR 160,000, LPs EUR 1,240,000.

Second exit at a loss. Tranche B is sold for EUR 100,000, a loss of EUR 300,000.

How an escrow protects investors

If the LPA retains 50% of each carry entitlement in escrow, EUR 80,000 is paid at the first exit and EUR 80,000 retained. At final liquidation, lifetime carry is EUR 100,000: EUR 60,000 of the escrow goes to the LPs and EUR 20,000 is released to the carry holder. The final position reconciles to the cash:

Real agreements also deal with taxes on carry already paid, ownership of and interest on the escrow, and the enforceability of repayment.

Carry calculated on an early profitable realisation may not equal carry earned over the whole investment. A cumulative waterfall that defers carry until all contributed capital is returned reduces that risk without always removing the need for reconciliation.

Clawback vs escrow

An escrow retains cash before it reaches the carry holder; a clawback is a contractual obligation to return over-distributed carry when the final entitlement is lower than what was paid. They are often used together. A clawback clause states who is liable, whether the obligation is gross or net of personal taxes, when it is tested, what security backs it and how repayment is enforced. Institutional guidance such as the ILPA Principles 3.0 stresses transparent carry calculations and safeguards against excess distributions.

9. European vs American waterfall in a Luxembourg SPV

The terms describe economic models, not the domicile of the fund; a Luxembourg SCSp can adopt either.

The ILPA Model LPA provides separate economic models for whole-of-fund and deal-by-deal waterfalls. For an SCSp holding a single investment with one final cash distribution, whole-of-fund and deal-by-deal waterfalls may produce the same result where the capital-return basis, expense treatment, preferred return and catch-up provisions are equivalent; differences in those definitions produce different allocations even with a single investment. The models diverge further with partial exits, follow-on funding, dividend recapitalisations, several investments or unequal participation, so the model should follow the actual cash-flow profile of the deal, not the label. The structure of single-deal vehicles is explained in our deal-by-deal SPV guide.

10. The waterfall provisions that must be precise in the LPA

The waterfall should be drafted so that the administrator can calculate it from the transaction records without undocumented commercial assumptions.

Timing and day-count conventions

A preferred return accruing from the date investors fund gives a different result from one accruing from the acquisition date. The LPA states the day-count basis, for example actual days over 365, and how partial returns of capital reduce future accrual.

Cash available for distribution

An SPV may receive EUR 2 million from an exit without EUR 2 million being distributable. Agreed transaction expenses, liabilities, foreign withholding taxes, unpaid vehicle expenses and approved reserves come first; escrowed proceeds and earn-outs enter the waterfall only when released or received. The LPA defines both the distributable amount and the point at which proceeds enter the waterfall.

In-kind distributions

An IPO or a share-for-share acquisition may leave the SPV holding securities rather than cash. The LPA addresses valuation, transfer restrictions, whether an in-kind distribution triggers carry, how the carry holder receives its share and whether enough liquidity remains for expenses and taxes. The reporting fair value of an asset is not cash available for distribution.

11. Tax: carried interest is not the same as the waterfall

The waterfall decides who is economically entitled to proceeds; tax law decides how that entitlement is characterised and taxed in each recipient's hands. Three points connect the two:

• MBT and the GP. The SCSp is generally transparent for corporate income tax, subject to exceptions such as the reverse hybrid rules, but a corporate GP holding at least 5% of the partnership interests can make it deemed commercial for municipal business tax under Article 14(4) LITL. This is one reason carry and sponsor commitments are commonly held outside the corporate GP; the analysis follows the rights actually documented in the LPA. See Luxembourg SCSp Tax: Transparency, the 5% GP Rule and Investor Reporting.
• The 2026 carried interest regime. The Law of 3 February 2026 amended Article 99bis LITL for qualifying carried interest received by eligible Luxembourg tax-resident individuals: contractual carry taxed at one quarter of the global rate, and participation-linked carry that can be exempt where more than six months have elapsed, subject to Article 100 LITL. The reform removed the former condition that investors first recover their whole investment, which gives flexibility to deal-by-deal carry, but it does not override the LPA: if the LPA requires full return of capital before carry, that stays binding. The regime is intended for qualifying individuals involved in investment management, not for every beneficiary of the waterfall, and ordinary co-investment returns are analysed separately; non-resident carry holders are taxed under their own rules and the applicable treaties. A waterfall without an explicit preferred-return hurdle does not automatically qualify either: Article 99bis requires a genuine participation in the AIF's outperformance, and although the law prescribes no minimum hurdle, the economic threshold and carry terms must be consistent with market practice and are assessed separately from the contractual calculation.
• Waterfall labels are not tax labels. A distribution classified as return of capital under the LPA is not automatically tax-free for every investor, because the tax character of income allocated through a transparent SCSp follows the underlying dividends, gains, expenses and withholding taxes. The administrator therefore keeps four records apart: contractual waterfall allocations, accounting income and capital-account movements, cash distributed, and taxable income with its classification.

12. Accounting for carried interest

The waterfall is an operating calculation linked to the books, not a spreadsheet built when the exit arrives. The records it draws on are commitments, contributions, cost basis, operating expenses, realised proceeds, valuation movements, previous distributions and the carry allocation history.

Accrued, crystallised and paid carry

1. Accrued carry: calculated for financial reporting under the governing documents and the accounting framework, potentially on unrealised values.
2. Crystallised carry: the entitlement established once the contractual conditions are met.
3. Paid carry: the cash or assets actually distributed to the carry holder, net of any escrow.

An unrealised increase in a start-up's valuation does not by itself allow carry to be distributed: valuation and accounting policies govern recognition and presentation, the LPA governs entitlement. The IPEV Valuation Guidelines, updated in December 2025, are the reference framework for fair value in private capital.

What an investor distribution notice should show

Enough to reconcile the payment to the LPA: distribution date, available proceeds, returned capital, allocated profit, carried interest, withholding taxes, recallable amounts where applicable and cumulative distributions. The Invest Europe Investor Reporting Guidelines (2024) also address disclosure of realised and unrealised carry, escrow balances and potential clawback exposure.

Reconciliation controls

Before any distribution is approved, the GP and the administrator reconcile the calculation to the records. The core control is: distributable cash = LP distributions + carry payments + escrow allocations, with any amounts retained for liabilities or reserves shown separately. An escrow allocation is not a cash distribution: where the escrow stays on the SPV's balance sheet as restricted cash, it is presented and reconciled according to its legal and accounting structure until it is released. The waterfall reconciles to the partner capital accounts and the cash movements. A calculation can be arithmetically correct and still wrong if it uses outdated commitments, the wrong investment cost, the wrong compounding basis or an unrecorded earlier distribution.

13. How Fundequate supports waterfall calculations and reporting

For sponsors and syndicate leads the difficulty is rarely knowing that carry is 20%. It is applying the right percentage to the right base, at the right time, from records that stay consistent through the life of the investment.

Fundequate combines Luxembourg expert-comptable expertise, specialised SPV operations and a proprietary digital platform. Commitments, capital calls, contributions, capital accounts, distributions and reporting sit on one set of records, and authorised users access their financial data and reports online through the investor portal. The LPA's economic terms are translated into an auditable calculation supported by the vehicle's books, connecting:

• the signed LPA and the agreed waterfall parameters;
• investor contributions and capital-account records;
• investment cost and expense allocations;
• exit proceeds and approved reserves;
• carry calculations, distribution notices and escrow balances;
• investor statements and reporting history.

The GP and the AIFM keep their legal and regulatory decision-making responsibilities; accounting and operations provide the calculations and records behind them. This matters most for repeat syndicates and deal-by-deal programmes, where one sponsor runs several SCSps with different investors, carry rates, hurdles or follow-on terms, each of which needs its own correct calculation and books.

A defensible waterfall is one that investors can understand, the administrator can reproduce and the GP can reconcile to the LPA and the books. See our syndicate and SCSp solutions, accounting and reporting and fund documentation services.

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