CSC’s 2024 Distribution Waterfalls survey found significant pushback among LPs when they found waterfall provisions unreasonable or lacking in transparency. How can GPs respond to this significant market challenge?
Fundraising and fund terms negotiations are where GPs come up against LP expectations. The latest data indicates that GPs need advanced preparation and systems to meet these expectations and deal with LP demands about waterfall provisions and fund terms. Clear terms are critical to closing the deal in a fundraising round and to maintaining good relations with LPs.
Our Distribution Waterfalls 2024 survey collated responses from 200 GPs and 200 LPs equally allocated between North America, Europe, and Asia Pacific. It found LPs pushing back against GPs over waterfall provisions and many not committing in the first place over issues with waterfalls.
What are the top LP expectations around waterfall distribution terms in fund agreements?
When LPs were asked if they have pushed back on unreasonable waterfall provisions in Limited Partnership Agreement negotiations or decided not to commit to a fund because of a lack of transparency or unreasonableness on waterfall provisions they responded as follows:
- LPs pushing back once against GPs over waterfall terms—64%
- LPs pushing back multiple times against GPs over waterfall terms—15%
- LPs deciding not to commit several times over GP waterfall provisions—39%
- LPs deciding not to commit once over GP waterfall provisions—36%
Given this type of reaction, GPs who prepare to meet LP expectations in advance regarding waterfall distribution provisions in their fund terms are more likely to secure LP commitments and enable a smoother fundraising process. Crucially, LPs don’t seem to hesitate when declining commitment to funds when GPs are not ready to modify waterfall distribution provisions.
How GPs can align waterfall provisions with LP expectations
GPs, when asked if, over the past two years, any LPs declined to invest based on either a lack of flexibility in modifying waterfall provisions, or a perception that these would be detrimental to an optimal GP and LP alignment, responded as follows:
- GPs with significant number of LPs declining to invest over inflexibility on waterfall provisions—42%
- GPs with small number of LPs declining to invest over inflexibility on waterfall provisions—45%
As for the specifics of what LPs want when they assess the GP’s fund waterfall distribution provisions and other matters, they noted these five elements:
- Simplicity
- Acceptability
- Standardization
- Clarity
- Transparency
LPs, when asked what their key barriers or sticking points are to agreeing to waterfall distribution provisions with GPs, cited the following, in order of importance:
- Alignment of interests between GPs and LPs
- Complexity and structure
- Appropriate timing and frequency of distribution
- Carried interest and fee structures
- Clawback provisions
In meeting all these goals, GPs can benefit from external third-party support from expert fund management professionals such as CSC, who can provide the systems and the domain expertise to provide clear, transparent waterfall distribution mechanisms, and deliver data and distributions to LPs smoothly and simply.
How to meet LPs’ great expectations
LPs themselves show finely balanced approaches when it comes to their responses on GP waterfalls provisions over the past three years, especially with regards to cash-flow modelling and GP and LP alignment.
- LPs overall satisfied with their GP waterfalls provisions—42%
- LPs very satisfied with their GP waterfalls provisions—10%
In addition, when asked if they agreed that GPs should be allowed to provide different LPs with distinct terms and levels of transparency, results found double the number of LPs stating GPs should have the ability to provide different LPs with specific terms and levels of clarity at 66%. Just 32% stated that GPs should provide all LPs with the same terms and levels of transparency.
Clearly, GPs need to be ready to anticipate and adapt to LP expectations when it comes to waterfall distribution terms and the specific needs of individual LPs.
If GPs are going to meet the needs of most LPs who accept differing waterfall distribution terms and levels of transparency across a fund, they need to be ready to deliver more complex reporting to give each LP accurate data, despite the divergence of terms.
This will increase the operational burden and reduce transparency, emphasizing the value add provided by external service providers like CSC, who can manage the complexity and disparate needs involved through well-established systems developed across a range of fund types.
How CSC can help
CSC can help GPs anticipate the priorities and needs of their LPs for waterfall distribution agreements and respond accordingly with tailored solutions that make the management and reporting of complex fund structures straightforward, accurate, and transparent. GP and LP alignment, GPs’ operating budgets, and quality of services and communications for LPs can all benefit from CSC’s extensive experience with multiple fund types. Additionally, our expertise in managing sophisticated outsourced systems, allowing GPs to focus on executing their business.
CSC is the world’s leading provider of global business administration and compliance solutions, specializing in tailored outsourcing and co-sourcing solutions. The trusted partner of choice for more than 70% of the PEI 300, we help our clients navigate operational and regulatory complexities for every phase of the fund lifecycle
Ready to streamline your waterfall distribution agreements? Download our Distribution Waterfalls 2024 report and discover how CSC helps GPs meet LP expectations, manage fund terms, and align provisions.
