Author: Gert-Tom Draisma / www.TristanFinance.com

First published: 24th of September 2026

Latest update: 2nd of October 2026

Status: First Draft

Part III established that the economic perimeter of a waterfall cannot be inferred merely from the legal fund structure.

A single fund may contain:

• different investments;
• different carry pockets;
• different economic streams;
• realised and unrealised positions;
• fees and expenses with different waterfall treatment;
• recycling and recallable distributions; and
• non-cash economic events.

The central principle was:

Correct Mathematics + Wrong Economic Perimeter = Wrong Carry

Part IV introduces another dimension.

So far, we have largely assumed that all investors participate in the relevant fund economics in the same proportions and on the same terms.

In practice, they may not.

Two investors in the same legal fund can have different:

• closing dates;
• contribution dates;
• contribution amounts;
• equalisation payments;
• management-fee arrangements;
• expense allocations;
• investment participation;
• excused investments;
• side-letter terms;
• economic classes;
• preferred-return histories;
• distribution histories; and
• remaining commitments.

Consequently:

Same Fund ≠ Same Waterfall State for Every Investor

This raises one of the most important questions in waterfall modelling:

Can investor cash flows be aggregated, the waterfall calculated once, and the resulting carry allocated back to investors?

Sometimes the answer is economically yes.

Sometimes it is not.

Mathematically, if W represents the waterfall function and A and B represent the economic histories of two investors, the question is whether:

W(A + B) = W(A) + W(B)

If this relationship holds, the waterfall is linear with respect to the relevant aggregation.

If it does not:

W(A + B) ≠ W(A) + W(B)

then calculating the waterfall on aggregated data can produce a different result from calculating each investor separately.

This is not merely a technology problem.

It is an economic question.

The fact that a system can combine two sets of cash flows does not mean that the governing economics permit them to be combined before the waterfall is calculated.

Therefore:

Ability to Aggregate Data ≠ Economic Validity of Aggregation

Part IV develops this problem progressively.

It begins with perfectly proportional investors, where aggregation can be straightforward.

It then introduces:

• different contribution histories;
• subsequent closings;
• equalisation;
• excused investments;
• different fees and expenses;
• investor-specific terms;
• different economic populations;
• multiple vehicles; and
• parallel fund structures.

The final sections address the reverse problem:

Once carry has been calculated across an aggregated economic structure, how should it be disaggregated back to the relevant vehicles or investors?

The governing sequence is:

Economic Population → Calculation Level → Waterfall Result

and the central warning is:

Calculate Then Aggregate ≠ Necessarily Aggregate Then Calculate

Section A — The Calculation Population

1. The Fund Is Not Necessarily the Calculation Unit

Consider a fund with:

€100m Total Commitments

Investor A:

€60m Commitment

Investor B:

€40m Commitment

If both investors:

• entered on the same date;
• participate in every investment;
• bear every expense proportionally;
• have identical fee terms;
• have identical waterfall terms;
• contribute and receive distributions in exact 60:40 proportions,

then their economic histories are simply scaled versions of one another.

If Investor A contributes:

€60m

Investor B contributes:

€40m

and the fund distributes:

€150m

their gross distributions are:

A:

€90m

B:

€60m

In this simple case, calculating the waterfall at fund level and allocating the result 60:40 may produce the same result as calculating each investor separately.

But this equivalence arises from the economic relationship between the investors.

It does not arise merely because both investors belong to the same fund.

2. Economic Population

Before calculating a waterfall, define the population over which the rules operate.

That population might be:

• the entire fund;
• a class of investors;
• a group of investors;
• an individual investor;
• investors participating in a particular investment;
• investors participating in a carry pocket;
• investors participating in a particular economic stream;
• several parallel vehicles considered together.

Therefore:

Legal Fund Population ≠ Necessarily Waterfall Population

The correct calculation level follows from the governing economics.

3. Fund-Level Calculation

Under a fund-level approach:

All Relevant Investor Economics

↓

Aggregate Fund State

↓

Fund Waterfall

↓

Total Carry

↓

Allocation of Result

This can be efficient and economically correct where investors have sufficiently aligned economic histories.

4. Investor-Level Calculation

Under an investor-level approach:

Investor A Events → Waterfall A

Investor B Events → Waterfall B

Investor C Events → Waterfall C

Then:

Carry A + Carry B + Carry C = Aggregate Investor-Level Carry

The result may or may not equal a single fund-level calculation.

That is the issue Part IV examines.

Section B — Perfectly Proportional Investors

5. Basic Proportional Example

Assume:

• Investor A = 60%;
• Investor B = 40%;
• no preferred return;
• 20% carry;
• all economics are exactly proportional.

Fund contributes:

€100m

Fund distributes:

€150m

Fund profit:

€50m

Fund carry:

€10m

LP distribution after carry:

€140m

Allocate 60:40:

Investor A

LP distribution:

€84m

Contribution:

€60m

Investor profit after carry:

€24m

Allocated carry:

€6m

Investor B

LP distribution:

€56m

Contribution:

€40m

Investor profit after carry:

€16m

Allocated carry:

€4m

Total carry:

€10m

6. Calculate the Investors Separately

Investor A

Contribution:

€60m

Gross distribution before carry:

€90m

Profit before carry:

€30m

Carry:

€6m

Investor B

Contribution:

€40m

Gross distribution before carry:

€60m

Profit before carry:

€20m

Carry:

€4m

Total:

€10m

Therefore:

W(A + B) = W(A) + W(B)

in this example.

7. Scaling Does Not Necessarily Change the Economics

Investor A's cash flows are exactly:

1.5 × Investor B's Cash Flows

The waterfall rules are also identical.

The investors therefore occupy equivalent economic states at different scales.

This leads to an important principle:

Different Scale ≠ Necessarily Different Economics

If every relevant event is proportionally scaled and the waterfall itself behaves proportionally over those states, aggregation can preserve the economics.

Section C — Proportional Investors with a Preferred Return

8. Adding an 8% Preferred Return

Assume:

• A contributes €60m;
• B contributes €40m;
• both on the same date;
• 8% preferred return;
• same compounding methodology;
• same distribution dates;
• 100% catch-up;
• 20% carry.

Suppose the fund's preferred-return amount at the relevant date is:

€8m

Then:

A's proportional preferred return:

€4.8m

B's:

€3.2m

Fund-level catch-up:

€2m

Allocated proportionally:

A:

€1.2m

B:

€0.8m

The scaling relationship remains intact.

The time-based hurdle has not broken aggregation because the timing histories remain proportional.

9. What Makes Proportionality Work?

The relevant relationship is stronger than merely having the same commitment percentages.

Investors must have proportional economic histories.

That may require proportionality in:

• contribution amounts;
• contribution dates;
• distributions;
• distribution dates;
• fees;
• expenses;
• investment participation;
• recycling;
• write-offs;
• economic classifications.

Thus:

Same Commitment Percentage ≠ Necessarily Proportional Economic History

Section D — Different Contribution Dates

10. Breaking the Proportional History

Assume:

Investor A

Contributes:

€50m on 1 January 2026

Investor B

Contributes:

€50m on 1 January 2027

Both ultimately receive:

€75m on 1 January 2029

Total contributions:

€100m

Total distributions:

€150m

At aggregate level, the fund has made €50 million of profit.

But the investors' time-based performance differs materially.

Investor A's capital has been outstanding for three years.

Investor B's for two.

If the waterfall contains a time-based hurdle, the two investors need not occupy the same waterfall state.

11. Simple Preferred-Return Illustration

Assume:

• 8% simple preferred return;
• no intermediate distributions.

Investor A

Capital:

€50m

Three years:

€50m × 8% × 3 = €12m

Preferred return:

€12m

Investor B

Capital:

€50m

Two years:

€50m × 8% × 2 = €8m

Preferred return:

€8m

Total preferred return:

€20m

The investors have equal capital but different hurdle balances.

Therefore:

Equal Capital ≠ Equal Waterfall State

12. Why Commitment Percentage Is Not Enough

Both investors might each own:

50%

of the fund.

But their time-based economics differ.

Allocating every fund-level waterfall balance 50:50 would assign:

€10m Preferred Return

to each investor.

That would overstate B by €2 million and understate A by €2 million.

The fund-level total may still be correct:

€20m

but the investor-level allocation is wrong.

This introduces a crucial distinction:

Correct Aggregate Carry ≠ Necessarily Correct Investor Allocation

Section E — Aggregate Correctness Versus Investor Correctness

13. Two Separate Questions

When evaluating aggregation, ask:

Question 1

Does aggregation produce the correct total carry?

Question 2

Does aggregation preserve the correct allocation of that carry and related waterfall balances among investors?

The answer to one can be yes while the answer to the other is no.

Therefore:

Fund-Level Correctness ≠ Investor-Level Correctness

14. Aggregate Hurdle Can Conceal Investor Differences

Suppose:

• Investor A is already above its hurdle;
• Investor B remains below its hurdle.

An aggregate calculation may show the fund as being exactly at the hurdle.

That aggregate state can conceal the fact that the investors occupy different tiers.

Conceptually:

Investor A → Carry Tier

Investor B → Preferred-Return Tier

Aggregate:

Some Blended State

But no individual investor may actually occupy that blended state.

This is one of the main dangers of aggregation.

Section F — Waterfall Linearity

15. The Linearity Test

Let:

W(X)

represent the carry generated by applying the waterfall to economic history X.

For investors A and B, test:

W(A + B) ?= W(A) + W(B)

If:

W(A + B) = W(A) + W(B)

aggregation preserves the result for that economic situation.

If:

W(A + B) ≠ W(A) + W(B)

it does not.

This is a practical test, not merely a mathematical abstraction.

16. Why Waterfalls Can Be Non-Linear

Waterfalls contain thresholds.

Examples include:

• return of capital;
• preferred return;
• catch-up;
• MOIC thresholds;
• super-carry thresholds;
• NAV tests.

A small change in economic history can move one investor into a different tier.

Once investors occupy different tiers, adding their cash flows before applying the waterfall can produce a result that differs from applying the waterfall separately.

Therefore:

Different Cash-Flow Pattern → Potentially Different Waterfall Position

Section G — A Simple Non-Linearity Example

17. Two Investors, Different Performance

Assume a simplified hard hurdle.

Each investor has contributed:

€50m

Hurdle amount for each:

€10m

Carry:

20% above the hurdle

Investor A receives:

€80m

Investor B receives:

€55m

Investor A

Profit:

€30m

Hurdle:

€10m

Carry-bearing profit:

€20m

Carry:

€4m

Investor B

Profit:

€5m

Below hurdle.

Carry:

€0m

Total investor-level carry:

€4m

18. Aggregate the Investors

Aggregate contribution:

€100m

Aggregate distribution:

€135m

Profit:

€35m

Aggregate hurdle:

€20m

Carry-bearing profit:

€15m

Carry:

€3m

Therefore:

W(A + B) = €3m

while:

W(A) + W(B) = €4m

Thus:

W(A + B) ≠ W(A) + W(B)

Aggregation has reduced calculated carry by €1 million.

The reason is that Investor B's below-hurdle profit has effectively been used to dilute Investor A's above-hurdle performance.

19. The Reverse Effect Can Also Occur

Depending on the waterfall architecture and investor histories, aggregation can also accelerate or increase carry.

The direction of the error is not predetermined.

Therefore, the control should not ask:

Does aggregation make carry lower?

It should ask:

Does aggregation preserve the contractual economics?

That is the relevant test.

Section H — Piecewise Functions and Aggregation

20. Why Thresholds Matter

Part II represented waterfalls as piecewise functions.

For example:

• below hurdle: 0% marginal carry;
• catch-up: 100% marginal carry;
• residual: 20% marginal carry.

If Investor A is in the catch-up tier and Investor B is below the hurdle, the investors are subject to different local functions.

Aggregating them can create a synthetic state that corresponds to neither investor.

Therefore:

Different Tier Position → Aggregation Risk

21. Same Tier Can Be Easier to Aggregate

Suppose two investors:

• have identical contractual terms;
• are both comfortably inside the same residual 80:20 tier;
• have no remaining investor-specific hurdle differences.

For incremental value within that tier, the local waterfall may behave linearly.

An additional €1 million allocated proportionally may generate:

€200,000 Carry

regardless of whether it is processed separately or in aggregate.

This illustrates an important nuance.

A waterfall can be:

• non-linear globally;
• approximately or exactly linear within a particular tier.

Therefore:

Global Non-Linearity ≠ Non-Linearity at Every Point

Section I — Excused Investors

22. An Investor Does Not Participate in an Investment

Assume:

• Investor A = 50% commitment;
• Investor B = 50% commitment.

The fund makes:

Investment X

Cost:

€40m

Both participate equally.

Investment Y

Cost:

€40m

Investor B is excused.

Investor A therefore funds the relevant investor participation in Y without B participating in that investment.

The investors no longer have proportional investment histories.

23. Investment X

A contributes:

€20m

B contributes:

€20m

Investment X is realised for:

€60m

A gross proceeds:

€30m

B gross proceeds:

€30m

Each has:

€10m Profit

24. Investment Y

Only A participates.

Assume A contributes:

€40m

Investment Y is realised for:

€80m

A profit:

€40m

B:

No participation

Total investor economics:

A

Contributions:

€60m

Proceeds:

€110m

Profit:

€50m

B

Contributions:

€20m

Proceeds:

€30m

Profit:

€10m

The original 50:50 commitment ratio no longer describes the actual economic history.

25. Why Simple Pro-Rata Allocation Fails

Suppose total carry at the relevant level is:

€12m

Allocating 50:50 based on commitments gives:

A:

€6m

B:

€6m

But A generated far more of the relevant profit.

If the economics require carry to follow actual investment participation, the 50:50 allocation is wrong.

Therefore:

Commitment Percentage ≠ Necessarily Economic Participation Percentage

26. Excused Investments Can Break Waterfall Linearity

If A participates in an investment that B does not, the two investors can have different:

• capital bases;
• profit histories;
• hurdle balances;
• MOIC;
• IRR;
• carry-tier positions.

Thus:

Excused Investment → Different Cash-Flow History → Potentially Different Waterfall State

This is a classic reason to test investor-level economics rather than assume fund-level proportionality.

Section J — Excluded Investments and Regulatory Restrictions

27. Economic Effect

An investor may not participate in a particular investment for contractual, regulatory, legal or other reasons.

For waterfall purposes, the reason for the exclusion is less important than the resulting economic fact:

The investor does not share the same cash-flow history as the other investors.

Therefore the calculation needs to preserve the participation population for each relevant investment.

Conceptually:

Investment → Participating Investor Population

not merely:

Investment → Fund

Section K — Investor-Specific Fees

28. Different Management-Fee Economics

Assume:

• Investor A commitment = €50m;
• Investor B commitment = €50m.

Both participate equally in investments.

But:

Investor A

Management fee contribution:

€5m

Investor B

Management fee contribution:

€3m

perhaps because B has a contractual fee discount.

If management fees participate in the return-of-capital or preferred-return calculation, the investors no longer have identical waterfall histories.

29. Return-of-Capital Effect

Suppose:

Investment contributions:

A:

€50m

B:

€50m

Fee contributions:

A:

€5m

B:

€3m

If fees are returnable:

A return-of-capital base:

€55m

B:

€53m

An aggregated fund base is:

€108m

But allocating that base 50:50 would produce:

€54m each

Neither investor's actual balance.

Again:

Correct Aggregate Balance ≠ Correct Investor Balance

30. Preferred-Return Effect

If those fee contributions also earn preferred return, the difference propagates into:

• hurdle balances;
• catch-up timing;
• carry timing.

A seemingly small fee concession can therefore create an investor-specific waterfall state.

Section L — Investor-Specific Expenses

31. Expenses Need Not Be Shared Equally

Suppose an expense of:

€4m

is attributable only to a particular group of investors.

If Investor A bears €3 million and Investor B bears €1 million, allocating the expense 50:50 would distort their economics.

If the expense affects:

• returnable capital;
• preferred return;
• profit base,

the distortion can affect carry.

Therefore:

Fund Expense ≠ Necessarily Common Investor Expense

Section M — Side-Letter Economics

32. Side Letters Can Change Economic Inputs

Investor-specific arrangements can alter, among other things:

• fee rates;
• expense treatment;
• investment participation;
• economic rights;
• other terms relevant to the waterfall.

Part IV does not attempt to analyse the legal enforceability or interpretation of side letters.

The calculation principle is simpler:

If an investor-specific term changes an economic input to the waterfall, the model must preserve that difference.

Therefore:

Investor-Specific Legal Term → Investor-Specific Economic Rule → Potentially Investor-Specific Waterfall State

33. A Data Problem as Well as a Legal Problem

If the accounting system contains only:

Fund Management Fee = €8m

but the economic reality is:

• A bears €5m;
• B bears €3m,

the fund-level number is insufficient to reconstruct the investor economics.

Therefore:

Aggregate Accounting Data ≠ Necessarily Sufficient Waterfall Data

This issue becomes central later in the Bible when carry data and technology are considered.

Section N — Different Investor Classes

34. Class Economics

A fund can contain investor classes with different economics.

For example:

Class A

• 8% hurdle;
• 20% carry.

Class B

• 6% hurdle;
• 15% carry.

Even if both classes participate in exactly the same underlying investments, they do not share the same waterfall function.

Mathematically:

W_A ≠ W_B

Therefore, aggregating the cash flows before applying one common waterfall would be conceptually wrong.

35. Same Assets, Different Waterfalls

Suppose each class contributes:

€50m

Each receives gross value:

€75m

Profit per class:

€25m

Even before calculating the exact hurdle mechanics, the contractual functions differ.

Thus:

Same Investment Performance ≠ Same Investor Economics

The underlying portfolio is only one input.

The investor's contractual terms are another.

Section O — Subsequent Closings

36. The Closing Problem

Private equity funds commonly admit investors over more than one closing.

Suppose:

First Closing

Investor A enters on:

1 January 2026

Commitment:

€50m

Second Closing

Investor B enters on:

1 January 2027

Commitment:

€50m

By the time B enters, the fund may already have:

• made investments;
• paid management fees;
• incurred expenses;
• experienced changes in value.

If B simply began participating prospectively from 1 January 2027, A and B would have fundamentally different exposure to the fund's earlier economics.

Equalisation mechanisms are often used to address this.

Section P — Equalisation

37. Economic Purpose of Equalisation

At a conceptual level, equalisation seeks to place a later-closing investor into an economic position reflecting its participation in earlier fund activity according to the governing terms.

It can involve:

• contribution of amounts relating to earlier investments;
• reimbursement or reallocation to earlier investors;
• an equalisation amount;
• interest or another compensating amount;
• adjustments to capital accounts or economic histories.

The exact mechanism is contractual.

For waterfall purposes, the central question is:

What economic history should the later investor be treated as having after equalisation?

38. Simple Subsequent-Closing Example

Assume:

• Investor A enters 1 January;
• A funds €40m of investments;
• Investor B enters one year later;
• after B's admission, A and B should participate equally in those investments.

Economically, B needs to acquire exposure equivalent to:

€20m

of the earlier €40 million investment funding.

A simplified equalisation could therefore cause:

• B to fund €20m;
• A effectively to recover €20m.

Afterwards:

A economic participation:

€20m

B:

€20m

But the timing histories are not automatically identical.

A had capital at risk for a year before B entered.

This is where an equalisation charge or other contractual adjustment can become relevant.

39. Equalisation Does Not Simply Rewrite History

Suppose A funded €40 million on 1 January 2026.

B enters on 1 January 2027 and effectively assumes €20 million of that exposure.

For cash accounting:

B's payment occurs in 2027.

But for some economic purposes, the governing terms may seek to compensate A for having funded B's eventual share during the preceding period.

The waterfall model must therefore distinguish:

Actual Cash Date

from:

Economic Treatment Created by Equalisation

The equalisation mechanism determines how the later investor enters the existing economic state.

40. Equalisation Interest

Assume, purely for illustration:

• B's equalised amount = €20m;
• compensating rate = 8%;
• period = one year.

Equalisation amount:

€20m

Compensating amount:

€1.6m

Total payment:

€21.6m

But the €1.6 million must be classified correctly.

It may not be economically equivalent to:

• an investment contribution;
• a preferred-return contribution;
• ordinary fund profit.

Its waterfall treatment follows the governing terms.

Therefore:

Cash Paid at Equalisation ≠ Automatically Waterfall Contribution

Section Q — Equalisation and Preferred Return

41. The Difficult Question

Suppose B enters after one year.

Should B's waterfall history be treated as though:

1. B contributed its share only on the actual later-closing date; or
2. B economically entered the earlier investment from its original date, with the equalisation mechanism compensating for the delay; or
3. another contractual methodology applies?

The answer can materially affect:

• preferred return;
• IRR;
• capital balances;
• carry.

This is why subsequent closings cannot be modelled merely by adding a new investor record on the closing date.

42. Two Possible Histories

Assume:

• economic exposure = €20m;
• original investment date = 1 January 2026;
• B closes = 1 January 2027;
• hurdle = 8%.

History A — Actual-Date Treatment

B's €20m begins hurdle accrual:

1 January 2027

History B — Earlier Economic-Date Treatment

B's relevant exposure is economically treated from:

1 January 2026

At the closing date, one year of hurdle history already exists.

Those two histories are not equivalent.

The contractual equalisation rules determine which economic representation is correct.

Section R — Equalisation and Linearity

43. Equalisation Can Restore Some Proportionality

Before B enters:

A is the only investor.

After a properly implemented equalisation mechanism, A and B may become economically aligned for some future fund events.

But this does not mean their complete historical cash-flow records become identical.

There may still be:

• equalisation payments;
• compensating amounts;
• different actual funding dates;
• investor-specific accounting entries.

Therefore:

Equalisation Can Align Economics Without Making Historical Cash Flows Identical

This distinction is important for modelling.

44. Prospective Versus Historical Linearity

After equalisation, future events may once again occur 50:50.

Thus the investors may be proportional prospectively.

But historical waterfall state still needs to reflect the equalisation mechanism.

Therefore:

Future Proportionality ≠ Historical Identity

Section S — A Full Investor-Level Example

45. Fund Facts

Assume:

• Investor A commitment = €60m;
• Investor B commitment = €40m;
• 8% simple preferred return for illustration;
• 20% carry;
• full catch-up.

Year 1

A contributes:

€30m

B contributes:

€20m

Year 2

A is excused from one investment.

A contributes:

€10m

B contributes:

€20m

Total

A contributions:

€40m

B contributions:

€40m

Despite commitments of 60:40, actual contributed capital is now 50:50.

Already:

Commitment Ratio ≠ Contribution Ratio

46. Different Dates

Suppose:

A's €30m Year-1 contribution was made one year before the Year-2 contributions.

B also contributed €20m in Year 1.

Preferred return therefore depends on:

• amount;
• date.

A and B can have different preferred-return balances even though both have contributed €40 million in total.

Thus:

Same Cumulative Contribution ≠ Same Preferred Return

47. Different Investment Outcomes

Suppose the investment from which A was excused performs extremely well.

B receives an additional:

€30m profit

from that investment.

Now B may move into the carry tier while A remains closer to its hurdle.

An aggregate fund-level state can conceal this divergence.

This is precisely the environment in which investor-level testing becomes important.

Section T — Investor-Level Carry Is Not Participant Carry

48. Avoiding a Terminology Trap

An investor-level waterfall determines carry attributable to the economics of an LP or LP population.

That is different from allocating the GP's carry among individual carry participants.

The sequence remains:

Investor/Fund Economics

↓

Waterfall

↓

Carry Generated

↓

Carry Pool

↓

Carry Cap Table

↓

Individual Carry Participants

Therefore:

Investor-Level Carry ≠ Individual GP Participant Carry

The latter belongs principally in Chapters 6 and 7.

Section U — Aggregation Tests

49. Test 1 — Proportional Cash Flows

Ask:

Are all relevant cash flows proportional by amount and date?

If yes, aggregation may be possible.

If no, continue testing.

50. Test 2 — Identical Waterfall Rules

Ask whether investors have identical:

• hurdle rates;
• compounding conventions;
• catch-up;
• carry percentages;
• super-carry rules;
• return-of-capital definitions.

If not:

Different Waterfall Functions → Separate Calculation Populations May Be Required

51. Test 3 — Identical Investment Participation

Ask whether every investor participates proportionally in every relevant investment.

If not:

Investment Participation Divergence → Potential Waterfall Divergence

52. Test 4 — Identical Fee and Expense Economics

Ask whether investors bear:

• management fees;
• fund expenses;
• broken-deal costs;
• other relevant costs

in the same proportions.

If not, aggregation may distort return-of-capital and hurdle balances.

53. Test 5 — Same Tier Position

Even if histories differ, investors may currently occupy the same local waterfall tier.

That can make some incremental calculations behave linearly.

But this should be tested rather than assumed.

54. Test 6 — Numerical Proof

Ultimately, compare:

W(A + B)

with:

W(A) + W(B)

using representative scenarios.

If the results differ materially, the aggregation is not economically neutral.

This is one of the strongest practical controls available.

Section V — Aggregate First or Calculate First?

55. Two Calculation Routes

Route A — Aggregate First

Investor Events → Aggregate → Waterfall → Carry

Route B — Calculate First

Investor A → Waterfall A

Investor B → Waterfall B

then:

Carry A + Carry B

If the economics are linear:

Route A = Route B

If not:

Route A ≠ Route B

Therefore:

Calculate Then Aggregate ≠ Necessarily Aggregate Then Calculate

56. The Difference Is Information

Suppose:

Aggregate-first carry:

€9.2m

Calculate-first carry:

€10.0m

Difference:

€0.8m

That difference should not immediately be treated as a rounding problem.

It is evidence that:

• investors occupy different states;
• economic rules differ;
• classifications differ;
• or aggregation has changed the waterfall outcome.

The variance itself is a diagnostic.

Section W — Economic Population Mapping

57. Population Before Calculation

A complex fund can be represented as a set of economic populations.

For example:

Population 1

Investors participating in all investments.

Population 2

Investors participating in Investment X but not Y.

Population 3

Investors subject to a particular fee arrangement.

Population 4

A separate investor class.

The model can then determine which waterfall rules apply to each population.

58. Population Does Not Necessarily Mean One Investor

An economic population may contain many investors.

If 25 investors have genuinely identical relevant economics, there may be no economic reason to run 25 independent calculations.

They may be represented as one homogeneous population and subsequently allocated proportionally.

Therefore the objective is not:

Calculate everything at the most granular possible level.

It is:

Calculate at the lowest level necessary to preserve the economics.

This gives:

Required Granularity = Lowest Level That Preserves Economic Differences

59. Over-Granularity Has Costs Too

Calculating every investor separately when their economics are perfectly identical can:

• increase processing;
• increase reconciliation complexity;
• create unnecessary rounding differences;
• make explanations harder.

More granularity is not automatically more correct.

Therefore:

More Granular ≠ Necessarily More Economically Accurate

The appropriate level is determined by economic differences.

Section X — Parallel Vehicles

60. The Problem Moves Beyond One Legal Fund

Private equity structures can include multiple vehicles investing alongside one another.

For example:

• main partnership;
• parallel partnership;
• alternative investment vehicle;
• another related investment vehicle.

Legally, they may be distinct.

Economically, they may participate together in the same investment programme.

This creates the opposite problem from investor segregation.

Earlier we asked:

When must one legal fund be split into several economic populations?

Now we ask:

When must several legal vehicles be combined into one economic population?

Therefore:

Several Legal Vehicles ≠ Necessarily Several Independent Waterfalls

Section Y — Basic Parallel-Vehicle Example

61. Two Vehicles

Assume:

Vehicle A

Commitments:

€300m

Vehicle B

Commitments:

€200m

Total economic programme:

€500m

Suppose investments are made 60:40.

If the governing economics require the vehicles to share one aggregate waterfall, the calculation population is:

Vehicle A + Vehicle B

not two independent waterfalls.

62. Why Separate Calculation Can Be Wrong

Assume:

Vehicle A

Capital:

€60m

Value:

€120m

Profit:

€60m

Vehicle B

Capital:

€40m

Value:

€20m

Loss:

€20m

If calculated separately at 20%:

A carry:

€12m

B carry:

€0m

Total:

€12m

If economically aggregated:

Capital:

€100m

Value:

€140m

Profit:

€40m

Carry:

€8m

Difference:

€4m

Therefore:

Separate Legal Vehicle Calculation ≠ Necessarily Correct Economic Calculation

Section Z — Aggregation Across Parallel Vehicles

63. Aggregate the Relevant Economics

Where the governing arrangement requires aggregation, the conceptual process is:

Vehicle A Events

Vehicle B Events

Vehicle C Events

↓

Aggregated Economic Waterfall

↓

Total Carry

This is analogous to a whole-fund calculation across legal boundaries.

64. Aggregation Requires Consistent Classification

Before aggregation, the model must ensure that equivalent events are treated consistently.

For example:

• investment contributions;
• fees;
• expenses;
• distributions;
• write-offs;
• recycling;
• preferred-return dates.

If Vehicle A records a cost as an investment contribution and Vehicle B records an economically equivalent amount as a generic expense, simple aggregation can still be wrong.

Therefore:

Aggregation Requires Economic Normalisation

not merely addition.

Section AA — Parallel Vehicles with Different Cash-Flow Timing

65. Same Investment, Different Funding Dates

Suppose Vehicle A funds its share of an investment on:

1 January

Vehicle B funds on:

15 January

If the hurdle is time-based, aggregation needs to preserve those dates unless the governing economics specify a common economic date.

Simply combining the amounts under 1 January or 15 January changes the time-based calculation.

Thus:

Aggregated Population ≠ Loss of Underlying Economic Dates

66. Aggregate State Can Still Require Granular Inputs

This distinction is fundamental.

The waterfall may operate on an aggregated economic population while still requiring granular events to calculate that aggregate state correctly.

Therefore:

Aggregate Calculation ≠ Aggregate Source Data

You may need detailed vehicle-level or investor-level data even when the final waterfall is calculated at a higher level.

Section AB — Disaggregation

67. The Reverse Problem

Suppose two vehicles are economically aggregated.

The waterfall produces:

€20m Total Carry

Now the calculation must determine:

How much of the €20 million belongs to Vehicle A and how much to Vehicle B?

This is a separate calculation problem.

The fact that total carry has been determined does not automatically determine its allocation between vehicles.

Therefore:

Aggregate Carry Result ≠ Automatically Pro-Rata Carry by Vehicle

68. The Tempting Commitment-Based Allocation

Suppose:

• Vehicle A commitments = €300m;
• Vehicle B commitments = €200m.

Commitment ratio:

60:40

Total carry:

€20m

Simple allocation:

A:

€12m

B:

€8m

This is easy.

But is it economically correct?

Only if commitment proportions are the appropriate allocation basis.

They may not be.

Section AC — Why Commitment Pro-Rata Can Fail

69. Different Investment Participation

Suppose Vehicle A and B do not participate in every investment in exactly 60:40 proportions.

Then their contribution to the aggregated profit can differ from their commitment ratio.

For example:

Investment X

A participates:

80%

B:

20%

Investment Y

A:

50%

B:

50%

If X and Y have very different performance, a 60:40 commitment allocation of carry may not reflect the economics that generated it.

70. Numerical Example

Assume:

Investment X

Profit:

€40m

Participation:

A 80%:

€32m

B 20%:

€8m

Investment Y

Profit:

€10m

Participation:

A 50%:

€5m

B 50%:

€5m

Total profit:

A:

€37m

B:

€13m

Combined:

€50m

At 20% carry:

€10m

If carry follows profit contribution:

A:

€7.4m

B:

€2.6m

If allocated 60:40 by commitments:

A:

€6m

B:

€4m

The difference is material.

Section AD — NAV Pro-Rata Can Also Fail

71. Current NAV Is Not Necessarily the Carry Driver

Suppose total carry is calculated from cumulative realised and unrealised economics.

Allocating it based solely on current NAV may ignore:

• earlier realised distributions;
• losses already recognised;
• different funding dates;
• preferred-return histories;
• investment participation;
• prior carry allocations.

Therefore:

Current NAV Percentage ≠ Necessarily Carry Allocation Percentage

NAV is a point-in-time value.

Carry is often a cumulative economic result.

Section AE — Contribution Pro-Rata Can Fail

72. Same Contributions, Different Returns

Suppose:

Vehicle A contributions:

€50m

Vehicle B contributions:

€50m

But:

A value:

€90m

B value:

€60m

Total profit:

€50m

A generated:

€40m

B:

€10m

A 50:50 allocation of carry based on contributions ignores the different economic performance.

Therefore:

Contribution Share ≠ Necessarily Carry Share

Section AF — Disaggregation Must Follow the Economics

73. General Principle

If several vehicles are aggregated because they form one economic waterfall population, the subsequent disaggregation should follow the allocation methodology specified by the governing economics.

Potential drivers can include:

• investment participation;
• cumulative profit contribution;
• investor-level waterfall results;
• another contractually defined methodology.

The correct basis cannot be inferred solely from:

• commitment;
• NAV;
• contributed capital.

Therefore:

Ability to Aggregate ≠ Ability to Disaggregate Arbitrarily

Section AG — Aggregation and Disaggregation Are Different Questions

74. Two Decisions

Decision 1

Which entities belong together for purposes of calculating total carry?

Decision 2

How should the resulting carry be allocated back among those entities?

These decisions may use different logic.

Thus:

Aggregation Rule ≠ Disaggregation Rule

This is important in both model design and legal interpretation.

Section AH — A Three-Vehicle Example

75. Structure

Assume three parallel vehicles:

Vehicle A

Commitment:

€200m

Vehicle B

Commitment:

€200m

Vehicle C

Commitment:

€100m

Total:

€500m

But investment participation varies.

76. Investment 1

Cost:

€100m

Participation:

A:

40%

B:

40%

C:

20%

Proceeds:

€200m

Profit:

€100m

Profit attribution:

A:

€40m

B:

€40m

C:

€20m

77. Investment 2

Cost:

€100m

C is excluded.

Participation:

A:

50%

B:

50%

Proceeds:

€60m

Loss:

€40m

Loss attribution:

A:

€20m

B:

€20m

C:

€0m

78. Investment 3

Cost:

€50m

Participation:

A:

20%

B:

40%

C:

40%

Proceeds:

€100m

Profit:

€50m

Profit attribution:

A:

€10m

B:

€20m

C:

€20m

79. Aggregate Economics

Total profit:

Investment 1:

+€100m

Investment 2:

−€40m

Investment 3:

+€50m

Net:

€110m

At 20% carry:

€22m

80. Vehicle Economic Contributions

A

Profit:

€40m − €20m + €10m = €30m

B

Profit:

€40m − €20m + €20m = €40m

C

Profit:

€20m + €0m + €20m = €40m

Total:

€110m

If the governing economics allocate carry according to these profit contributions:

A:

€6m

B:

€8m

C:

€8m

Total:

€22m

81. Compare Commitment Allocation

Commitment percentages:

A:

40%

B:

40%

C:

20%

Applying those to €22 million:

A:

€8.8m

B:

€8.8m

C:

€4.4m

Compare economic-profit allocation:

The total is correct under both:

€22m

But the vehicle allocations differ dramatically.

Therefore:

Correct Total Carry ≠ Correct Vehicle Allocation

Section AI — Parallel Vehicles with Preferred Return

82. Timing Adds Another Dimension

Suppose Vehicles A, B and C fund the same investments in different currencies or on slightly different dates.

If the aggregated waterfall contains a time-based hurdle, the calculation must determine whether:

• each vehicle's actual funding date matters;
• a common economic investment date applies;
• equalisation or another mechanism aligns the vehicles.

The aggregation rule does not answer this automatically.

83. Aggregate Hurdle State

An aggregated waterfall can contain:

• contributions from Vehicle A;
• contributions from Vehicle B;
• contributions from Vehicle C;

each with its own economic date.

The preferred-return engine developed in Part II can still operate on those granular events.

Thus:

Multiple Vehicles → One Economic Population → Many Dated Events → One Waterfall State

This is different from replacing all vehicle contributions with one synthetic contribution.

Section AJ — Currency Differences

84. Parallel Vehicles Can Operate in Different Currencies

Suppose:

• Vehicle A operates in EUR;
• Vehicle B operates in USD.

If their economics must be aggregated, currency becomes part of the calculation specification.

Questions include:

• what is the waterfall currency?
• when are cash flows translated?
• which exchange rate applies?
• are FX gains and losses part of carry economics?

Part VI will address foreign-currency calculations in more detail.

For Part IV, the principle is:

Aggregation Across Currencies Requires a Defined Translation Rule

Without one, amounts cannot simply be added.

Section AK — Wrong Aggregation Methods

85. Wrong: Allocate Everything by Commitment

Commitment is useful for many purposes.

It is not automatically the correct basis for:

• preferred return;
• carry;
• expenses;
• investment participation;
• parallel-vehicle disaggregation.

Therefore:

Commitment Percentage ≠ Universal Allocation Key

86. Wrong: Aggregate Because Investors Have the Same Carry Percentage

Two investors can both have:

20% Carry

but different:

• hurdle balances;
• contribution dates;
• investment participation;
• expenses.

Same carry rate does not establish economic equivalence.

87. Wrong: Calculate Separately Because Investors Have Different Cash Dates

Different actual cash dates do not automatically require separate waterfalls if the governing economics deliberately align those events through:

• equalisation;
• common economic dates;
• another contractual mechanism.

Therefore:

Different Cash Dates ≠ Automatically Different Economic Histories

The economic treatment must be established.

88. Wrong: Assume Equalisation Makes Everything Identical

Equalisation may align particular economics.

It does not necessarily eliminate every historical difference.

The model should implement what equalisation actually does, not replace the later investor's history with a fictional copy of the earlier investor's history unless that is economically appropriate.

89. Wrong: Aggregate Parallel Vehicles by Legal Convenience

Two vehicles may be easy to consolidate in reporting.

That does not establish that they share one carry waterfall.

Conversely, separate legal accounts do not establish separate waterfall economics.

Therefore:

Accounting Consolidation ≠ Waterfall Aggregation

90. Wrong: Disaggregate Total Carry by Current NAV

Current NAV can be a poor allocation basis for a cumulative carry amount.

The disaggregation methodology should follow the economics that generated the carry.

Section AL — A Full Aggregation Example

91. Investor Population

Assume three investors.

Investor A

Commitment:

€50m

Investor B

Commitment:

€30m

Investor C

Commitment:

€20m

Initially:

50:30:20

Assume all participate proportionally in Investment 1.

92. Investment 1

Cost:

€40m

Investor funding:

A:

€20m

B:

€12m

C:

€8m

Investment is realised for:

€80m

Gross proceeds:

A:

€40m

B:

€24m

C:

€16m

Profit:

A:

€20m

B:

€12m

C:

€8m

At this stage the histories remain perfectly proportional.

Aggregation is straightforward.

93. Investment 2

Cost:

€30m

Investor C is excused.

A and B fund in proportion to their relative commitments:

A:

€18.75m

B:

€11.25m

C:

€0m

Investment 2 is realised for:

€45m

Proceeds:

A:

€28.125m

B:

€16.875m

Profit:

A:

€9.375m

B:

€5.625m

C:

€0m

The original 50:30:20 proportionality has been broken.

94. Investor Profit Histories

A

Profit:

€20m + €9.375m = €29.375m

B

Profit:

€12m + €5.625m = €17.625m

C

Profit:

€8m

Total:

€55m

The profit proportions are now approximately:

A:

53.41%

B:

32.05%

C:

14.55%

not:

50:30:20

95. Carry Without a Hurdle

At 20%:

Total carry:

€11m

If carry follows these investment profits:

A:

€5.875m

B:

€3.525m

C:

€1.6m

If instead allocated by commitments:

A:

€5.5m

B:

€3.3m

C:

€2.2m

Total is still:

€11m

But C would receive €0.6 million too much carry attribution and A/B too little.

96. Add Investor-Specific Fee Economics

Now assume:

• A bears €5m fees;
• B bears €3m;
• C bears €1m.

Net profits:

A:

€24.375m

B:

€14.625m

C:

€7m

Total:

€46m

The investor economics diverge further.

If fees are part of the waterfall perimeter, the original commitment percentages are increasingly irrelevant to the actual carry state.

Section AM — A Full Non-Linearity Example

97. Investor States

Assume a hard hurdle equal to €10 million profit for each investor.

Investor A:

€25m Profit

Investor B:

€12m Profit

Investor C:

€5m Profit

Carry above hurdle:

20%

A

Carry-bearing profit:

€15m

Carry:

€3m

B

Carry-bearing profit:

€2m

Carry:

€0.4m

C

Below hurdle:

€0m Carry

Total investor-level carry:

€3.4m

98. Aggregate Calculation

Total profit:

€42m

Aggregate hurdle:

€30m

Excess:

€12m

Carry:

€2.4m

Thus:

W(A + B + C) = €2.4m

but:

W(A) + W(B) + W(C) = €3.4m

Difference:

€1m

The aggregated calculation allowed C's below-hurdle performance to absorb part of A's and B's above-hurdle performance.

Whether that is correct depends entirely on the economic population defined by the governing terms.

Section AN — Aggregation as a Control

99. Run Both Calculations

Where aggregation is potentially sensitive, a useful control is to calculate:

Calculation A

Waterfall on aggregate population.

Calculation B

Waterfalls on constituent populations.

Then compare:

Aggregation Variance = Aggregate Waterfall Result − Sum of Constituent Waterfall Results

If:

Aggregation Variance = €0

the calculations agree for that scenario.

If not, investigate why.

100. Zero Variance Does Not Prove Universal Linearity

Suppose one test case produces:

€0 Variance

That does not prove the waterfall will aggregate correctly in every possible state.

Perhaps all investors happened to be:

• below the hurdle; or
• above catch-up in the residual tier.

Another scenario could place them in different tiers.

Therefore aggregation testing should include:

• low performance;
• hurdle boundary;
• catch-up;
• high performance;
• losses;
• investor-specific differences.

Section AO — Boundary Testing by Investor

101. Different Investors Around the Same Threshold

Suppose target hurdle:

8%

Investor A:

7.99%

Investor B:

8.00%

Investor C:

8.01%

An aggregate IRR might be:

8.00%

But economically the investors occupy three distinct positions relative to the threshold.

This is precisely where aggregation can conceal economically important differences.

Therefore:

Aggregate Threshold Position ≠ Individual Threshold Position

Section AP — Reconciliation

102. Investor-to-Fund Reconciliation

The underlying data should reconcile:

Sum of Investor Contributions = Fund Contributions

subject to any amounts attributable outside the investor population.

Similarly:

Sum of Investor Distributions = Fund LP Distributions

and:

Sum of Investor Allocated Expenses = Relevant Fund Expenses

These are data reconciliations.

They do not prove that the waterfall should be calculated at fund level.

103. Carry Reconciliation

If the governing economics require investor-level calculation:

Total Carry = Σ Investor-Level Carry

If the governing economics require fund-level calculation followed by allocation:

Total Allocated Carry = Fund-Level Carry

Both should reconcile to their governing calculation architecture.

104. Vehicle Reconciliation

For aggregated parallel vehicles:

Σ Vehicle Economic Events = Aggregated Economic Events

and after disaggregation:

Σ Vehicle Carry Allocation = Aggregate Carry

But the allocation basis must remain economically justified.

Section AQ — Building the Population Matrix

105. A Practical Representation

A useful conceptual matrix might identify:

The purpose is not to maximise data complexity.

It is to preserve every dimension that can change the economics.

106. The Economic Key

Conceptually, an economic event might therefore be identified by:

Fund

Vehicle

Investor Population

Investment

Carry Pocket

Economic Stream

Economic Date

Event Classification

Not every fund requires every dimension.

But removing a dimension that changes the economics can make the correct waterfall impossible to reconstruct.

Section AR — Choosing the Correct Calculation Level

107. Start at the Highest Possible Level

A practical approach is to begin by asking whether the waterfall can be calculated at the broadest economic level.

If all investors are genuinely economically homogeneous, fund-level calculation may be appropriate.

If differences exist, identify which differences actually affect the waterfall.

Then split the population only where necessary.

This produces:

Broad Population

↓

Identify Economic Differences

↓

Separate Only Where Difference Changes Waterfall

↓

Calculate

This avoids both under-granularity and unnecessary over-granularity.

108. Homogeneous Economic Groups

Suppose a fund has 100 investors.

Ninety investors have identical terms and perfectly proportional histories.

Ten have investor-specific arrangements.

It may be possible to calculate:

• one homogeneous population for the 90;
• separate populations for the relevant exceptions.

There is no inherent need for 100 independent waterfall models if the economics do not require them.

Therefore:

Calculation Granularity Should Follow Economic Diversity

Section AS — Architecture of an Aggregation Engine

109. The Wrong Architecture

A simplistic system might operate:

Fund ID → Sum Cash Flows → Run Waterfall

This assumes the fund is always the correct economic population.

Part IV has demonstrated why that assumption can fail.

110. A Better Architecture

A more robust conceptual architecture is:

Economic Events

↓

Apply Population Rules

↓

Create Homogeneous Economic Populations

↓

Run Applicable Waterfall

↓

Aggregate or Disaggregate Results as Required

↓

Reconcile

This allows the calculation architecture to follow the economics rather than the legal database hierarchy.

Section AT — End-to-End Parallel-Vehicle Case

111. Structure

Assume:

Main Fund

Commitments:

€300m

Parallel Fund

Commitments:

€200m

Total:

€500m

Waterfall:

• 8% preferred return;
• 100% catch-up;
• 20% carry.

Assume the governing economics require the two vehicles to be aggregated.

112. Investment A

Cost:

€100m

Participation:

Main:

60% = €60m

Parallel:

40% = €40m

Proceeds:

€180m

Profit:

€80m

Profit attribution:

Main:

€48m

Parallel:

€32m

113. Investment B

Cost:

€100m

Participation:

Main:

80% = €80m

Parallel:

20% = €20m

Proceeds:

€50m

Loss:

€50m

Loss attribution:

Main:

€40m

Parallel:

€10m

114. Investment C

Cost:

€100m

Participation:

Main:

50% = €50m

Parallel:

50% = €50m

Proceeds:

€170m

Profit:

€70m

Profit attribution:

Main:

€35m

Parallel:

€35m

115. Aggregate Economics

Total cost:

€300m

Total proceeds:

€400m

Profit:

€100m

Assume the relevant preferred-return requirement at the calculation date is:

€40m

Soft hurdle with full catch-up.

Preferred profit:

€40m

Required 20% catch-up:

€10m

Remaining profit:

€50m

Residual carry:

€10m

Total carry:

€20m

Check:

€20m / €100m = 20%

116. Vehicle Profit Contribution

Main Fund

Investment A:

+€48m

Investment B:

−€40m

Investment C:

+€35m

Total:

€43m

Parallel Fund

Investment A:

+€32m

Investment B:

−€10m

Investment C:

+€35m

Total:

€57m

Combined:

€100m

117. Why Commitment Allocation Would Be Questionable

Commitments are 60:40.

A simple commitment allocation of €20 million carry gives:

Main:

€12m

Parallel:

€8m

But their profit contributions are:

Main:

43%

Parallel:

57%

A simple profit-proportional allocation would instead give:

Main:

€8.6m

Parallel:

€11.4m

These are radically different.

Which is correct cannot be determined from arithmetic alone.

The governing allocation methodology must specify how the aggregated carry is attributed back to the vehicles.

118. Preferred Return Complicates Disaggregation Further

The previous profit-proportional allocation may itself be insufficient if:

• the vehicles funded on different dates;
• their preferred-return balances differ;
• they bore different fees;
• their hurdle contributions differ.

Therefore even profit contribution may not always be the correct disaggregation basis.

This reinforces:

Aggregate Carry Result ≠ Automatically Pro-Rata Carry by Vehicle

and:

Ability to Aggregate ≠ Ability to Disaggregate Arbitrarily

Section AU — Common Failure Cases

119. Fund-Level Carry Is Correct, Investor Allocation Is Wrong

A model can correctly calculate:

€20m Total Carry

but allocate it incorrectly among investors.

The aggregate control passes.

The investor-level economics fail.

Therefore both levels need independent controls.

120. Investor Calculations Are Individually Correct, but They Should Have Been Aggregated

The reverse is also possible.

Each vehicle's waterfall may be mathematically correct when calculated independently.

But if the governing economics require cross-collateralisation across the vehicles, the separate calculations are economically wrong.

Thus:

Correct Individual Calculations + Wrong Population = Wrong Aggregate Carry

121. Equalisation Is Booked but Not Reflected in Waterfall State

The accounting system may correctly record an equalisation payment.

But if the waterfall engine does not translate that payment into the intended economic history, the subsequent hurdle calculation can still be wrong.

Therefore:

Correct Accounting Entry ≠ Automatically Correct Waterfall State

122. Excused Investor Flag Exists but Is Ignored by Carry

A system may correctly identify an investor as excused from an investment.

If the carry engine nevertheless allocates that investment's economics using general commitment percentages, the data exists but is not being used economically.

Therefore:

Data Availability ≠ Correct Economic Application

Section AV — Controls for Part IV

123. Population Control

For every waterfall calculation, identify explicitly:

What is the economic population?

If the answer is merely:

the fund,

verify whether that is genuinely sufficient.

124. Proportionality Control

For investors assumed to be proportional, test:

Investor A Event / Investor B Event

across:

• contributions;
• distributions;
• fees;
• expenses;
• investment participation.

If the ratios vary materially, the proportionality assumption requires investigation.

125. Linearity Control

Calculate:

W(A + B)

and:

W(A) + W(B)

across representative scenarios.

Record and explain any variance.

126. Equalisation Control

After a subsequent closing, verify that the resulting investor states reflect the intended equalisation economics.

Do not merely verify that the equalisation cash was paid.

Verify the economic state.

127. Excused-Investor Control

For every excluded investment:

Participation = 0

for the excused investor in every relevant:

• contribution;
• distribution;
• gain/loss;
• expense;
• waterfall state,

unless the governing terms specify otherwise.

128. Parallel-Vehicle Aggregation Control

Verify:

Σ Relevant Vehicle Events = Aggregated Waterfall Events

without losing:

• dates;
• classifications;
• currencies;
• investment attribution.

129. Disaggregation Control

After allocating aggregate carry:

Σ Vehicle Carry = Aggregate Carry

This arithmetic control is necessary.

But also verify that the allocation basis matches the governing economics.

Arithmetic reconciliation alone does not prove economic correctness.

Section AW — What Part IV Has Established

130. The Fund Is Not Automatically the Waterfall Unit

A legal fund can contain investors with materially different economic histories.

Therefore:

Same Legal Fund ≠ Same Waterfall State for Every Investor

The correct calculation population must be determined economically.

131. Scaling Is Different from Economic Difference

Two investors can have different amounts but identical proportional histories.

In that case:

Different Scale ≠ Necessarily Different Economics

But equal commitments alone do not establish proportionality.

What matters is the complete relevant economic history.

132. Aggregation Is Conditional

Where the waterfall preserves the relevant relationship:

W(A + B) = W(A) + W(B)

aggregation can preserve the economics.

Where investors occupy different states:

W(A + B) ≠ W(A) + W(B)

aggregation changes the result.

Therefore:

Ability to Aggregate Data ≠ Economic Validity of Aggregation

133. Correct Total Does Not Guarantee Correct Allocation

A fund-level calculation can produce the correct total carry while allocating that carry incorrectly among investors.

Likewise, a vehicle-level allocation can reconcile perfectly to total carry while using the wrong allocation basis.

Therefore:

Correct Aggregate Carry ≠ Necessarily Correct Investor or Vehicle Allocation

134. Subsequent Closings Change Economic History

A later-closing investor does not automatically have the same historical economics as an earlier investor.

Equalisation can align some or all of those economics according to the governing terms.

Therefore:

Equalisation Payment → Economic Adjustment

not merely:

Equalisation Payment → Cash Entry

The intended economic state must be represented.

135. Parallel Vehicles Reverse the Problem

Within one legal fund, the model may need to separate economic populations.

Across several legal vehicles, it may need to aggregate them.

Therefore:

One Legal Fund → Potentially Several Economic Populations

and:

Several Legal Vehicles → Potentially One Economic Population

Legal structure alone does not determine the calculation boundary.

136. Aggregation and Disaggregation Are Separate Rules

The process for parallel structures is:

Individual Vehicles

↓

Normalise Economic Events

↓

Aggregate Relevant Economics

↓

Run Waterfall

↓

Determine Total Carry

↓

Disaggregate According to Governing Economics

Therefore:

Aggregation Rule ≠ Disaggregation Rule

and:

Ability to Aggregate ≠ Ability to Disaggregate Arbitrarily

137. The General Calculation Principle

Across Parts I to IV, the waterfall calculation has now developed into:

Governing Economics

↓

Economic Population

↓

Economic Perimeter

↓

Economic Events

↓

Economic Dates

↓

Waterfall State

↓

Performance Tests

↓

Allocation Tiers

↓

Carry Result

↓

Allocation / Disaggregation

↓

Reconciliation

Each stage is necessary.

A correct formula at the end cannot repair a mistake made at the beginning.

138. Transition to Part V

Parts I to IV have largely answered how carry is calculated from an identified economic history.

Part V introduces a different problem:

What happens when the fund has not finished?

At an interim reporting date, the fund may contain:

• realised investments;
• unrealised investments;
• current NAV;
• remaining commitments;
• investments still to be made;
• future management fees and expenses;
• recycled capital;
• carry already distributed;
• carry calculated but withheld;
• tax advances;
• escrow balances.

The final economic outcome is unknown.

Yet GPs, LPs, accountants, administrators and systems may still need to determine:

• realised carry;
• total carry;
• unrealised carry;
• carry available for distribution;
• carry retained;
• potential future carry exposure.

The fundamental relationship becomes:

Unrealised Carry = Total Carry − Realised Carry

But calculating total carry before the fund has completed its life requires assumptions about the unresolved economic state.

One of the most important is remaining commitment.

A fund with:

€100m NAV

and:

€0 Remaining Commitment

is not necessarily economically equivalent to a fund with:

€100m NAV

and:

€30m Remaining Commitment

even though current NAV is identical.

Furthermore, simply deducting €30 million from NAV does not necessarily produce the same waterfall result as introducing a hypothetical €30 million future contribution.

Therefore:

Same Net Economic Value ≠ Necessarily Same Waterfall Result

Part V will develop these interim calculations in detail, including:

• realised carry;
• total carry;
• unrealised carry;
• NAV-based hypothetical liquidation;
• remaining commitment;
• investment-period versus post-investment-period treatment;
• hypothetical drawdowns;
• conservative methodologies;
• recycling and recallable amounts in interim calculations;
• distributions in kind;
• subscription facilities;
• tax distributions and tax advances;
• carry generated versus carry distributed;
• escrow and holdbacks; and
• the evolution of carry through the life of the fund.

The central question becomes:

How much carry exists today when the final fund economics do not yet exist?

Need assistance with your Carried Interest Challenges? Reach out to us:

[email protected]

Or ask your questions here:

References and Further Reading

Investor-Level and Fund-Level Waterfall Calculations

• Stefanova, Mariya (ed.). The Definitive Guide to Carried Interest. Private Equity International, 2017. See particularly the chapters addressing waterfall calculations, fund-level and investor-level economics, carried-interest modelling and the practical implementation of carried interest.
• Draisma, Gert-Tom. “Using Technology to Calculate and Recognise Carried Interest on the GP Side.” In Mariya Stefanova (ed.), The Definitive Guide to Carried Interest. Private Equity International, 2017, Chapter 11.
• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0: Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners. 2019. See particularly the principles concerning carried interest, distribution waterfalls, investor alignment, fees and expenses, side letters, parallel vehicles and investor-specific arrangements.
• Invest Europe. Professional Standards Handbook. See particularly the sections concerning fund structures, investor participation, fund terms, carried interest, allocations, subsequent closings, equalisation and investor reporting.

Economic Populations and Aggregation

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning alignment of interests, allocation of investment opportunities, investor-specific arrangements, parallel vehicles, co-investments and the consistent treatment of investors.
• Invest Europe. Professional Standards Handbook — Terms in the Fund Documents. See particularly the guidance concerning investor rights, economic terms, investment allocation, carried interest, parallel structures and the allocation of fund economics among investors.
• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See particularly the provisions concerning capital contributions, allocations, distributions, carried interest, investor participation, excused investments, subsequent closings and related partnership economics.

Investor-Level Economics and Investor-Specific Terms

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning investor-specific arrangements, side letters, fee concessions, expense allocation, transparency and equal treatment of similarly situated investors.
• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See the provisions concerning limited partner commitments, capital contributions, allocations, distributions, excuse and exclusion rights, default provisions and economic adjustments among limited partners.
• Invest Europe. Professional Standards Handbook — Managing Your Relationship with LPs. See particularly the guidance concerning investor communications, side letters, investor-specific rights, allocations, reporting and consistency of treatment.

Excused and Excluded Investors

• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See particularly the provisions dealing with excuse and exclusion rights, investment participation, capital contributions and the allocation of related expenses and proceeds.
• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See the principles concerning allocation of investment opportunities, conflicts of interest, investor-specific arrangements and transparency.
• Invest Europe. Professional Standards Handbook. See the guidance concerning investment restrictions, investor-specific limitations, allocation of investments and the treatment of investors subject to legal, regulatory or contractual restrictions.

Subsequent Closings and Equalisation

• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See particularly the provisions concerning subsequent closings, admission of additional limited partners, equalisation contributions, adjustments between earlier and later investors and related economic treatment.
• Invest Europe. Professional Standards Handbook — Forming and Raising a Fund. See particularly the guidance concerning first and subsequent closings, admission of additional investors, equalisation mechanisms, commitments and the economic treatment of later-closing investors.
• Invest Europe. Professional Standards Handbook — Terms in the Fund Documents. See particularly the discussion of subsequent closings, equalisation, commitments, drawdowns and allocation of fund economics among investors admitted at different times.

Preferred Return and Equalisation

• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See the interaction between capital contributions, subsequent closings, equalisation and distribution waterfall provisions.
• Stefanova, Mariya (ed.). The Definitive Guide to Carried Interest. Private Equity International, 2017. See the discussion of preferred returns, timing of capital contributions, waterfall mechanics and the treatment of different investor cash-flow histories.
• Invest Europe. Professional Standards Handbook. See the sections addressing hurdle rates, preferred returns, subsequent closings and equalisation mechanisms.

Management Fees and Investor-Specific Fee Arrangements

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning management fees, fee discounts, fee offsets, partnership expenses, side-letter arrangements and transparency of investor-specific economics.
• Institutional Limited Partners Association (ILPA). ILPA Reporting Template and Reporting Guidance. See the reporting framework for management fees, partnership expenses, offsets, contributions, distributions and carried interest.
• Invest Europe. Professional Standards Handbook. See particularly the guidance concerning management-fee structures, investor-specific fee arrangements, fee offsets and allocation of partnership expenses.

Expense Allocation

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning allocation of partnership expenses, organisational expenses, broken-deal expenses and expenses attributable to particular investors or investment activities.
• U.S. Securities and Exchange Commission. Private Fund Adviser Resources and Guidance. See relevant guidance and enforcement materials concerning allocation of fees and expenses among private funds, investors, co-investment vehicles and related entities.
• Invest Europe. Professional Standards Handbook. See the sections concerning fund expenses, allocation methodologies, investor-specific costs and transparency of costs borne by investors.

Side Letters and Different Investor Classes

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning side letters, investor-specific economic arrangements, transparency, governance and treatment of similarly situated investors.
• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See the provisions concerning limited partner rights, economic terms, classes, excuse rights, allocations and distributions.
• Invest Europe. Professional Standards Handbook — Terms in the Fund Documents. See the guidance concerning investor classes, side letters, preferential arrangements, management fees and other investor-specific economic terms.

Parallel Funds and Parallel Vehicles

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning parallel funds, alternative investment vehicles, allocation of investment opportunities, conflicts of interest, expenses and alignment across related investment vehicles.
• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See relevant provisions concerning parallel vehicles, alternative investment vehicles, investment allocation, expenses, capital contributions, distributions and carried interest.
• Invest Europe. Professional Standards Handbook. See particularly the sections concerning parallel fund structures, alternative investment vehicles, co-investment arrangements, allocation of investments and the treatment of related investment vehicles.
• Metrick, Andrew and Ayako Yasuda. Venture Capital and the Finance of Innovation. Wiley. See the treatment of private investment fund structures, limited partnerships, investor economics, management fees and carried interest.

Allocation and Disaggregation Across Vehicles

• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See particularly the principles concerning allocation of investments, fees and expenses across parallel funds and related vehicles, conflicts of interest and consistency of economic treatment.
• Invest Europe. Professional Standards Handbook. See the guidance concerning investment allocation, parallel vehicles, co-investments, fund expenses and allocation methodologies across related structures.
• U.S. Securities and Exchange Commission. Private Fund Adviser Resources and Guidance. See relevant guidance and enforcement materials concerning allocation of investments, fees and expenses among private funds, parallel vehicles, co-investment vehicles and other advisory clients.

Alternative Investment Vehicles

• Institutional Limited Partners Association (ILPA). Model Limited Partnership Agreement. See relevant provisions concerning alternative investment vehicles and the allocation of investments, contributions, distributions, expenses and other economics between the main partnership and alternative vehicles.
• Institutional Limited Partners Association (ILPA). ILPA Principles 3.0. 2019. See the principles concerning alternative investment vehicles, parallel structures, transparency, conflicts and allocation of fund economics.
• Invest Europe. Professional Standards Handbook. See the sections concerning fund structuring, alternative investment vehicles, parallel arrangements and investment allocation.

Investor Reporting and Reconciliation

• Institutional Limited Partners Association (ILPA). ILPA Reporting Template and Reporting Guidance. See the reporting framework for investor commitments, contributions, distributions, NAV, management fees, partnership expenses and carried interest.
• Institutional Limited Partners Association (ILPA). Performance Template. See the framework for reporting and reconciling fund-level and investment-level cash flows and performance information.
• Invest Europe. Investor Reporting Guidelines. See particularly the guidance concerning commitments, drawdowns, distributions, NAV, investor capital accounts, fees, expenses, carried interest and reconciliation between fund-level and investor-level information.

Fund Accounting and Capital Allocation

• American Institute of Certified Public Accountants (AICPA). Audit and Accounting Guide: Investment Companies. See the discussion of investment-company accounting, partners' capital, allocations, investment valuation and financial reporting for investment funds.
• International Accounting Standards Board. IFRS 10 — Consolidated Financial Statements. See the investment-entity provisions relevant to the financial reporting structure of private investment entities.
• International Accounting Standards Board. IFRS 13 — Fair Value Measurement. Reference source for fair-value principles relevant to NAV and investment valuation used in private-fund reporting.

Waterfall Modelling, Linearity and Calculation Control

• Stefanova, Mariya (ed.). The Definitive Guide to Carried Interest. Private Equity International, 2017. See particularly the material concerning waterfall modelling, calculation methodologies, investor economics and implementation of carried-interest calculations.
• Draisma, Gert-Tom. “Using Technology to Calculate and Recognise Carried Interest on the GP Side.” In Mariya Stefanova (ed.), The Definitive Guide to Carried Interest. Private Equity International, 2017, Chapter 11. See particularly the discussion of translating contractual economics into system-based calculations, data requirements and controlled calculation processes.
• Institutional Limited Partners Association (ILPA). ILPA Reporting Template and Reporting Guidance. Useful reference for the underlying investor-level data required to reconcile contributions, distributions, fees, expenses, NAV and carried interest.

Further Reading

• Phalippou, Ludovic. Private Equity Laid Bare. Routledge. See particularly the discussion of private equity fund structures, investor cash flows, fees, carried interest and performance measurement.
• Gompers, Paul A. and Josh Lerner. The Venture Capital Cycle. MIT Press. See the discussion of limited partnership structures, investor economics, contractual arrangements and compensation of general partners.
• Metrick, Andrew and Ayako Yasuda. Venture Capital and the Finance of Innovation. Wiley. See particularly the treatment of fund structures, management fees, carried interest and limited-partner economics.
• Robinson, David T. and Berk A. Sensoy. “Do Private Equity Fund Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance.” The Review of Financial Studies, Vol. 26, No. 11, 2013, pp. 2760–2797. Useful background on private equity compensation, fund cash flows, management fees and carried interest.
• Kaplan, Steven N. and Antoinette Schoar. “Private Equity Performance: Returns, Persistence, and Capital Flows.” The Journal of Finance, Vol. 60, No. 4, 2005, pp. 1791–1823. Useful background on private equity fund cash flows, performance and investor capital flows.

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