Why tiers exist
A waterfall allocates cash between investors and the sponsor in a defined order. Each tier is satisfied before the next receives anything. The order, not the headline split, determines what an investor actually receives.
The common tiers
Return of capital repays contributed capital. Preferred return pays investors a stated annual rate on unreturned capital, usually accruing and often compounding. Catch-up then pays the sponsor until the sponsor has received its agreed share of profits distributed so far. Promote — also called carried interest — splits the remainder, often 80/20 in favour of investors.
A hurdle introduces a further split that only applies once a stated return threshold is met, so the sponsor's share increases with performance.
What to check
Is the preferred return cumulative and compounding? Is it calculated on contributed capital or on unreturned capital? Is the catch-up full or partial? Are hurdles measured on internal rate of return or on an equity multiple? Do different investor classes carry different terms?
Two vehicles quoting the same 8 per cent preferred and 20 per cent promote can distribute materially different amounts on identical cash flows because of these details.