Private Equity Waterfall
Below is a private equity waterfall chart showing favorable returns with two hurdles an investment must meet before the cash flow split begins to change. The light blue bar (the GP portion of the payout) increases (or progress) as these performance hurdles are met. Promoting GP interests (also known as carried interests) is one of the keys to aligning economic interests.
Hurdle rates at each investment level are market-driven and strictly negotiated. Not only the rate but also the method of calculation (i.e., simple, compound, IRR) depends on several qualitative and quantitative factors specific to trading and GP in general.
Risky trades with more volatile cash flows and longer payout periods or uncertain outcomes attract fewer investors, allowing LPs to get better terms. It allows you to achieve bigger payouts faster. The same logic applies to GP's historical performance. Companies with strong track records and long lists of previous investors pay the lowest priority returns and are promoted faster than less experienced peers. LPs also tend to hedge risks with greener GPs by including clawbacks or capping incentive fees.