Heather Heys
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Single-interim clawbacks are deployed in a quarter of private equity funds with American waterfalls, Preqin Term Intelligence shows
While interim clawbacks are widely used in American waterfall models1 as a means of ensuring fairness and accountability between fund managers and investors in the distribution of profits, at least a quarter of private equity funds with American waterfalls only deploy a single or one-off interim clawback, Preqin Term Intelligence shows.
This single deployment, as opposed to multiple or annual deployments, serves to water down the effectiveness of the interim clawback as an investor protection, since it presents only a single or one-off opportunity to address the default risk of the GP clawback.
To reduce the risk of significant clawback liabilities accumulating over time, LPs should seek to include multiple or annual interim clawbacks within the limited partnership agreement (LPA). This will allow for a more frequent recalibration of the GP’s carried interest distribution.
An interim clawback refers to a provision under which the GP’s potential clawback liability will be calculated at an interim point or points in the fund’s life. If it is determined that the GP has received excess carried interest at this interim point, or if the total distributions to LPs do not meet agreed-upon thresholds, the GP must reimburse LPs accordingly.
The inclusion of an interim clawback provision gives LPs earlier notice of a clawback event, so they do not have to wait until it is flagged at the final clawback determination date. This helps mitigate the risk of LPs not receiving the full clawback amount they are entitled to, and enhances LP-GP alignment.
Preqin Term Intelligence indicates that around 80% of the benchmarked North America-focused private equity funds with American waterfalls deploy interim clawbacks across all fund sizes. In contrast, for EMEA-focused private equity funds, those with assets under management (AUM) of more than $1bn deployed interim clawbacks at nearly double the rate of those funds with less than $1bn AUM (Fig. 1).
Fig. 1: Most benchmarked North America-focused private equity funds deploy interim clawbacks (American waterfall)
Interim clawbacks by fund size, North America vs. EMEA-focused funds
Source: Term Intelligence, Preqin
Interim clawbacks can take various forms, including multiple, annual, or one-off. Where private equity funds have multiple disposals during their investment period, which result in several allocations of carried interest to GPs, it is common for LPs to advocate for multiple or annual interim clawbacks, triggered at each disposal or at a specific point each year. Other private equity funds, in contrast, adopt a one-off interim clawback, typically executed at the end of the initial term or following specific events, such as the removal of the GP. Multiple or annual interim clawbacks allow for a more frequent recalibration of the GP’s carried interest distribution, reducing the risk of significant clawback liabilities accumulating over time.
Preqin Term Intelligence shows that multiple interim clawbacks have the highest rate of deployment in private equity funds with American waterfalls, at around 40% (Fig. 2). This is followed by single interim clawbacks, which are deployed in a quarter of private equity funds. However, EMEA-focused funds have a higher frequency of one-off funds (30%) versus North America-focused (25%). Annual interim clawbacks bring up the rear, deployed by 17% and 10% of North America and EMEA-focused private equity funds, respectively.
Fig. 2: A quarter of North America-focused private equity funds deploy one-off interim clawbacks (American waterfall)
Types of interim clawbacks in North America vs. EMEA-focused funds
Source: Term Intelligence, Preqin
While single or one-off interim clawbacks do provide LP protection, they fall short of offering comprehensive safeguards for investors. Multiple interim clawbacks spread across the fund's lifecycle are far more effective in addressing the inherent risks of the American waterfall, particularly if teamed with escrows and clawback guarantees. When a GP’s carried interest distribution is recalibrated more frequently through multiple interim clawbacks, there is less risk that significant clawback liabilities could accumulate over time. This approach ensures greater alignment between GPs and investors throughout the fund's operation, as it holds GPs accountable at regular intervals. It provides greater transparency and predictability for investors, which can help build trust and confidence in the fund’s management practices.
Term Intelligence is a fund terms benchmarking solution that enables you to compare LPA terms against the wider market. With Term Intelligence, you can negotiate LPA terms more effectively, draft competitive fund terms backed by market data, understand which ILPA principles the market is adopting, and expand into new asset classes. Learn more about Term Intelligence.
1. American waterfall definition: LPs are entitled to receive a return of capital invested in all realized, written off, and written down investments (plus a preferred return thereon) before the GP can receive carried interest, but not capital invested in unrealized investments (or a preferred return with respect thereto). Carry is calculated taking into consideration any previously realized losses on deals that have been disposed of, and any 'write-offs' and 'write-downs' experienced by assets not yet sold. To the extent that there are losses on subsequent deals after the carry has been taken on earlier dispositions, the GP must return the excess through a payment known as a 'clawback'.
European waterfall definition: LPs receive a return of all previous capital contributions and preferred return before the GP earns its carried interest.
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