New global study by CSC reveals growing complexity and pressures in alternative fund management. See the full study here.
WILMINGTON, Delaware — October 30, 2024 — New research by CSC surveying senior executives in the private capital industry and institutional investors reveals that an overwhelming majority of limited partners (LPs) are calling for greater transparency in waterfall distributions—the order in which investment returns are allocated.
The new report "Distribution Waterfalls 2024: Transparency, Technology, Trust" by CSC, a leading provider of business, legal, financial, and digital brand services, surveyed 200 GPs and 200 LPs across North America, Europe, and Asia Pacific, to understand their views on transparency and customization in waterfall calculations.
According to the findings, 86% of LPs believe it is important or critical to enhance clarity around the timing and structure of distributions. The report underscores the growing pressure on general partners (GPs) to meet these demands, particularly as liquidity events slow down and waterfall provisions become more complex.
Almost two-thirds (64%) of LPs have pushed back on waterfall provisions they found lacking in transparency, with 39% choosing not to commit to certain investments due to these concerns. Key areas of scrutiny include the return of contributions, preferred return to LPs, and carried interest to the GP.
“There needs to be greater collaboration and alignment between GPs and LPs,” says Alejandro Jr. Tan, senior manager of fund services at CSC. “The renaissance of private markets offers more opportunities for both GPs and LPs. However, it’s critical that they work towards achieving better alignment of interests, increased transparency, fairness, and trust-building.”
LPs are losing confidence in the accuracy and transparency of waterfall calculations. Nearly three-quarters (74%) report that waterfalls have become progressively more complicated over the past two years, further hindering clear reporting and communication. Compounding the computational complexity is a greater demand for customization among LPs. In fact, 66% of LPs believe that GPs should tailor terms and transparency levels to better align with their individual preferences, as a one-size-fits-all approach no longer meets diverse needs.
In response, nearly half (46%) of GPs anticipate that they will need to allocate more resources to meet LP demands for customization in waterfall provisions, while 43% expect to spend significant time and energy addressing these needs.
To address growing complexity and transparency requirements, many GPs are turning to technology and outsourcing to specialized providers. Research shows that 50% of GPs have invested in technology over the past two years to enhance transparency and reduce calculation errors. Additionally, 61% plan significant upgrades over the next two years to strengthen their systems, highlighting the need for robust technology infrastructure.
Tan added, “The growing demand for transparency and customization in waterfall provisions is prompting more GPs to embrace outsourcing. By partnering with third-party specialists, GPs can ensure accurate and efficient waterfall calculations, leveraging their expertise to build trust. LPs value precise and accurate calculations that align with contractual terms. As specialist intermediaries, third-party providers can also help to mitigate conflicts of interest.”
Distribution Waterfalls 2024: Transparency, Technology, Trust
Amid increasingly challenging conditions for extracting performance from private market investments, understanding the components and details of distribution waterfalls is more crucial than ever. The role that waterfall calculations play in general partner (GP) and limited partner (LP) relationships has never been greater.
According to Bain & Company’s Private Equity Midyear Report 2024, worldwide private equity exits are likely to deliver some $361 billion by year-end. This is 17% better than the previous year, but it’s still the second-worst year for private equity exit value since 2016.
LPs looking to extract optimal results from their private markets commitments want to be well informed about the structuring and timing of their anticipated liquidity events, and fund managers need to have the systems and processes in place to meet their expectations.
CSC’s Distribution Waterfalls 2024 survey collated responses from 200 GPs and 200 LPs equally distributed between North America, Europe, and APAC.
The survey finds that a solid majority (86%) of LPs believe it is important or critical to increase transparency and clarity over the timing of distributions, especially given the recent slowdown in exits and other liquidity events.
Outsourcing services related to waterfall modeling and calculation seems to be a major theme and a key differentiator in the industry. GPs are overwhelmingly committed to outsourcing, and LPs preferentially invest with those funds that outsource. With transparency a major concern for LPs, GPs have been investing heavily in technology to improve their services and relationships with their institutional investors.
LP sentiment key highlights
LPs prefer outsourced waterfalls
87% of LPs said they would be more likely to invest in a GP that outsourced waterfall modeling and calculation to specialist third parties. Of this, 43% said “absolutely.”
Transparency issues trigger pushback
LPs have pushed back over unreasonable waterfall provisions. Two-thirds (64%) have done so with provisions they found lacking in transparency or unreasonable, but only once. 15% have pushed back on a few occasions.
LPs reject unclear waterfalls
39% have decided not to commit to a GP on several occasions due to unreasonable waterfall provisions.
Waterfall complexity continues to rise
Three-quarters (74%) of LP respondents see waterfall calculations as slightly or significantly more complex than two years ago.
GP sentiment key highlights
Standardized waterfall models
61% of GPs say they have already standardized their approach to waterfall arrangements for all LPs. Around one in 10 (9%) plan to do so over the next two years.
Waterfall modifications on the rise
88% expect the number of variations and modifications in waterfall arrangements driven by LP pushback to increase over the next two years.
Upgrading infrastructure
Half (50%) of GPs have made investments in their technology infrastructure over the past two years to deliver an enhanced level of data and waterfall distribution information to LPs and diminish the risk of calculation errors occurring. However, 61% also said they will be making significant upgrades, and a further 39% will be making minor upgrades, over the next two years. This shows that even after 50% have made significant upgrades over the past two years, many admit they will have to do so again, underscoring a persuasive case for outsourcing.
Demand for transparency
62% of GPs say “transparency around relationships with other LPs” is the area that has received the most scrutiny by LPs in terms of the investment relationship over the lifetime of a fund.
Our spokespeople
“As a business at the center of global private markets, CSC has seen many fund groups. We’ve seen many different types of waterfalls, and over the years, we’ve developed significant knowledge as to what you see in the industry. When you have numerous clients, and you've got distinct types of vehicles, you get to see different types of limited partnership agreements and how they establish them. As a firm, we add value or have added value to our clients in many different areas, including waterfalls.” - David Garcia Director, Client Services, U.S. Fund Services, CSC
“A GP should invest in efficiency gains from automation, leading to cost savings and improved operational effectiveness. This will enhance the GP/LP relationship through streamlined processes, accurate reporting, and efficient communication.” - Alejandro Jr. Tan Senior Manager of Fund Services, Jersey, CSC
“A waterfall is much more than a number, it is an independent interpretation of the agreed terms-this is a process about interpretation of the equalization (in wording and in numbers). An independent service provider like CSC, with expertise and technology, can provide private capital clients with cost-effective support.” - Silvia Tong Director of Fund Services, North Asia, CSC
Different regions, different waterfalls
The two basic established methods, European or American, into which private capital distribution waterfall schedules are classified continue to define the timing and allocation of distribution proceeds to GPs and LPs. However, the industry is increasingly dividing between them in more complex and nuanced ways (for more in-depth information on the European and American waterfall systems, read our free guide here).
Naturally, GP and LP incumbents in the developed private capital markets tend to follow their home base preference.
Debate has persisted over the relative merits of each type, but not enough to trigger lasting changes in either.
“I think the European model is the more conservative option. It always protects the limited partners.” - David Garcia Director, Client Services, U.S. Fund Services, CSC
“For the APAC region, and especially for China, fund structures are becoming more complex and might include multiple fund vehicles where each may have different terms and fee arrangements. In addition, as LPs become more sophisticated and experienced they are requesting more transparency, and looking for waterfalls tailored to them.” - Silvia Tong Director of Fund Services, North Asia, CSC
To receive a copy of CSC’s Distribution Waterfalls 2024: Transparency, Technology, Trust report, = download it here.
About CSC
CSC is the trusted partner of choice for more than 90% of the Fortune 500®, more than 90% of the 100 Best Global Brands (Interbrand®), and more than 70% of the PEI 300. We are the world’s leading provider of global business administration and compliance solutions, specialized administration services to alternative asset managers across a range of fund strategies, transactions involving capital markets participants in both public and private markets, domain name system management and digital brand and fraud protection, and corporate tax software solutions. Founded in 1899 and headquartered in Wilmington, Delaware, USA, CSC prides itself on being privately held and professionally managed for more than 125 years. CSC has office locations and capabilities in more than 140 jurisdictions across Europe, the Americas, Asia Pacific, and the Middle East. We are a global company capable of doing business wherever our clients are—and we accomplish that by employing experts in every business we serve. We are the business behind business®. Learn more at cscglobal.com.
