Waterfall Distributions and Scenario Modeling: Private Equity and Real Estate Investments

Waterfall distributions divide investment profits or capital gains among a group or pooled investment participants. The distribution establishes a hierarchy giving payouts to limited partners (LP) and general partners (GP).  The distribution waterfall works like cascading water falling into a series of vertically aligned buckets where the money goes to investors, partners, and stakeholders in a hierarchical-tiered fashion.  

There are two types of waterfall distribution models through which returns are distributed: American and European. In general, investors are paid before fund managers under the European distribution waterfall, whereas in the American distribution waterfall, managers are paid before investors. However, there are few custom hybrid models where investors have set up their own.  


The calculations used for these financial models have become increasingly complex and are even more complex when scenario models are introduced into the overall scope and reporting equation. 

Scenario modeling can be a valuable tool in helping PE Funds to manage risks and plan for unexpected events. By simulating different scenarios, such as doomsday events, clawback situations, end-of-fund events, or other potential risks, PE funds can identify potential issues and develop strategies to mitigate them. This can help to ensure that the fund’s investors receive the returns they expect, even in adverse conditions. 


Here are some of the benefits of using a waterfall calculation engine to run scenario models for private equity firms:

  • Improved Decision Making: Scenario modeling enables private equity firms to run simulations of different investment scenarios and evaluate potential outcomes. This allows them to make informed decisions about how to allocate resources and manage risk. 
  • Risk Management: By modeling different scenarios, private equity firms can identify potential risks and develop strategies to mitigate them. This can help to protect the firm’s investments and minimize losses. 
  • Transparency: The use of a waterfall calculation engine provides transparency in the distribution of profits to investors. LPs can see how profits are being allocated and have a better understanding of their potential returns. 
  • Accuracy: A waterfall calculation engine uses sophisticated algorithms to calculate the distribution of profits accurately. This ensures that investors receive their fair share of the profits based on the fund’s performance. 
  • Efficiency: A waterfall calculation engine automates the distribution of profits, saving time and reducing errors associated with manual calculations. 
  • Flexibility: Scenario modeling and waterfall calculations are highly flexible, allowing private equity firms to adjust the model to reflect changes in market conditions or investment strategies. 


In the following sections, we explore various scenarios that may impact a fund’s performance. Scenario modeling can help to identify and mitigate these risks.

Doomsday Scenarios 

  • Doomsday scenarios refer to extreme situations that are unlikely but could have catastrophic consequences. These scenarios are often used to stress-test systems, models, and strategies to ensure they can withstand extreme conditions. 
  • Scenario modeling can be used to simulate and analyze different doomsday scenarios. For example, a financial institution may use scenario modeling to simulate the impact of a major stock market crash, an economic recession, or a natural disaster such as a hurricane or earthquake. By modeling these extreme scenarios, institutions can identify potential weaknesses in their systems and make adjustments to improve their resilience.

Clawback Scenarios 

  • Clawback scenarios refer to situations where a company or organization is required to recover money or assets that have already been distributed. This could be due to a legal settlement, regulatory action, or other factors. 
  • Scenario modeling can be used to simulate and analyze different clawback scenarios. For example, a financial institution may use scenario modeling to simulate the impact of a clawback of executive compensation or bonuses. By modeling these scenarios, institutions can identify potential financial risks and develop strategies to mitigate them. 

End of Fund Life or Liquidation  

  • As a private equity fund nears the end of its life, the General Partners (GPs) and Limited Partners (LPs) must make important decisions regarding how the fund will be liquidated. One critical aspect of this process is determining how the fund’s remaining assets will be distributed among the LPs. 
  • Scenario modeling and waterfall calculations can play a crucial role in this process. By simulating different scenarios and analyzing their potential impact on the fund’s value, GPs and LPs can make informed decisions about how to distribute the remaining assets. 
  • For example, suppose that a fund is nearing the end of its life and has several remaining investments. One scenario that could be modeled is a situation where the fund’s investments perform poorly, and their value decreases significantly. In this case, the waterfall calculations would be adjusted accordingly, and LPs would receive a smaller share of the remaining assets. 
  • On the other hand, if the fund’s investments perform well, and their value increases significantly, LPs may receive a larger share of the remaining assets. By modeling these scenarios, GPs and LPs can develop a range of possible outcomes and plan accordingly. 
  • Additionally, scenario modeling can also be used to evaluate the impact of different liquidation strategies. For example, the fund may choose to sell its remaining assets to a third-party buyer, distribute them in-kind to the LPs, or some combination of both. By modeling these scenarios, GPs and LPs can evaluate the potential benefits and risks of each strategy and make an informed decision.  

Other Uses for Waterfall Distribution Calculation Scenario Modeling  

In addition to doomsday and clawback scenarios, scenario modeling can be used to analyze a wide range of other scenarios. For example: 

  • Market Volatility: Scenario modeling can be used to simulate and analyze the impact of market volatility on investment portfolios. 
  • Cybersecurity Breaches: Scenario modeling can simulate and analyze cybersecurity breaches’ impact on a company’s operations and financials. 
  • Pandemics: Scenario modeling can be used to simulate and analyze the impact of pandemics on a company’s operations, supply chain, and financials. 

Scenario modeling can help organizations identify potential risks and develop mitigation strategies. By testing different scenarios, organizations can better understand their vulnerabilities and improve their ability to manage risk.  

Automation of reporting via investor portals  

No matter how complex your waterfall calculations, ThoughtFocus can help you automate, connect and integrate with other systems, and distribute via investor portals. ThoughtFocus excels in taking your current processes and systems, building a centralized data model, and delivering intelligence and insight to your investors from a single pane of glass. This allows you to scale faster: 

  • Reduce report distribution time  
  • Eliminate accounting errors 
  • Generate dynamic statements immediately 
  • Increase transparency and grow your investors 

Better manage the complexities of fund growth and transparency

In summary, scenario modeling and waterfall calculations are essential tools for GPs and LPs to manage the liquidation process of a private equity fund. By simulating different scenarios and evaluating potential outcomes, they can make informed decisions and ensure that the remaining assets are distributed fairly and efficiently.  

The benefits are clear. Using a waterfall calculation engine to run scenario models provides private equity firms with numerous benefits, including improved decision-making, risk management, transparency, accuracy, efficiency, and flexibility. 


If you’re a private equity firm or a real estate company looking for a better view your ROI or make your fund calculations simpler and scalable, ThoughtFocus can help. Reach out to our team of financial and technology solution experts at betterfuturefaster@thoughtfocus.com for more information, and we’ll get back to you at the earliest. 




macon Raine