Waterfall distributions – the order in which returns are allocated within private markets investments – need more transparency.
CSC, an administration and compliance provider, found that an overwhelming majority of limited partners (LPs) – the investors – are calling for greater transparency in waterfall distributions.
According to the findings, 86% of LPs believe it is important or critical to enhance clarity around the timing and structure of distributions. This could be a challenge for general partners as liquidity events slow down and waterfall provisions become more complex.
In a report called ‘Distribution waterfalls 2024: Transparency, technology, trust” by CSC, surveyed 200 general partners and 200 LPs across North America, Europe, and Asia Pacific, to understand their views on transparency and customisation in waterfall calculations.
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.
Making matters worse, computational complexity is a greater demand for customisation among LPs. Some 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 customisation in waterfall provisions, while 43% expect to spend significant time and energy addressing these needs.
Some 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.
