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  • Writer's pictureAleksey Krylov

Aleksey Krylov Shares with Students Waterfall Calculations Lessons

Updated: Dec 29, 2023

Blast from the past: A few years ago, I spoke in front of a class ran by Joel Palathinkal

at Sutton Capital. Students were eager to learn real-life CFO lessons about waterfall calculations.

Waterfall calculations are commonly used in finance and investment management to distribute profits or cash flows among different stakeholders or investment partners. Some elements we discussed:

  1. Analyze Cash Flow Inputs: To perform waterfall calculations accurately, gather the necessary cash flow inputs. It all starts there: Without the cash flow, there would be nothing to distribute. So start with accurate, up-to-date and complete financial data, historical or projected. These inputs typically include investment contributions, profits, losses, expenses, and any other relevant financial metrics.

  2. Understanding the Structure: Before diving into the calculations, it's crucial to understand the structure of the waterfall. Waterfalls typically consist of a series of distribution tiers or levels, each with its own set of rules and priorities. Familiarizing yourself with the specific waterfall arrangement in your organization or investment fund is the next step in the analysis. It often involves little modeling; in fact, most of the relevant information is found in the investment and transaction document, which requires careful review.

  3. Identify Priority and Hurdle Rates: Waterfalls often include preferred returns or hurdle rates, which determine the minimum return required for certain stakeholders to receive distributions. As a CFO, you should know the priority order and the corresponding hurdle rates for each level of the waterfall.

  4. Calculate Preferred Returns: Start the calculations by determining whether the preferred returns or hurdle rates have been achieved. If the returns exceed the hurdle rates, calculate the preferred returns for each level and allocate them accordingly. This step ensures that the stakeholders entitled to preferred returns receive their due share.

  5. Allocate Profits and Carry: After fulfilling the preferred returns, distribute the remaining profits or cash flows among the stakeholders based on the waterfall structure. This step involves applying specific rules, such as catch-up provisions or profit-sharing percentages, to determine the distribution amounts for each level.

  6. Account for Clawbacks and Losses: In some cases, waterfalls may have provisions for clawbacks, which allow the return of previously distributed profits or carry in the event of losses or underperformance. Understand the clawback provisions in your waterfall and incorporate them into your calculations if applicable.

  7. Validate and Verify Results: Once you have performed the waterfall calculations, it's crucial to validate and verify the results. Double-check the accuracy of your calculations and ensure that they align with the terms and provisions outlined in the waterfall structure.

  8. Communicate Effectively: As a CFO, you play a vital role in communicating the results of the waterfall calculations to stakeholders. Clearly explain the distribution amounts, the rationale behind the allocations, and any relevant terms or provisions. Effective communication helps maintain transparency and fosters trust among stakeholders.

Remember, these lessons provide a general overview of waterfall calculations. It's essential to consider the specific requirements and provisions of your organization or investment fund's waterfall when performing calculations as a CFO.

Without further ado, here is the video:



About Aleksey Krylov, FTERA Advisors

Aleksey Krylov served in CFO roles of public and VC-backed private companies. As investor, he contributed to 25+ private equity deals that have deployed $500 million. He has advised 50+ clients on raising $1.6 billion in equity in the healthcare, consumer, media, software, energy, and industrial sectors.

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