What is a 'waterfall' provision commonly found in private equity or hedge fund agreements?

Question: What is a 'waterfall' provision commonly found in private equity or hedge fund agreements?

Answer options: ✅ A clause that dictates the order in which funds are distributed to investors and the general partner after profits are realized.

• A mechanism for automatically reinvesting all dividends and interest payments.
• A liquidity provision allowing investors to withdraw capital at any time without penalty.
• A section outlining the fund's investment in environmentally friendly projects.

Correct answer: A clause that dictates the order in which funds are distributed to investors and the general partner after profits are realized.

Explanation: A waterfall provision outlines the priority and distribution of cash flows (profits and capital) from an investment vehicle, such as a private equity fund, to its limited partners (investors) and the general partner (manager). It defines how profits are shared, often including hurdles and preferred returns.