The size of distributions 

Given that private equity funds invest in a range of companies or assets to provide diversification and avoid too much capital being concentrated in a single investment, each distribution is usually relatively small compared to the full fund size. 

Pitchbook, for example, estimates that the average size of distribution tends to be about 5% of a fund size. However, it also notes that some distributions can be significant, with the average largest distribution during a fund’s life of 32% of the fund size.²

These larger distributions—which may be made up of more than one realisation—are most likely to occur some way through the fund's life. Fund managers need time to make the investments, execute value creation plans and then realise returns. Indeed, distributions tend to be most common in the fund’s sixth, seventh and eighth year, according to Pitchbook.² They can also continue beyond the traditional ten-year life of a private equity fund – extensions to the fund life are commonplace to allow all investments to be realised.

The range of distribution sizes and the fact that funds make distributions when selling or realising an investment means that capital flows back to investors tend to be lumpy. In addition, fund managers may not realise a position all in one go but instead over time to avoid influencing the price, which is often the case when a private equity sponsor lists a portfolio company on a stock exchange. 

‍The effect of waterfalls on distributions

An essential part of the private equity model is alignment of fund manager’s compensation with the fund’s returns. To achieve this, private equity fund managers charge a performance fee, or carried interest, typically set at around 20% of the excess profits of the fund. 

This affects how funds distribute capital. Investors will always receive their capital back, plus some element of return, before the fund manager can start to share in the profits. The model for this is known as a waterfall and has three main steps: 

1. The fund distributes capital to investors until they have received back the full amount they initially invested.
2. The fund then distributes capital to investors up to a pre-agreed preferred return or hurdle rate – this is a return on capital, usually set at around 8%, that investors receive before the fund manager can start receiving any carried interest.
3. Catch-up and carried interest then kicks in. This means the fund manager receives the next distributions until it has caught up its percentage of carried interest. So, if this were 20%, the fund manager takes distributions until profits are split 20% to the fund manager and 80% to the investors. All future distributions continue with this 20/80 split.

The pecking order of distributions also varies according to whether a fund uses a US-style waterfall or European-style waterfall:

• In US waterfalls, distribution splits are applied on a deal-by-deal basis. The proportion of capital invested and the preferred return allocated to each deal must be returned to investors before the fund manager receives carried interest.
• In European waterfalls, distributions are split on a whole fund basis. This means that investors in a fund must receive the entirety of the capital they have committed to a fund, plus the preferred return on that amount, before the fund manager can receive any share of the profit.

‍A final word: to understand distributions is to better manage portfolio 

Private equity’s cash flows are markedly different from other asset classes and distributions, in particular, can be quite a complex area. However, for investors, understanding the basic mechanics of when and how capital flows back to them can help them manage their liquidity and investment portfolios more effectively.