Clawback
Also called Clawback provision, Promote clawback.
A clawback requires a general partner to return promote it has already been paid when the final result shows it was not earned. It exists because deal-by-deal waterfalls pay promote on the winners before the losers are known.
How it works
The need arises from one specific structure. An American, deal-by-deal waterfall tests each investment on its own, so promote is paid on the first profitable exit even though later investments may lose money and leave the limited partners short of their capital and preferred return across the fund. A European, whole-fund waterfall has no such gap, because it returns all capital and preferred return before any promote is paid at all. The clawback is the patch that lets a sponsor be paid early without being overpaid finally.
It is a computation at the end of the fund's life and the terms of that computation are negotiated. Whether the obligation is measured before or after the tax the general partner already paid on the promote is the most consequential of them: an after-tax clawback caps the return at what the sponsor actually kept, and the shortfall falls on the limited partners. Interim testing, sometimes annual, catches a problem while there is still promote flowing to withhold.
The provision is worth exactly the credit standing behind it. A clawback owed by an entity that has already distributed the promote to individuals is a promise against an empty balance sheet, which is why limited partners ask for a guarantee from named principals, an escrow holding a share of each promote payment, or both. The question is never whether there is a clawback. It is what secures it.
Formula
Clawback = promote paid to date - promote the general partner would have earned on the final whole-fund result- The final result is measured across every investment, after all fees and expenses
- An after-tax clawback reduces the obligation by the tax the general partner already paid, and the difference is borne by the limited partners
- Escrowing a share of each promote payment, commonly 20 to 30 percent, is the usual security
Worked example
Illustrative fund with two investments and $10,000,000 of limited partner capital in each. An 8 percent compounded preferred return, a full catch-up and a 20 percent promote, tested deal by deal over a five-year life.
| Deal one distributionsLP $16,400,000, GP promote $1,600,000 | $18,000,000 |
|---|---|
| Deal two distributionsall to the limited partner | $7,500,000 |
| Limited partner capital across both | $20,000,000 |
| Limited partner total distributions | $23,900,000 |
| Preferred return accrued across both | $9,386,562 |
| Clawback due | $1,600,000, the entire promote |
The limited partners received $3,900,000 of profit against $9,386,562 of accrued preferred return, so measured across the fund the general partner earned no promote at all. Deal one on its own said otherwise, and the clawback is the only thing that corrects it.
Conventions worth knowing
- Ask whether the obligation is measured before or after the general partner's tax. It is the difference between a full return and a partial one.
- Ask what secures it: a guarantee from named principals whose balance sheets are disclosed, an escrow of each promote payment, or nothing at all.
The common mistake
Treating the existence of a clawback as the protection
A clawback clause is a right to sue an entity, and by the time it is triggered the promote has usually been distributed to individuals and spent. A limited partner who negotiated for the clause and not for its security has bought a document. The version that works withholds a share of every promote payment in escrow until the fund's final test, or is guaranteed personally by disclosed principals, and it is tested along the way rather than once at the end when there is nothing left to recover.
Related terms
- Distribution waterfallA distribution waterfall is the ordered set of tiers that determines how cash is split between limited and general partners. Each tier is filled completely before any money reaches the next one, and the general partner's share rises as it goes.
- PromoteThe promote is the general partner's share of profits in excess of its pro rata capital contribution, earned once the limited partners have received their capital back plus the preferred return. It is the performance compensation in a real estate partnership.
- Preferred returnA preferred return is a threshold rate of return that limited partners receive on their capital before the general partner participates in profits beyond its own pro rata share. It is a priority in the distribution queue, not a promise that the money will be there.
- GP catch-upA general partner catch-up is a waterfall tier in which the general partner receives most or all of the distributions after the preferred return has been paid, until it has received its full promote percentage of all profit distributed so far. It restores the economic bargain the preferred return interrupted.
- Capital callA capital call is a demand on partners to fund committed equity, at closing or in stages as the business plan needs it. Calling capital later rather than all at once raises the internal rate of return without changing the equity multiple, and failing to fund a call carries penalties written into the operating agreement.
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.