What is the purpose of a catch-up mechanism in PE waterfall?

• A. To guarantee LPs receive the majority of profits before GP.
• B. To set the carried interest to a fixed 50/50 split.
• C. To allow the GP to catch up on distributions after the hurdle, ensuring the final carried interest split is achieved.
• D. To cap the GP's share at a fixed percentage.

Answer: (C)

The catch-up mechanism is about aligning incentives so the final carried interest split hits the agreed target once LPs have received their minimum return. After LPs are paid back their capital and the hurdle (preferred return) is satisfied, the catch-up allows the GP to receive most or all of the next profits until the GP’s cumulative share reaches the carried interest level. In other words, the GP is given a chance to “catch up” to the amount of profit they’re entitled to under the carried interest, so that when the catch-up is complete, the remaining profits split follows the intended 20% to the GP (and 80% to the LPs, for example) or whatever the negotiated ratio is. This structure protects LPs by ensuring they receive the preferred return first, while still ensuring the GP is rewarded once the hurdle has been cleared and the carried interest target is achieved.