Explain the concept of a typical equity waterfall with preferred return and catch-up. Which statement is correct?

• A. The investor preferred return is paid first; after preferred return, sponsor catches up via a catch-up tranche until splits align; then profits split (often 70/30 or similar) with sponsor receiving promote based on hurdle.
• B. The investor preferred return is paid after profits are split 50/50.
• C. Sponsor catch-up before preferred return.
• D. There is no catch-up.

Answer: (A)

The key idea here is how distributions flow in an equity waterfall. In a typical structure, investors first receive a preferred return on their contributed capital, ensuring they are paid a minimum return before the sponsor gets any profits. Only after that preferred return is satisfied does a catch-up kick in, letting the sponsor receive profits until the overall economics align with the intended split (the sponsor’s share catching up to reach the target distribution). Once the catch-up is complete and the hurdle is addressed, the remaining profits are split according to the agreed equity split, with the sponsor’s promote earned once the hurdle is met.

So the described sequence—investor gets the preferred return first, then the sponsor catches up via a catch-up tranche until the splits align, then profits are split (often 70/30) and the sponsor receives promote as the hurdle is reached—matches the standard structure. The other options conflict with this priority order or omit the catch-up mechanism, which is why they’re not correct.