In a typical equity waterfall, what is the purpose of the catch-up mechanism?

• A. It pays the sponsor a portion of profits before investors receive any returns.
• B. It accelerates distribution of profits to the sponsor after the preferred return is met so the sponsor catches up to a target split.
• C. It prevents any sponsor profits until the investor is fully paid.
• D. It reduces the investor's return to fund the sponsor's profit.

Answer: (B)

The catch-up in an equity waterfall is designed to align the sponsor’s earned share with the agreed profit split after investors have received their preferred return. Once the investors have achieved their preferred return, the catch-up accelerates profits to the sponsor so that the sponsor “catches up” to the target distribution split. After this catch-up phase, the remaining profits flow according to the established split (often giving the sponsor the carried interest once the target is reached).

So the best description is that it accelerates distributions to the sponsor after the preferred return is met, enabling the sponsor to reach the agreed-upon share of profits. This isn’t about paying the sponsor before investors’ returns, nor about delaying sponsor profits or reducing investors’ returns.