What is the first step in a waterfall?

• A. Determining how much total cash is available to distribute
• B. Calculating equity multiples
• C. Estimating operating expenses
• D. Determining tax liability

Answer: (A)

The first step in a waterfall is to determine how much total cash is available to distribute. This creates the base pool that will be allocated to investors under the waterfall rules. In practice, you project the asset’s cash flows and subtract operating expenses, capital expenditures, debt service, reserves, and any other uses to arrive at cash available for distribution (often called cash flow available to equity). Once that amount is known, you apply the waterfall: return of initial invested capital, then any preferred return to limited partners, then any catch-up to the sponsor, and finally the remaining cash splits (the promote) according to the agreed structure. If you try to jump ahead to calculating equity multiples or tax implications before you know the total distributable cash, you’d be allocating based on an undefined base, which undermines the integrity of the distribution plan.