The equity waterfall

What is an equity waterfall?

When a private equity-backed portfolio company is sold or refinanced, the proceeds do not flow directly to shareholders. Instead, they are distributed in a strict order of priority — from the most senior creditors down to the ordinary shareholders who sit at the bottom. This sequenced distribution is called the equity waterfall.

The waterfall matters enormously to fund administrators and CFOs because the order of priority — and the quantum at each tier — determines the actual return to every investor class. A management team with sweet equity, a co-invest vehicle, and the main fund can each have very different effective multiples depending on where enterprise value falls relative to the claims above them.

Understanding the waterfall is also a prerequisite for accurate cap table modelling. Every instrument on the cap table — ordinary shares, preference shares, and shareholder loans — has a defined position in the waterfall, and the accrued values of prefs and SHLs at any given date directly affect the residual equity value available to ordinary shareholders.

The typical PE waterfall

In a standard UK/Luxembourg PE structure, the waterfall flows in the following order. Senior debt sits above everything; below it sit shareholder loans (with accrued interest), then preference shares (with accrued coupon), and finally ordinary shares absorb whatever residual value remains.

The cascade is mechanical: each layer is paid in full before the layer below receives anything. If enterprise value is insufficient to satisfy a senior claim, the layers below it receive nothing. In practice, most PE exits are structured to ensure at least some residual reaches ordinary shareholders, but the exact amount is highly sensitive to the accrued instrument values on exit day.

Worked example

The table below shows the waterfall for a hypothetical exit at an enterprise value of £68.0m, with net debt of £12.4m, shareholder loans of £6.2m principal plus £0.9m accrued interest, and preference shares of £13.5m principal plus £1.6m accrued coupon.

Layer	Amount (£m)	Cumulative deducted (£m)	Residual (£m)
Enterprise value	68.0	—	68.0
Less: Senior debt repayment	(12.4)	12.4	55.6
Less: SHL principal + accrued interest	(7.1)	19.5	48.5
Less: Pref principal + accrued coupon	(15.1)	34.6	33.4
Equity value (ordinary shareholders)	33.4	—	33.4

The £33.4m residual is the equity value. It is this figure — not enterprise value — that is divided among ordinary shareholders in proportion to their respective shareholdings. Note that both the SHL interest (£0.9m) and pref coupon (£1.6m) are accrued values: the longer the hold period, the greater their drag on the equity residual.

Distribution among shareholders

Once the equity value has been determined, it is split across the ordinary shareholder register. In a typical PE structure this includes the main fund, any co-invest vehicle, the management team, and an employee benefit trust (EBT) or similar nominee.

Shareholder	Ownership	Proceeds (£m)
Fund (Meridian Capital II)	72.4%	24.2
Co-invest vehicle	14.2%	4.7
Management (via nominee)	9.7%	3.2
EBT / other	3.7%	1.2
Total	100.0%	33.4

These percentages are the fully diluted ordinary share ownership as recorded on the cap table at the exit date. They are distinct from any economic entitlement carried by preference shares or shareholder loans, which were already satisfied higher up the waterfall.

Money multiples

CapTab calculates accrued SHL interest and pref coupons automatically for any given date, so the instrument values feeding into the waterfall are always up to date.

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