European-style and American-style internal rate of return (IRR) hurdle waterfalls are two different methods of calculating the distribution of profits in a private equity or real estate fund.
In an IRR hurdle waterfall, profits are distributed to investors based on a certain rate of return, or hurdle rate, that must be met before the profits are split between the investors and the fund manager.
European-style IRR hurdle waterfalls require that the hurdle rate be achieved over the entire life of the investment. Once the hurdle rate is met, profits are typically split between the investors and the fund manager based on a predetermined percentage, often referred to as the promote. This percentage can vary depending on the specifics of the deal.
In other words, the LP / investor must receive 100% of the cash flows until they achieve a defined IRR (this means return of initial investment plus the return due).
In contrast, American-style IRR hurdle waterfalls allow for the GP and LP to earn their returns on invested capital at the same time and usually via pari passu. Basically, you set the split rate up to the first LP hurdle at something other than 100%/0% for the LP/GP share of available distributions.
These are just general styles and no matter where you are investing in real estate, the terms of the deal can be whatever each party agrees to. It will be explicitly defined how this works and is worth reading before making decisions or trying to negotiate.
Article found in Joint Venture.
