Sudhvik Partners Fund III exits its first deal early for a big gain and later loses heavily on its second. Compare the carry paid under a deal-by-deal waterfall and a whole-fund waterfall, and work out the clawback at the end.

Deal by deal the GP collects Rs 160 crore, Rs 60 crore of it in year 3; whole fund it earns Rs 110 crore, all in year 6, so the clawback is Rs 50 crore. Deal by deal never nets deal 2's Rs 250 crore loss against the gains, so the GP is overpaid by 20% of that loss. The clawback recovers it, but only if the GP still has the money.

Picture a cricket team's bonus. One captain pays a bonus to each player after every good innings. Another waits until the season ends and pays only if the team finished in profit. The first pays early and pays for good innings even in a losing season. A deal-by-deal waterfall tests each exit on its own and pays carry as soon as that deal clears the hurdle; a whole-fund waterfall pays nothing until LPs have all their capital back and the fund as a whole has cleared it. The second is often called a European waterfall and the first an American one. The 8% hurdleThe minimum annual return LPs must earn before the GP takes any share of the profits. is the same; what it is measured on is not.

Deal by deal: deal 1 is 2.5x in three years, 35.7% a year, so the GP takes 20% of Rs 300 crore, Rs 60 crore, in year 3. In year 6 the rest of the portfolio, 2.0x in six years or 12.2% a year, adds Rs 100 crore. Deal 2 adds nothing, and nothing is taken back for it. Total: Rs 160 crore. Whole fund: by year 6 LPs have received Rs 1,550 crore on Rs 1,000 crore, the fund's IRR of 9.3% clears 8%, and with a full catch-up the GP earns 20% of the net gain of Rs 550 crore, Rs 110 crore, all of it at the end.

The GP has been paid Rs 160 crore but is entitled, looking at the whole fund, to Rs 110 crore. The Rs 50 crore difference is exactly 20% of deal 2's Rs 250 crore loss: carry paid on gains the fund later gave back. A clawbackA clause requiring the GP to return carry it has received if, at the end of the fund, it turns out to have been paid more than its share of the total profit. clause makes the GP return it when the fund winds up.

The trouble is collection. The Rs 60 crore paid in year 3 has been split among partners and taxed, and some of those partners may have left the firm. A clawback is a promise to repay money already spent, so LPs protect it with an escrow, holding back part of each carry payment until the fund ends, and with personal guarantees from the partners. Many agreements cap the clawback at the carry net of the tax already paid on it, which means LPs can recover less than the gross overpayment. Say that limit in the interview; it is the point most candidates miss.

The LP's view to close on: the deal-by-deal structure is not illegal or unusual, but it moves risk from GP to LP. A fund that sells its winners early and holds its losers longest pays the most early carry. That is why LPs in India and abroad push for whole-fund waterfalls, or at least deal-by-deal with losses on realised deals netted first and a meaningful escrow.