Loading the player...

What is a 'Clawback'

A clawback provision is generally associated with private equity funds. Based on the compensation structures for private equity funds, clawback provisions protect limited partners for paying fees they shouldn't. Clawbacks provisions enable investors to normalize the final carry of the fund by taking back carry paid on previous investments to avoid incurring losses on other investments in the portfolio.

BREAKING DOWN 'Clawback'

Clawback provisions are typically triggered when a fund is being liquidated, and depending on previous distributions, may result in the general partners of the fund to return all carry to investors. Taxes are often a major factor with clawbacks, as some portion of distribution carry is earmarked to pay tax liabilities.

Why Clawbacks Exist

When private equity was a new asset class, the general partners of the fund only received distributions from the fund they managed after all limited partners had received their initial capital contributions back. Typically, this could be up to 10 years after the start of the fund. Over time, private equity managers negotiated with their investors and new contracts and funds allowed general partners receive distributions earlier.

Clawbacks were created to protect limited partners in three ways. If the total fund does not reach its target preferred return, known as the hurdle rate (which is usually around 8%), a clawback could be triggered. Second, if at the end of the fund's life it is determined that the general partner earned profits exceeding the contractual ceiling (usually around 20%), a clawback could be triggered. In a third, more complicated case, a clawback may be triggered if a limited partner has not received his share of catch-up period profits.

Clawbacks are triggered at the end of a fund's life when all investments have been liquidated. At that point, any excess carried interest received by the general partners is calculated, taken back and distributed to the limited partners, pro rata.

Private equity firms do not find clawbacks favorable, as they add elements of risk and uncertainty to fund's returns and the firm's operations. Nonetheless, clawbacks are extremely popular among limited partner investors and will likely remain a staple in private equity contracts for years to come.

Another Clawback Definition

Another definition of a clawback consists of money or benefits that are distributed to an investor and then taken back as a result of special circumstances. For example, purchasing certain investments provides taxable benefits contingent upon holding periods. When an investor sells these investments before they have reached maturity, the tax benefits must be forfeited.

RELATED TERMS
  1. Tax Clawback Agreement

    An arrangement whereby the tax benefits received from a given ...
  2. Dividend Clawback

    An arrangement under which those financing a project agree to ...
  3. Carried Interest

    A share of any profits that the general partners of private equity ...
  4. Limited Partner

    A partner in a partnership whose liability is limited to the ...
  5. Incentive Distribution Rights - ...

    These give a limited partnership's general partner an increasing ...
  6. General Partner

    Owners of a partnership who have unlimited liability. A general ...
Related Articles
  1. Investing

    What Does Clawback Mean?

    A clawback occurs when money or benefits that have been distributed are taken back because of unforeseen or unusual circumstances.
  2. Investing

    Learn The Lingo Of Private Equity Investing

    Because of the non-public nature of private equity, it can be difficult to the learn the lingo. We break it down here.
  3. Investing

    What is Carried Interest?

    Carried interest is the percentage of a private equity or a hedge fund’s profits that its general partners receive as compensation.
  4. Investing

    Understanding the Accounting of Private Equity Funds

    Read about private equity accounting and how it is different than that of other investment vehicles. The nature of private equity makes a difference.
  5. Financial Advisor

    How To Invest In Private Equity Real Estate

    A brief introduction to private equity real estate, and what investors should know if they want to get started.
  6. Financial Advisor

    Partners Group: Investment Manager Highlight (PGHN)

    Get an inside look at some of the key executives and the investment approach of the global private equity investment firm Partners Group.
  7. Managing Wealth

    How To Start Your Own Private Equity Fund

    Here's a how-to guide on starting on starting a private equity firm.
  8. Small Business

    How To Create A Business Succession Plan

    Make sure the business you built continues to thrive long after you've left the helm.
  9. Investing

    Private Equity Management: Fees & Regulation

    Since Dodd-Frank was signed into law in 2010, private equity firms can no longer operate largely unregulated, but the industry remains robust.
  10. Small Business

    MLPs and Limited Partnerships: How They Differ

    Limited partnerships and master limited partnerships have one difference that makes all the difference.
RELATED FAQS
  1. What is the difference between a silent partner and a general partner?

    Understand the difference between a person designated as a silent partner and a general partner under the partnership business ... Read Answer >>
  2. What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth ... Read Answer >>
  3. What's the difference between limited liability partnership and general partnership?

    Learn the differences between general partnerships and limited liability partnerships; each type has unique traits, benefits ... Read Answer >>
  4. How does the risk profile of private equity investments compare to those of other ...

    Learn how the risk profile of private equity investment compares to other asset classes and the aspects investors should ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center