What is meant by 'fundraising waterfall'?

The term 'fundraising waterfall' refers to a structure for distributing investment returns among different stakeholders involved in a private equity fund or investment vehicle. This concept is crucial in understanding how profits from investments are allocated. Typically, the waterfall structure delineates the order in which profits are distributed, usually prioritizing limited partners (investors) before the general partners (managers) receive their share.

In practice, this means that investors will first recoup their initial investment and, in many cases, also receive a preferred return before any proceeds are shared with the managers of the fund. This tiered approach often includes various hurdles or benchmarks that must be met before additional returns are distributed, which ensures that all parties have aligned interests.

Understanding the fundraising waterfall is vital for both investors and fund managers as it impacts investment strategies, decision-making, and the overall attractiveness of the investment opportunity. This is why the correct answer highlights its function as a distribution mechanism for investment returns rather than focusing on areas like financial portfolios, investor engagement methods, or pricing strategies for funds.