September 12, 2023

Carried Interest (Carry)

Carried Interest (Carry) Meaning

Carried interest (or carry) refers to profits earned by the general partners in private equity, hedge funds and venture capital. It is provided to general partners for their role and not due to their investment in the fund.

Carried interest is a performance-based incentive and aligns with the fund’s returns. It is the main source of the general partner’s compensation and usually amounts to about 20 percent of profits. That way, the general partner has a vested interest in maximizing returns.

Carried interest is usually applied to the whole fund’s overall returns (called a European waterfall) but may also be done deal-by-deal (called American waterfall).

To better understand how carried interest is calculated, suppose investors (also known as limited partners) and general partners contributed $2 billion to a private equity fund. Say investors provided $1.9 billion and the general partners $100 million.

At the end of five years, the fund exited all investments and received a total of $5 billion. Investors would first receive $2 billion which is the contributed capital returned. The balance of $3 billion would be split in an 80:20 ratio between investors and general partners. Investors would get $2.4 billion and the general partners $600 million.

The carried interest is only paid out if the fund realizes a minimum level of return referred to as the hurdle rate. So if the fund was aiming for 7 percent but only realized a 5 percent return for a period, fund investors may ‘claw back’ some of the carried interest in order to cover the performance shortfall.

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