Carried interest
What is Carried interest?
Carried interest is a contractual share of private-fund profits allocated to the manager or general partner after applying the fund's distribution waterfall.
Carry models should reproduce the governing waterfall using actual dated contributions, distributions, realized proceeds, NAV, fees, preferred return, catch-up, escrow, and clawback. A headline percentage is insufficient. Investor-specific side letters, parallel vehicles, currency, and tax can create different economic results.
Interim accrual is not final entitlement when later losses, clawback, tax, or escrow can reverse the amount.
Reporting should separate accounting accrual, allocated carry, cash paid, escrowed amount, potential clawback, and final entitlement.
Economic purpose
Carry rewards investment performance and can align the manager with investors, but creates asymmetric incentives if the manager receives gains without equivalent loss. The common headline percentage does not describe the full arrangement. Preferred return, catch-up, fee base, GP commitment, realization, escrow, clawback, and tax all affect economics.
Waterfall structures
A whole-fund or European waterfall generally returns capital and required preference across the fund before carry. A deal-by-deal or American waterfall can pay carry after individual realizations while other investments remain unrealized. Hybrids exist. The distribution sequence and allocation base must be modeled from documents, not inferred from regional labels.
Preferred return and catch-up
A preferred return may accrue before carry, using simple or compound calculations and specific contribution and distribution dates. A catch-up can then allocate a large share of subsequent proceeds to the GP until the agreed profit split is reached. A preferred return is a threshold in the waterfall, not a guaranteed investor return.
Clawback and escrow
Early carry can exceed final entitlement if later deals lose money. Clawback requires recipients to return excess, often after tax and subject to guarantees, caps, and timing. Escrow withholds part of distributions to support repayment. Creditworthiness and enforceability matter because a contractual claim may be difficult to collect years later.
Practical review
Rebuild scenarios for gains, losses, timing, recycling, write-offs, partial exits, expenses, taxes, and termination. Identify recipients, vesting, escrow, guarantees, netting, and final test. Reconcile accrued and paid carry each period. Compare gross and net returns and avoid describing carry as due solely from positive NAV before the contractual waterfall is satisfied.
Also known as: carry
Sources and further reading
- ILPA Principles 3.0, Institutional Limited Partners Association
- Investments in Private Capital: Equity and Debt, CFA Institute