What is carried interest? How fund managers share in profits
By Unlearnt
Carried interest, often just ‘carry', is the share of an investment fund's profits paid to the people who manage it. In private equity and venture capital it is commonly around 20% of the gains, and it sits on top of a separate management fee. The point is to tie most of the managers' reward to how the investments actually perform.
A share of the profit, not a fee on the fund
A fund usually charges two things. A management fee, often around 2% of committed capital a year, is paid regardless of performance and covers running the firm. Carried interest is different: it is a percentage of the profit the fund makes, so the managers earn it only if the investments gain value.
This is the ‘2 and 20' shorthand: roughly a 2% fee and 20% carry. The fee keeps the lights on; the carry is meant to align the managers, the general partner or GP, with the investors, the limited partners or LPs, because most of their upside comes only when the LPs profit.
A worked example: 20% of the gain
Suppose investors commit £100m and the fund later exits its investments for £150m. These figures are illustrative. First the £100m of capital is returned to the investors, leaving £50m of profit.
The £50m profit is then split. With 20% carried interest, £10m goes to the managers and £40m to the investors. So on a £50m gain the carry is £10m, earned only because the fund made a profit above the capital returned.
£150m exit: capital back first, then an 80/20 split of profit.
£50m profit, split
The hurdle and the catch-up
Most funds add a preferred return, or hurdle, before any carry is paid, often around 8% a year to the investors. Below that return the managers receive no carry. Above it, a catch-up provision lets the managers take a larger share of the next profits until the overall split reaches the agreed ratio, such as 80/20.
The exact order and terms vary by fund and are set in its agreement. The important idea is that carry is calculated after the investors get their capital back, and usually a minimum return, not on the first pound of proceeds.
Misconception: carry is a fee on the whole fund
Carried interest applies to profit, not to the whole fund. If a fund returns less than the capital invested, there is normally no carry at all, and clawback terms can require managers to return carry taken early if later results disappoint. That is the opposite of a fixed fee.
Its tax treatment is debated. In several countries carried interest has often been taxed as a capital gain rather than ordinary income, which critics argue understates what is effectively a reward for managing other people's money. Rules differ by jurisdiction and change over time.
Check your understanding
Optional: apply the idea to a new scenario.
A fund draws £100m from investors and later exits for £180m, with no fees in this simplified example and 20% carried interest above the return of capital. How is the £80m profit split between investors and managers, and what happens to the managers' carry if the fund had instead exited at £90m?
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