Carried interest (or 'carry') is the share of a fund's profits that the general partner receives as performance compensation, typically 20% of net profits above a preferred return (hurdle rate). Carried interest aligns GP and LP interests by ensuring the manager is rewarded for generating positive investment returns rather than simply collecting management fees.
The mechanics of carried interest depend on the fund's distribution waterfall. In a European (whole-fund) waterfall, carry is not paid until the GP has returned all contributed capital plus the preferred return (typically 8%) to LPs. In an American (deal-by-deal) waterfall, carry can be distributed after each individual investment is realized, subject to a clawback provision that protects LPs if later investments underperform.
Carried interest is a critical component of GP economics and directly relevant to GP stakes valuation. When a buyer acquires a minority stake in a GP, they are purchasing a share of both the management fee stream and the carried interest from current and future funds. The embedded carry from existing funds (often called 'accrued carry') and the expected carry from future fund raises are major drivers of GP stakes transaction pricing.
The standard 20% carried interest has come under pressure from large institutional LPs who negotiate reduced carry rates, co-investment rights with no carry, and longer lock-up periods before carry vests. Emerging managers may offer more favorable carry terms to attract anchor investors. Our database tracks carry structures across the GP universe to identify trends.
Tax treatment of carried interest remains a significant policy debate. In the US, carried interest has historically been taxed as long-term capital gains (currently 20%) rather than ordinary income (up to 37%), provided investments are held for at least 3 years. Various legislative proposals have sought to change this treatment. The tax status of carry directly affects GP economics and, by extension, GP stakes valuations.
Understanding carry economics is essential for evaluating GP quality. A GP with multiple generations of carry-generating funds has a more valuable and diversified revenue stream than a first-time manager. Our platform provides visibility into fund count, vintage distribution, and performance metrics that help estimate carry potential across the GP universe.