Fund Mechanicscarried-interest

Carried Interest (Carry)

Also known as Carry, Carried Interest, Performance Fee, Incentive Allocation

Mikael Andersson
Mikael Andersson
VC Analyst · Updated

Carried interest is the GP's share of fund profits, typically 20%, paid only after LPs receive back their contributed capital plus a preferred return. Carry is the GP's primary compensation and the reason venture is a performance-driven business.

Formula

GP Carry = Carry Rate × (Distributions - Return of Capital - Preferred Return)
Carry Rate
Negotiated GP profit share, typically 20%
Distributions
Cash and securities paid out by the fund
Return of Capital
Total LP capital contributions through capital calls
Preferred Return
Hurdle paid to LPs before GP carry begins, typically 8% IRR

In depth

Carry is computed inside the waterfall, not as a flat percentage of distributions. The order matters. First, returned capital pays LPs back dollar for dollar. Second, the preferred return pays LPs an annualized hurdle (8% is standard) on contributed capital. Third, in funds with a GP catch-up, the GP receives 100% of the next distributions until it has collected its agreed share of profits to date. Fourth, remaining proceeds split 80/20 in favor of LPs.

The carry rate is one number; the structure that produces it has many levers. Hurdle compounding, whether the catch-up is full or partial, deal-by-deal versus whole-of-fund timing, interim clawback testing, and the GP commitment percentage all change the dollar amount of carry on the same fund-level multiple. LPs negotiate the structure as hard as the rate.

Why it matters

Carry is what makes the GP look like an LP economically. A 2.5x fund creates a GP carry payout that can be 10 to 20 times the GP's own capital commitment, which is the asymmetry that aligns the GP with outsized fund outcomes. The flip side is that on a 1.0x fund the GP earns zero carry and lives on fees alone, which is why second-fundraises depend on Fund I winners.

Worked example

$100M fund, 20% carry, 8% hurdle, full GP catch-up, whole-of-fund waterfall. Fund returns $250M after 10 years.

StepLP receivesGP receivesRunning total to LP
1. Return of capital$100M$0$100M
2. 8% preferred return (cum.)$116M$0$216M
3. GP catch-up (to 20% of profit)$0$29M$216M
4. 80/20 split of remainder ($5M)$4M$1M$220M

Total profit was $250M − $100M = $150M. The GP collects $30M (20% of $150M). LPs collect $220M (return of capital plus 80% of profit). On a deal-by-deal waterfall with no interim clawback, the GP could have started receiving carry from the first profitable exit, exposing LPs to clawback risk if later deals soured.

Frequently asked

What's a typical carry rate in venture?

20% is the long-standing standard, applied by roughly 71% of funds. Top-decile firms sometimes negotiate 25% or 30% on premium funds. Emerging managers occasionally offer 15% on early funds to win first LPs.

How is carry different from a management fee?

Management fees are paid annually regardless of performance, calculated as a percentage of committed or invested capital. Carry is a profit share paid only after LPs earn back their capital plus the hurdle. Fees fund operations; carry is the wealth event.

When does carry actually get paid?

On a whole-of-fund (European) waterfall, the GP receives no carry until LPs have been returned 100% of committed capital plus the 8% preferred return. On a deal-by-deal (American) waterfall, carry can flow on each profitable exit, subject to clawback if later deals lose money.

Is carried interest taxed as capital gains?

In the US, yes, when the underlying gain is long-term. The Tax Cuts and Jobs Act extended the holding period requirement to three years for carry to qualify as long-term capital gains. Periodic legislative proposals to tax carry as ordinary income have not passed at the federal level.

What is a GP clawback?

If a GP collects carry early under a deal-by-deal waterfall and later deals lose money such that the GP received more than its agreed share over the fund's life, the GP must return the excess. ILPA recommends interim clawback testing and full GP clawback protection.

Sources & further reading