Carried Interest Overview
As discussed in my prior post on management fee, the long-standing fee model for private equity funds has been a “2 and 20” model, referring to a 2% management fee and a 20% carried interest. But what is this “carried interest?”
Carried interest, also known as “carry,” “profit participation,” “promote” or the "distribution waterfall," is the share of the fund’s profit the fund’s manager (also known as “general partner” or “GP”) earns if the fund returns a profit to the fund’s investors (also known as “limited partners” or “LPs”). See my prior post "LP Corner: US Private Equity Fund Structure - The Limited Partnership" for more detailed descriptions of LPs and the GP.
When a private equity fund calls capital from its LP investors (this is known as “paid-in-capital’ or “called capital” - see my prior post "LP Corner: On Committed Capital, Called Capital and Uncalled Capital" for further discussion of this topic), the GP manager of the fund will use that capital to make investments and to pay for fund expenses, such as management fee. When the investments are realized, the amount in excess of the original investment amount is profit.
The Two types of Carry: Whole Fund and Deal-by-Deal
There are two main types of carry: whole fund carry and deal-by-deal carry.
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