Carried Interest
Carried interest is the share of investment profits — typically 20% — that a private equity or hedge fund general partner receives as compensation, distinct from the management fee charged on assets under management.
Carried interest, often called the carry, aligns the general partner's financial interests with those of the limited partners who provide the capital. Rather than receiving a fixed salary, the GP earns a meaningful portion of the upside only if the fund generates returns above a defined threshold. This structure incentivizes managers to focus on long-term value creation rather than asset gathering.
In private equity, carry is typically earned only after the fund returns all invested capital to LPs plus a preferred return, commonly set at 8% per year — the hurdle rate. Once the hurdle is cleared, the GP receives 20% of profits, though some funds use a catch-up provision allowing the GP to receive a disproportionate share of returns until it has earned 20% of total profits, not just the profits above the hurdle.
Carried interest is taxed in the United States as long-term capital gain rather than ordinary income, provided the holding period of the underlying investments exceeds three years under current law. This favorable tax treatment has been a persistent subject of legislative debate, with critics arguing that compensation for managing other people's money should be taxed as ordinary income regardless of how it is structured. Proponents contend that carry represents a risk-bearing co-investment alongside LPs and therefore deserves capital gains treatment.
The 20% carry percentage is standard but not universal. Top-tier buyout and venture funds with strong track records sometimes negotiate 25% or 30% carry, reflecting their bargaining power. Emerging managers may accept 15% to attract their first institutional LPs. Understanding the carry structure is essential when evaluating the economics of an alternative investment fund.