Carried interest

Carried interest is the contingent half of a manager's economics and the reason people stay in the industry. It is conventionally a fifth of the fund's profits, and the word profits is doing real work: carry is calculated above returned capital and the preferred return, never on gross proceeds.

It is paid through the distribution waterfall, which runs in four stages. Return of all contributed capital, including the part drawn to pay fees. Then the preferred return on that capital. Then a catch up, bringing the manager up to its full percentage of everything distributed above capital, since it received nothing in the first two stages. Then the remainder splits, conventionally eighty to investors and twenty to the manager.

European and American practice differ here in a way worth knowing. European funds overwhelmingly use a whole fund waterfall: nothing is paid as carry until the entire fund has returned all capital plus the preferred return, so early winners must cover later losers first. The American convention has historically been deal by deal, paying carry on each realisation with a clawback and often an escrow if the fund ends short. The eventual arithmetic can match; the manager's timing and the amount of trust the structure requires do not.

The consequence for an individual is the part candidates miss. Carry is allocated to people as a share of the fund's carry pool, vests over years, and arrives only when the fund pays it. One excellent deal inside a fund with two failures can produce nothing at all for the person who did it, which is why a strong deal level IRR is necessary for a good personal outcome and nowhere near sufficient.