What Is Carried Interest?
Carried interest, or simply carry, is the general partner's share of the profits generated by a private equity, venture capital, or hedge fund. The industry standard is 20% of profits, which sits alongside the management fee in the classic 2-and-20 compensation model. While the management fee keeps the lights on, carry is the real prize that aligns the fund manager with investor returns.
In most private funds, carry is only earned after limited partners have received back all of their invested capital plus a preferred return, known as the hurdle rate, commonly 8% per year. The order in which exit proceeds flow to LPs and the GP is spelled out in the fund's distribution waterfall.
Carry Math and the Waterfall
A typical waterfall works in steps: first LPs get their capital back, then LPs receive the preferred return, then the GP often receives a catch-up so that profits are split as if the hurdle did not exist, and finally remaining profits are split 80/20 between LPs and the GP. Some funds calculate carry deal by deal (American waterfall), while others calculate it on the whole fund (European waterfall), which is more LP-friendly.
Many funds also include a clawback provision requiring the GP to return carry if early wins are followed by later losses, so that the 20% is ultimately measured against the fund's total performance.
Example
Take a $1 billion fund that doubles, returning $2 billion. The $1 billion of profit is split 80/20, so limited partners receive $1.8 billion in total and the general partner earns $200 million of carried interest. That carry pool is divided among the firm's partners and investment professionals, which is why carry allocations are a central part of buy-side compensation negotiations.
If the same fund instead returned only $1.05 billion against an 8% hurdle, the GP would earn no carry at all, since profits never cleared the preferred return owed to LPs.
Why It Matters
Carried interest is the engine of wealth creation in private markets and the reason fund economics scale so dramatically with performance. It is also politically controversial because in the United States carry has generally been taxed as capital gains rather than ordinary income, a treatment critics call the carried interest loophole.
In private equity interviews, being able to walk through a 2-and-20 structure, an 8% hurdle, and a simple carry calculation on a fund that doubles is a common and very passable test of whether you understand how the business actually makes money.
