The Private Equity Professional Guide to Carried Interest
Carried Interest or simply carry is incentive compensation provided to private equity fund managers to align their interests with the fund capital-providing investors.
山西为什么叫晋Basically,carry is a percentage of a fund profits that fund managers get to keep on top of their management fees,and is a significant component of private equity compensation.Carry typically averages about20%of the fund profits and ranges from as high as50%in exceptional cas to as low as in the single digits.With the proliferation of private equity funds, there is increasing downward pressure on carry as fund managers compete with each other to attract investor capital.
Private Equity Structure
Figure1:Private Equity Structure
The investment team consists of Individual Fund Managers who come together to form a General Partner entity(the private equity firm)under which they rai capital for a Fund,and identify and manage investments in Portfolio Companies.The General Partner typically invests anywhere from1%to3%of the total fund.The rest of the money comes from outside investors wealthy individuals,trusts,pension funds,ast management companies,etc.each of which is a Limited Partner in the fund,with its share proportional to its capital contribution.Some private equity firms also have institutional sponsors or are captive units or spinoffs of other companies.
皇太极是谁Carried Interest Factors
Carried interest is the share of a fund net profits allocated to the General Partner.It refers to the General Partner being carried by investors becau it receives a share in profits disproportionate to its capital commitment to the fund.橄榄菜怎么吃
Fund managers receive carry and a management fee,which industry executives feel is justified becau each investment requires a lot of work to generate a profit.Fund managers do a lot of due-diligence before making an investment becau they invest massive chunks of capital, typically to ac
quire majority ownership.Thereafter,fund managers are heavily involved in strategy,business development,financial management and restructuring,and operational details.They work to turn a company back to profitability,to restructure it to generate higher returns,or to unlock hidden value all the way through a liquidity event (an acquisition,an IPO,or a recapitalization).
Carry is typically vested over anywhere from1year(in very rare cas) to6years(on the high side),with three to four years being the average. Fortunately for investors,a higher title within the firm does not result in a shorter vesting period.Investors prefer multi-year vesting periods to keep fund managers focud on long term profitability.
Equity-Bad Carry
Equity-bad carry is the traditional concept of carry from the time private equity firms came into being.Interest in a fund is allocated as shares bad on each Limited Partner capital contribution,with a certain
percentage of the shares(typically20%)allocated to the General Partner as carry.Carry shares usually have a multi-year vesting period that tracks investments made.Equity carry is typically split between nior executives at the private equity firm.Keep in mind there are many flavors of carried i
nterest so doing an apples to apples comparison of two different carry packages is difficult.
Hurdle Rates
Typically,the General Partner only receives carry when the fund generates profits above a certain hurdle rate.Think of the hurdle rate as a specific internal rate of return(IRR)an annualized,compounded return rate that Limited Partners must get before the General Partner gets carried interest profits.
Simplistically,a Limited Partner could invest in,say,an equity index that generates a6%annual return.By investing in a private equity fund, Limited Partners take on higher-than-market risk and want a minimum rate of return(hurdle rate)before sharing profits with the General Partner.
Assume a fund with a10%hurdle rate and a20%carry.When the fund makes a profit,it is first allocated so each Limited Partner receives its cumulative IRR of10%on contributed and unreturned capital.Next, 80%of all remaining profit is allocated to partners(proportional to their respective capital commitments)and20%is allocated to the General Partner.The General Partner typically has a100%atch-up allocation on carried interest.
口干舌燥是什么原因引起的Floors
Some funds are structured with a loor where carried interest is only allocated on investments where net profits exceed the hurdle rate.There is no General Partner atch-up provision,and this approach,not surprisingly,is strongly resisted by General Partners.
皮黄腔Who Keeps Carry?
In reality,very few private equity teams get full dibs on their carry. Retired partners often get a share of carry for a certain period after they retire as part of a buyout of their equity in the firm.Private equity firms that are either spun out,have minority shareholders,or are owned by a parent company,often pay a significant chunk(10%to50%)of carry to their old or existing owners.
Escrow and Claw-Back恰到好处
Many investors demand escrow and law-back arrangements so early over-payments can be returned if the fund underperforms as a whole. Practically speaking,though,claw-backs are difficult to enforce, especially if carry recipients have either left the firm or suffered major financial tbacks such as investing their carry in shares that subquently collapd or using carry to pay off a divorce ttlement.
中国少先队Carry Structures from Around the World
According ,on average,Limited Partners are more generous in the U.S.,where returns are often also more outsized than in other countries.In the U.S.,it is common to e carry on a deal-by-deal basis with escrow and claw-back provisions.
Europe typically follows a whole-of-fund approach where managing partners get their share of the profits only after investors have been paid capital and returns on drawn-down capital.Some European investors disallow carry for the term of the fund,which is typically5years. Private equity in Australia is dominated by a handful of limited partners who tend to push for conrvative carry terms,similar to the European model.In Australia,typically,only funds with a well-established history of consistent and profitable performance are in a position to negotiate favorable carry terms.
Accounting for Carry
Private equity firms u different accounting approaches for carry.Some account for carry on an accruals basis–as investment returns are realized and portfolio valuations are periodically adjusted,carried
interest accruals are adjusted.Some u the cash basis to record carry as it is paid and received.Still others u option valuation techniques to determine carry at the beginning of a new investment.
The Many Flavors of Carry
Private equity firms with a solid track record can negotiate carry,fees, and payout arrangements that are favorable to the General Partner. Newer firms are at a slight disadvantage when negotiating compensation. As a result,management fees,carry,payment approaches,and profit calculation formulas are negotiated terms that vary from firm to firm. As a result,there are many different carry structures of varying complexity.For example,some private equity firms determine carry on a deal-by-deal basis while others spread it across all the firm investments. Sometimes,carry is granted up-front for the life of the fund,other times it is granted annually.Formulas also vary on how carry might be forfeited for tho who leave the firm.
Whole-of-Fund Carry
With whole-of-fund carry,the General Partner can only withdraw carry after achieving a hurdle rate on the entire capital invested and after Limited Partners have received their capital and returns.Esntially, Limited Partners have a preferred right to returns.This structure protects investors against early payments of carry on funds that ultimately do not perform to agreed hurdle rates.It also benefits fund managers by lowering tax rates on carry.
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Certain countries,such as the U.K.,allow a ba cost shift tied to inflation that increa the cost of the ast each year and reduces ba cost and tax on carry held for longer periods,as typically happens with
whole-of-fund.This does not apply for the U.S.where there is no inflation-related increa in ba cost.
Investments at a private equity firm are typically made by a small team of managing partners.One executive investments may do really well, while another may lag.Whole-of-fund only rewards collective success;it does not reward individual performance.Therefore,managing partners must be very comfortable with shared risk and rewards when they
