What Is Carried interest?
In quantitative finance, carried interest refers to a share of profits or investment gains that are allocated to investment managers or general partners in certain types of investment funds, particularly private equity funds, venture capital funds, and sometimes hedge funds. It represents a portion of the fund’s profits that the manager or general partner is entitled to receive as compensation.
Carried interest is typically structured as a profit-sharing arrangement. It is distributed to the investment manager or general partner after the fund’s investors, also known as limited partners, have received a predetermined return on their investments, often referred to as the hurdle rate or preferred return. The manager or general partner receives a share of any profits above this hurdle rate, usually a percentage ranging from 10% to 30%.
The term “carried interest” derives from the concept that the investment manager or general partner carries an interest in the fund’s profits, in addition to their capital investment. The carried interest serves as an incentive for the manager to maximize the fund’s performance and generate strong investment returns, as their compensation is directly tied to the success of the investments.
Because carried interest is not exited or liquidated, it is more tax efficient there are no capital gains for holding.