Carried Interest
Carry is not just 20% of profits. It is mathematically gated behind hurdle rates and catch-up provisions.
The 80/20 Baseline
Standard venture capital funds charge "2-and-20"—2% management fees and 20% carried interest (carry). Carry represents the General Partner's (GP's) share of the fund's profits. However, they don't get a dime of carry until they return capital to the Limited Partners (LPs).
The Hurdle Rate
Many institutional LPs require a "preferred return" or "hurdle rate" (often 8% annualized) before the GP can start collecting carry. This means the fund must return the principal plus an 8% compounding return to LPs before the GP shares in the upside.
The 100% GP Catch-Up
Once the hurdle is cleared, standard LPAs include a "GP Catch-up" tier. In this tier, 100% of the next dollars of profit go entirely to the GP until the GP has received 20% of all profits distributed to date. After the catch-up is fully funded, profits are split 80/20.
| Tier | Description | LP Share | GP Share |
|---|---|---|---|
| 1. Principal | Return of 100% committed capital | 100% | 0% |
| 2. Hurdle | Preferred return (e.g., 8%) | 100% | 0% |
| 3. Catch-up | GP gets paid until they hit 20% of total profit | 0% | 100% |
| 4. 80/20 Split | All remaining upside | 80% | 20% |
Deal-by-Deal vs. Whole Fund (American vs. European)
In an American Waterfall, carry is calculated deal-by-deal. If the GP's first investment returns 10x, they take 20% of that profit immediately, even if the rest of the fund hasn't exited. If the rest of the fund goes to zero, the GP might be subject to a "clawback".
In a European Waterfall, carry is calculated on the whole fund. The GP must return all drawn capital for the entire fund before taking a single dollar of carry on any exit.