Definition
What is Carried Interest?
The General Partner's share of fund profits above a hurdle rate — typically 20% — that aligns the manager's incentives with the limited partners'.
Carried interest ("carry") is the General Partner's percentage share of fund profits that exceeds a specified hurdle rate. It is the second leg of the "2 and 20" private-capital industry standard fee structure: 2% annual management fee plus 20% carried interest.
Mechanics: 1. Limited Partners commit capital and pay management fees during the investment period. 2. Fund returns capital to LPs first (return of contributed capital). 3. Fund returns the preferred return ("hurdle rate") to LPs — typically 8% per annum, compounded. 4. After the hurdle is met, the GP receives a catch-up — typically 100% of further profits until the GP has received an aggregate of 20% of all profits above the original LP capital. 5. Beyond the catch-up, all profits split 80% LP / 20% GP.
The 20% to the GP is the "carried interest" — the manager's share of value created above the hurdle.
Why the structure exists: carried interest aligns the manager's incentives with the LPs. The manager earns its base fees regardless of performance but only earns carry if the fund generates returns above the hurdle. Strong performance is materially compensated; weak performance leaves the manager on base fees only.
Standard variations: - Whole-fund carry — the manager earns carry only on the fund's total realised gain above the hurdle. Most NZ PE/VC funds use this structure. - Deal-by-deal carry — the manager earns carry on each successful deal individually. Common in US venture funds but rare in NZ. - European waterfall (whole-fund) vs American waterfall (deal-by-deal) — terminology overlaps with the above distinction.
Tax treatment in NZ: the GP's carried interest is taxable income to the GP entity at the corporate rate (28%) or flows through to GP principals at their marginal rate, depending on the GP's structure. It is not a capital gain.
Clawback provisions: sophisticated LP agreements include "clawback" clauses requiring the GP to return previously-distributed carry if later losses bring the total fund performance below the hurdle. Without clawback, GPs could collect carry on early wins and walk away if later losses cancel them out.
Related Terms
GP / LP Structure
The General Partner / Limited Partner structure used in NZ Limited Partnerships, where the GP manages and bears unlimited liability while LPs are passive with capped liability.
Limited Partnership (LP)
A fund structure where investors are limited partners with flow-through taxation and liability limited to their investment.
Private Equity (PE)
Investment in established private companies through buyouts, growth capital, or restructuring.
Venture Capital (VC)
Investment in early-stage, high-growth companies in exchange for equity, targeting significant returns.
Educational Content Disclaimer
This glossary provides general educational information only and does not constitute financial, legal, or tax advice. Definitions and explanations are simplified for educational purposes and may not cover all aspects or nuances of each term.
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