Angel Investors Network
    Glossary

    Carried Interest

    The share of profits, typically 20%, that fund managers receive as compensation after returning the invested capital and preferred return to limited partners.

    Carried interest is the performance-based compensation that general partners and fund managers earn from the profits of their investment fund, typically set at 20% of gains after returning the initial capital and any preferred return to limited partners. This arrangement aligns the interests of fund managers with investors by ensuring managers only profit when their investment decisions generate substantial returns.

    Why It Matters

    Carried interest represents the primary incentive structure in private equity, venture capital, and hedge funds. For angel investors considering joining organized funds or syndicates, understanding carry helps evaluate whether the fee structure justifies the potential returns. A standard "2 and 20" model—2% annual management fees plus 20% carried interest—means fund managers must clear a hurdle rate (typically 8% annually) before collecting their performance share. This hurdle protects investors from paying performance fees on mediocre results.

    Example

    Consider a $10 million early-stage venture fund with a standard carry structure. The fund raises capital from limited partners and charges 2% annual management fees plus 20% carried interest above an 8% hurdle rate. After five years, the fund's portfolio exits total $25 million. First, the LPs receive their $10 million initial investment back. Next, they receive their 8% annual preferred return (approximately $4.7 million compounded). The remaining profit of $10.3 million is split: LPs receive 80% ($8.24 million) while the fund managers receive 20% carried interest ($2.06 million). Without carried interest, managers would only earn their management fees of approximately $1 million over five years—the carry multiplies their compensation when performance is strong.

    Understanding carried interest requires familiarity with Hurdle Rate, the minimum return threshold LPs must receive before managers collect carry. The structure also connects to General Partner, the fund managers who earn carried interest, and Limited Partner, the investors who provide capital and receive returns before carry is calculated.