What is Carried Interest in Venture Capital?
And Why is this Important for Investors To Know.
What is carried interest and why does it matter for investors?
What is carried interest and why does it matter for investors? We took a definition from the tax policy center, so that's where this resource is from:
Carried interest is a right that entitles the general partner or GP of a private investment to a share of the fund's profits.
Typically, for a private equity or hedge fund, GP is itself a partnership that is owned by investment managers and usually contributes between 1 to 5 percent of the fund's initial capital and commits to managing the funds assets. What happens after? In exchange, the GP or the general partner receives an annual management fee which is roughly 2 percent, which is the most typical percentage of fee plus a carried interest of 20 percent of the fund's profits that exceed a certain hurdle rate of return.
Once you exceed a certain hurdle rate of return, the general partners of that fund make money. It incentivizes both sides. There is a small management fee, but then what's called a hurdle is surpassed and then once you go past that then you have a carried interest. Carried interest is the difference there between what passed the hurdle rate to that return. Let's say you invested $10 million into a startup and then that turns into being worth $100 million. What's the difference if there is a hurdle rate set in the purchase screening or the fund operating documents? Once you go past that, that $90 million is then multiplied 20 percent for the general partners and then the 80 percent typically goes back to the limited partners.
There is a lot more material on venture capital and how to invest in America's top startups in our course so make sure to sign up today. I absolutely recommend you check that out and look forward to working with you. Good luck.