In venture capital (VC), carried interest (often referred to as “carry”) is the share of profits that General Partners (GPs) or Fund Leads earn from a fund’s investment gains. It’s an essential part of the compensation for GPs, as it incentivizes them to maximize returns for the fund’s limited partners (LPs).
What is Carried Interest?
Carried interest represents a percentage of the fund’s profits that the General Partner receives once the initial investment (the capital invested by the LPs) has been returned. It’s typically structured as a performance fee, meaning the GP only earns carry if the fund performs well.
A 1x Multiple
The “1x multiple” is a common hurdle or benchmark in VC funds. It means that the fund must return at least the original capital invested by LPs before the GP earns any carried interest. Once this threshold is met, the GP is entitled to a percentage of the profits, usually around 20%.
Simple Example of Carried Interest Calculation
Let’s break it down with an example. Assume the following:
- A GP’s fund raised $10 million.
- The GP charges a 20% carry.
- The fund returns $20 million (2x the original investment).
Here’s how the carried interest would work:
1. Initial Investment Return (1x Multiple):
The LPs must first receive their original $10 million investment back.
2. Profit:
The fund returns $20 million, so the total profit is:
$20,000,000 - $10,000,000 = $10,000,000
3. Carried Interest (20%):
The GP is entitled to 20% of the $10 million profit:
$10,000,000 x 20% = $2,000,000
Thus, the GP would earn $2 million in carried interest, and the LPs would receive the remaining $8 million in profits.
Key Takeaways:
- Carried interest is a percentage of the profits, typically 20%.
- GPs only earn carry after the LPs have received their initial investment back (the 1x multiple).
- Carried interest aligns the interests of the GP and LPs, encouraging GPs to maximize the fund’s returns.