The formulas, tricks and trade secrets of Private Equity

Carried Interest Private Equity

Sample Chapter

In a previous post I talked about the fee structure of the typical private equity fund and in particular the 20% outperformance fee (also known as carried interest or carry). Well, people are drawn to working for private equity firms because of the carry, don’t let anyone tell you otherwise. However, it’s not as simple as just receiving 20% of cash outperformance; often, people who may not even work for the firm have a financial interest in the carry. This can come as a disturbing realisation for fledgling private equiteers, so I thought I’d explain it here.

The following list outlines the people and/or companies that often have a stake in the carry:

  1. The private equity team, which includes the founders, directors, associates and analysts (sometimes).
  2. Previous founders, who aren’t active in the firm anymore, but who struck profit sharing agreements.
  3. Previous team members, who keep the stake of carry that they accrued while employed (sometimes).
  4. Overarching parents (banks, etc), which may have a stake in the carry if the fund is captive.
  5. Early investors, which may have a stake for helping to establish the fund from a funding perspective.
  6. Legacy partners, which may be entitled to a stake as the result of the fund being spun out of them.

As you can see, the 20% carry can dwindle away quite quickly, depending on circumstances. Captive funds usually have it the hardest because they’re investing from the parent’s balance sheet and have no choice but to satiate their every desire.

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