Is PE worth it? Can someone explain how carry works (BPS, etc)

I tried googling carry and how its calculated but I am still a bit confused. I understand that carry depends on the size of the fund, along with how well the invested company has generated returns over the projected period. But is there a common carry rate that is used among the UMM firms? Also, what is BPS and why is it mostly set at 25?


Sorry for the very nooby question, I am contemplating if I want to do IB or PE long term. With all of the raises IBs are seeing, I don't know if carry is worth it in the long term. For example, I would be giving up on an associates pay at an IB (along with any A2A sign on bonuses) just to be "demoted" to an analyst at a PE firm. I understand this is where carry comes into, but how exactly does it work and how long would it take for me to receive this carry on average?

 
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Best case scenario is you go to a megafund that runs a shadow carry program for mid-level people. You won't get allocated anything until you are 3-4 years in, and you won't see cash for 2-3 years after that. If you are getting real carry the likelihood is that it won't get allocated until the later of (i) 3-4 years experience and (ii) a major fundraise. That carry won't turn into cash until the fund has had sufficient realisations to pay off the pref (if there is one) and start paying carry - this is likely to be 5-7 years. Tax treatment much more attractive on the latter in the US.

You can get very rich in PE but this is a 10-15 year project. If you have a short time horizon better to play for one-year options in IB or HF land.

Carry Workings

GP usually entitled to 20% of profit in excess of an 8% return. Often there is partial or full catch-up, i.e. the GP gets a greater share of CFs once the 8% preferred LP return hurdle is reached to "catch up" to 20% of ALL profit (not just the profit over 8%). Usually you need 200-300 bps of gross IRR over 8% to get through the catch-up, so as long as the fund is generating >12% gross you can ignore the pref.

Let's say it's a $20 bn megafund and it generates a 2x MOIC. That's $10 bn of profit and $2 bn of carry. One basis point (1 bps) of that is $200k, to be collected over the fund's realisation period (years 7-10 post raising). The allocation of the points will vary hugely between firms and also depends whether the GP is listed or not. It's not uncommon for mid/senior level partners to have 100+ bps, so they could make double digit millions off each fund if things go well.

 

I can only speak for the program I used to be in (MF, private partnership). The way that worked was that there were shadow carry bps which tracked the GP's carry entitlement on a realised and unrealised basis. The accrued balance on your capital account was cashed out every few years. This was paid as ordinary income (i.e. no tax benefit from carried interest treatment). I have no idea whether this structure is common in the market.

When I worked at a listed MF before that (albeit in a credit arm), we initially got RSUs for GP stock and they later introduced a 'mystery meat' structure that purported to track carry generation across the firm's many fund franchises. I left before that ever produced any cash.

 

I think the above is really best case. A more likely case is a MM fund following 2 years IB,  2 years Associate, 2 years Sr. Associate before you make VP and are allocated carry. From there I would plan on a solid 7 years before you see a realization (assuming the fund performs and is a european waterfall structure - you may see some before that if exits are good but it will be subject to a clawback) so figure 12-14 years into your career. That said I've seen associates make big money early in just the right situation so it does vary. 

 

Another important point - depending on the structure, the amount of allocable carry varies. For example, in my Fund, the GP (one man) kept 80% of all carry in our first fund, while distributing the remaining 20% to select employees. Over time we anticipate that % to ratchet down, giving the rest of the carry holders more long-term incentive to stay.

 

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