When Carry Actually Gets Paid!
When does carry actually get paid out in cash? Are there two main timeframes: a. when a portfolio company is sold and meets carry hurdle or b. when all investor capital has been returned and the carry hurdle is met? Hypothetical situations for more color: In timeframe a. in year 1 we invest 40M in a new portco 1, in year 2 we sell it for 80M. When new portco 1 is paid, does carry get paid?
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From what I understand carry is generally paid when the fund is realized, not just when the investment is. Could vary depending on fund structure e.g. if you're a traditional GP/LP fund vs an independent sponsor setting up separate SPVs for each investment on a deal-by-deal basis.
Depends on if the fund uses an American or European waterfall. You should also review the clawback provisions in the LPA.
Right, in the American structure, you get carry as you exit each company and return LP capital, correct? In European, you don't start getting carry until fund returns all investor capital, correct? For claw back provisions, only nuance I was thinking about is if in an American waterfall, our firm gets carry paid out after an exit, but I am not fully vested, would I get a payout that would be as if I was 100% vested and If I left before I actually was 100% vested, I would have to pay that carry back? Additionally, if at the end of returning all investor capital, if we didn't hit the hurdle, LPs would clawback carry from the fund until they hit their hurdle, correct?
Clawbacks are a heavily negotiated LPA term so you really need read the specific language. In general, there is an interim look back every 2-3 years where the waterfall would be re-run. Taxes are very important to consider as well, and most GPs are very good at structuring as efficient as possible. Also, while I don’t think it happens much in practice because a good GP should try to minimize indemnifications when it sells a company, most LPAs have indemnification provisions that allow distributions to be recalled up to a certain period in time.
Thank you for that detail. I'm still wondering about what happens in the scenario I laid out? Or if that scenario is even possible. Trying to understand the impacts of vesting on carry payout under and American waterfall.
MJ, your docs should hopefully address how vesting is handled. I don’t think there is necessarily a standard here, but obviously if you can negotiate getting the distribution at portfolio company sale (if not fully vested) that is better. You are correct that there would be a final and likely several interim waterfall calculations to make sure the hurdle is met. One other nuance is where the actual clawback liability actually resides (GP vs. individual). Again, read the docs! The details matter.
You have to read the docs. There is no standard here.
From what I understand, there are two main "flavors" of carry payout, but as everyone has said, you have to read the docs to understand it all fully.
The two basic forms of carry payout are the American Waterfall (also known as deal-by-deal) and the European Waterfall (also known as whole-fund). Differences below:
American Waterfall (Deal-by-Deal): In this structure, carry is calculated and paid out on a deal-by-deal basis, as soon as a portfolio company meets the carry hurdle and is sold. In the hypothetical situation you mentioned, if you invest $40M in a new portfolio company (portco 1) in year 1 and sell it for $80M in year 2, the carry would be paid out when portco 1 is sold, assuming it meets the carry hurdle.
European Waterfall (Whole-Fund): In this approach, carry is not paid out until all of the invested capital has been returned to the limited partners (LPs) and the carry hurdle is met for the entire fund. In your example, carry would not be paid out when portco 1 is sold, even if it meets the carry hurdle. Instead, it would be paid after all investor capital has been returned and the carry hurdle is met for the whole fund.
Regarding clawback provisions, these are non-standard terms and vary between funds. Essentially, clawbacks are designed to protect the LPs by ensuring that the GPs don't receive more carry than they're entitled to. If a GP has been overpaid, a clawback provision would require them to return the excess carry to the LPs. It's crucial to thoroughly review the fund documents to fully understand the specifics of any clawback provisions in place.
From the way you wrote this, is sounds like you're early enough in PE that you probably don't have access to the fund docs to read for yourself, but if you did, that would 100% be the thing you need to do.
On a somewhat unrelated note, has anyone seen less favourable carry waterfalls being negotiated in ongoing fundraises? With the difficult fundraising environment, would have thought this makes it much easier for LPs to negotiate European waterfalls if previous vintages had American.
The WSO thread below has a lot of really good stuff. neil88 has a FANTASTIC POV on this as he/she works in a large LP investing across primaries.
https://www.wallstreetoasis.com/forum/private-equity/troubled-fundraisi…
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