How is carry calculated?

Quick question that I have been wondering for a while. Say a VP at a PE firm is awarded "carry" in the firm. Lets just say its 50bps for argument's sake. $1 billion fund, 2% management fee and 20% carried interest. What does that 50bps get the VP in terms of comp? When is it distributed? Does that act as their bonus or is that on top of the bonus?

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Comments (25)

Sep 13, 2009 - 2:00pm

I'm pretty sure carry is only distributed once the fund has returned money to its LPs or at least profited from/sold their investments. Carry is a long-term golden handcuff to keep professionals engaged... that's why PE has such a low turnover for the most part. Everyone's waiting for that $5M pay day.

Cash bonuses are distributed at year end, and are separate from carry. Generally much smaller.

Sep 13, 2009 - 10:44pm

it really depends on a lot of factors. different firms measure carry different ways (it used to be per investment, but now most shops do it based on the fund performance as a whole). theres usually a hurdle rate (for example, the LPs need to receive their initial investment back plus X% before carry is given). some hurdles are soft where the GPs get carry off all profits once it reaches the hurdle (includes profits below the hurdle), while hard hurdle rates only get carry on profits above the hurdle. some hurdles are even linked to other factors, such as LIBOR or a t-bill. also, in most cases the management fee is reimbursed before carry is taken.
there are just way too many factors to take into account to give a straight forward answer. sorry!

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Best Response
Oct 11, 2009 - 12:05pm

Convenience - it looks like you're looking for the basics, so forget all of the details - here's a plain vanilla example - if you have a $1 billion fund (assume you're there from the outset of the fund) and you return $3 billion (pre-carry) to your investors over the life of the fund (so, 3x cash-on-cash return), the carried interest pool is $2 billion x 20% (typical for most funds, though some differ), or $400MM. If you have 25 bps, then you would receive .25% x $400MM, or $1MM. Now, again, this would most likely be spread out over the life of the fund. Also, as mentioned above, you have to clear a hurdle rate, often 8% (annualized). If you don't clear the annualized hurdle rate over the life of the fund, there is no carry - ZERO. Generally speaking, firms won't take carry distributions until the hurdle rate is covered (LP terms often dictate this), but assuming you don't have a ton of write-downs in your portfolio, one large exit can cover this... There's a lot to it, but this is a very basic example. Also, the carry can be clawed back in the event the firm takes early carry distributions and then has a ton of dogs later on which results in the hurdle rate not being met overall. Finally, while it is true that carry is separate from bonuses, the firm will generally provide enough bonus upon the closing (buy-side) of each transaction to cover your investment (which produces the carry later on) so that you don't come out-of-pocket. Then, the largest piece of the bonus is paid at year-end. Hope this helps....

Oct 11, 2009 - 12:22pm

One quick follow-up to keep in mind is that most firms will have a vesting period for those granted a piece of the carried interest pie - often 5 years, with a 20%/year vesting schedule. Some firms have a cliff schedule, which isn't nearly as favorable to the individual, obviously...

Oct 11, 2009 - 12:23pm

Carried Interest Value (Originally Posted: 07/18/2007)

ok, so i got some information about PE salaries, bonuses and carried interest % for 2000. For example it says that Associates get a 0.4%. Now my question is: it is 0.4% of how much on average? I know it is a 0.4% per deal made, but how many deals do they do per year and how big are they? i know that it is different from firm to firm, but can someone give an idea, perhaps dividing it into tiers. Also it says taht associates have a 24% of positions with carried interest if that helps in anyway.

Oct 11, 2009 - 12:24pm

Ok, so here's the math.

40 bps
x
Size of fund
x
Multiple-of-Money (MoM) less initial investment
x
Carried interest the GPs take of fund (generally 20%)

So, if the fund is $1B, returns 2.0x (15% IRR assuming 5 years), then the value of the 40 bps would be 40bps x $1B x (2.0x - 1.0x) x 20% = $800K over the time it takes to invest the fund. Obviously this can ramp up quickly with size of fund and MoM. This calc excludes the minimum returns threashold that the fund must reach before carry vests (generally 5-10%)

Oct 11, 2009 - 12:26pm

I know this is an old forum but i thought i would ask. Does anyone know the approx percentage of carry that VP's, principals and low level partners receive at PE shops (mega or middle market)?

Oct 11, 2009 - 12:27pm

mm RE PE firm here... I think they get 200 to 300 bps depending on seniority

So if you think about a theoretical fund size of 500m with a 2.0x multiple they'll get 2 or 3mm each by the end of the fund, which has a life of 5-6 years... say you spread 2.4mm over 6 years you're talking 400k / year in carry for a VP... then they'd get their typical salary of 200k (or whatever it may be) and usually yearly performance bonuses too, etc..

Oct 11, 2009 - 12:28pm

that could be slightly agressive, as think the VP's only net 450-500 or so usually in REPE.... it's not quite as high paying as vanilla PE I don't think... I know that VP's at a place like KKR can make more than that, but you have to consider the fund size, so they may only get 40 bps but thats worth more than 200 or 300 at a typical mm firm

Oct 11, 2009 - 12:32pm

it is the logical equivalent of "incentive fee" in the hedge fund world.

most people think of it has X% of profits, but it is actually far more complicated to compute because of the terms of the agreement.

the terms of the fund may also outline the allocation of the carry to the firm's MDs, Principals, etc.

Oct 11, 2009 - 12:33pm

In private equity, carry generally refers to all capital returns in excess of an initial investment amount. In practice, carry can be a bit more complicated depending on a transaction's equity structure (e.g., preferred vs. common vs. hybrid securities), but the general idea of carry remains the same.

The actual figures can range quite a bit, but PE funds will generally get to keep 20-30% of the carry on an investment, while secondary funds (i.e., PE fund-of-funds) will usually take home smaller amounts of 5-10%.

Oct 11, 2009 - 12:34pm

Need help with carry Calculation (Originally Posted: 07/12/2010)

Does anyone know how to properly calculate carry for an unrealized investment? For example you hold a portfolio company for 5 years, then IPO it, but cannot sell your stake for the next several years due to legal restrictions.

I believe you would still recognize carry on the fund p&l in a "unrealized gain" line item and then gradually decrease that line item as the carry is realized due to an actual sale of the stake.

Does anyone have a good internet resource or personal knowledge on how the carry would be calculated in such a scenario?

Oct 11, 2009 - 12:37pm

The unrealized value is essentially today's liquidation value (or technically should be, especially for a public investment) and is reflected in the capital account or investment value that an investor owns. So unrealized value would be allocated based on how the proceeds would be distributed; carry would be reflected in this. 20% of profits would go to the GP, the rest is allocated amongst the LPs pro rata for their commitments.

Oct 11, 2009 - 12:38pm
m8:
The unrealized value is essentially today's liquidation value (or technically should be, especially for a public investment) and is reflected in the capital account or investment value that an investor owns. So unrealized value would be allocated based on how the proceeds would be distributed; carry would be reflected in this. 20% of profits would go to the GP, the rest is allocated amongst the LPs pro rata for their commitments.

Thanks, this clears things up. Just needed to understand it from the LP's perspective.

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