Private Equity - Carried Interest?

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PEguy2011 - Certified Professional
Rank: Baboon | banana points 157

Have a question for all the PE guys here. I've been trying to figure out if the carried interest I get paid (middle level guy..senior associate/VP) is market. My fund based out of SF focuses on the middle market, but we have a decent fund size (between $2 and $2.5 billion).

I receive 0.5% carry on the latest fund, which based on some research I've read is average. However, I've heard rumblings from buddies of mine that it is on the smaller end of the scale. That said, they're not even in PE so i don't know if I should trust them.

Anyone care to share what their experience with carry has been?

Private Equity Carry

From the Wall Street Oasis Finance Dictionary

In Private Equity, carry is the profit earning between buying a business and then selling it and this is the key component of senior compensation. Mitt Romney of private equity firm Bain Capital earns the vast majority of his salary through his stake in Bain Capital and the resulting carried interest profits.

CompBanker - Private Equity Vice President:
  • 2 billion dollar fund * 2.5x ROIC less $2bn return of capital = $3 billiion profit.
  • 3 billion in profit * 20% GP return * 0.5% carry = $3.0 million.

Note that this is just an approximation and the $3.0 million will be paid out over the life of the fund, which can be 10+ years.

An observation on deal and firm size as it relates to compensation via carry.

Once you account for debt, fees, preferred return, the 0.5% won't get you as far as everyone thinks, but that's why 3x return on invested capital at a megafund where you're selling businesses for hundreds of millions to billions vs. a middle market fund where you're selling for hundreds of millions at best, makes a big difference in compensation as it relates to carry.

Carried Interest Private Equity Example

This post has been formatted. This was originally posted by certified user @PEguy2011, a private equity partner.

Suppose a business is purchased for 50 million. The purchase was funded with 30 million in equity and 20 million in debt. After a period of time the debt is written down to 10 million. The business is then sold for 150 million.

What would a .5% carry look like on this deal?

  • Paying off debt
    • 150mm - 10mm debt = 140mm
  • Transaction fees
    • 140mm - 5mm in fees = 135mm
  • Payback equity and Preferred Return for initial investment
    • 135mm - 30mm to payback equity = 105mm
    • 105mm - 5mm for preferred return = 100mm
  • Carry pool. Assuming 80/20 split
    • 100mm - 80mm to limited partners pool = 20mm
  • Your carry
    • 20mm * .05 (.5% carry) = 100k

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Comments (31)

Sep 8, 2011

From the 2011 PE Compensation Report regarding mid-level (senior associate / VP) employee carry allocations:

~45-50% got nothing
~30% got less than or equal to 1% carry
~20% got between 1% and 2% carry

Based on this, I would say you're smack in the middle. Can't speak to my own fund because I'm an associate and don't know what the other guys get. Hope this helps.

Sep 8, 2011

Thank you, very helpful. Good to know I'm not getting gypped.

Sep 9, 2011
PEguy2011:

Have a question for all the PE guys here. I've been trying to figure out if the carried interest I get paid (middle level guy..senior associate/VP) is market. My fund based out of SF focuses on the middle market, but we have a decent fund size (between $2 and $2.5 billion).

I receive 0.5% carry on the latest fund, which based on some research I've read is average. However, I've heard rumblings from buddies of mine that it is on the smaller end of the scale. That said, they're not even in PE so i don't know if I should trust them.

Anyone care to share what their experience with carry has been?

I would also try and take into account your fund structure (headcount, headcount by seniority level) to try and assess what the trickle down maybe.
$2B-2.5B is a very decent size and depending on these elements 0.5% could be decent as it could be sub-par.

Sep 10, 2011

How much is 0.5% carried interest?

If a fund that's $2bn gets a 18% return, and the fund's principal investors have a cutoff return of 8%, and 20% of the excess returns go to the PE fund investment team, how much is 0.5% carried interest?

Is it just $2bn * (18% - 8%) * 20% * 0.5%? That would be $200k, which would be pretty sweet if a VP gets $300-400k before carried interest.

Best Response
Sep 10, 2011

You're thinking about it all wrong. There are a few different methodologies, but yours is mathematically flawed. Try this method:

$2bn fund * 2.5x ROIC less $2bn return of capital = $3bn profit.
$3bn profit * 20% GP return * 0.5% carry = $3.0 million.

Note that this is just an approximation and the $3.0 million will be paid out over the life of the fund, which can be 10+ years.

    • 3
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Sep 10, 2011
CompBanker:

Also, another thing to keep in mind. While the limited partners may be entitled to an 8% preferred return (the hurdle), there is usually a "catch-up provision" that enables the general partners to receive 100% of the profits above the 8% hurdle rate until an 80/20 profit sharing split is achieved. After that, every dollar going forward is split on an 80/20 basis.

Ohh, I understand now. Wow, thanks.

Sep 10, 2011

Also, another thing to keep in mind. While the limited partners may be entitled to an 8% preferred return (the hurdle), there is usually a "catch-up provision" that enables the general partners to receive 100% of the profits above the 8% hurdle rate until an 80/20 profit sharing split is achieved. After that, every dollar going forward is split on an 80/20 basis.

Sep 8, 2011

The math is pretty basic actually. The way the waterfall works on a theoretical FUND level...

Let's say we manage $1 billion and i get 0.5% carried interest. That essentially means my interest in the fund is $1,000,000,000 x 20% carry x 0.5% my share of the carry = $1 million. The way it would get paid out is if the fund as a whole returned 3x on invested capital, i would get 2x my carry value or $2 million. Basically, 1x is to pay back the investor my share of the carry, and then i get the rest which is 2x.

That said, the way the waterfall works in ACTUALITY since most funds go on a deal by deal basis (you don't need to wait for the entire fund to be paid back before collecting your carry):

Let's say we purchase a business for $50 million of which $20 million is funded with debt. Then 3 years later, let's say we've amortized the debt down by $10mm and we sell the business for $150 million. Also, assume we haven't put any more equity in, nor taken any distributions. At this point, capital structure is $30mm equity, $10mm debt and we just sold the business for $150mm. The $150mm is used to pay the debt first, so proceeds are down to $140mm. Then we pay transaction fees/deal fees, so it's down to $135mm. Then we pay back the $30mm equity + preferred return to LPs, so we're down to $100mm. Finally, it's time for the carry to kick in. So the $100mm gets split 20/80 or $20mm to carry pool, $80mm to LPs. Of the $20mm, now i get my piece of the pie which is 0.5% or $100k.

Once you account for debt, fees, preferred return, the 0.5% won't get you as far as everyone thinks, but that's why 3x return on invested capital at a megafund where you're selling businesses for hundreds of millions to billions vs. a middle market fund where you're selling for hundreds of millions at best, makes a big difference in compensation as it relates to carry.

However, most megafunds don't underwrite to 3x return because it's so difficult to generate returns like that when you're paying half a billion to billions of dollars for businesses... whereas most middle market PE shops will underwrite and expect a 3x return minimum on their investments. So there is somewhat of a balance between the two.

    • 1
Sep 9, 2011
PEguy2011:

The math is pretty basic actually. The way the waterfall works on a theoretical FUND level...

Let's say we manage $1 billion and i get 0.5% carried interest. That essentially means my interest in the fund is $1,000,000,000 x 20% carry x 0.5% my share of the carry = $1 million. The way it would get paid out is if the fund as a whole returned 3x on invested capital, i would get 2x my carry value or $2 million. Basically, 1x is to pay back the investor my share of the carry, and then i get the rest which is 2x.

That said, the way the waterfall works in ACTUALITY since most funds go on a deal by deal basis (you don't need to wait for the entire fund to be paid back before collecting your carry):

Let's say we purchase a business for $50 million of which $20 million is funded with debt. Then 3 years later, let's say we've amortized the debt down by $10mm and we sell the business for $150 million. Also, assume we haven't put any more equity in, nor taken any distributions. At this point, capital structure is $30mm equity, $10mm debt and we just sold the business for $150mm. The $150mm is used to pay the debt first, so proceeds are down to $140mm. Then we pay transaction fees/deal fees, so it's down to $135mm. Then we pay back the $30mm equity + preferred return to LPs, so we're down to $100mm. Finally, it's time for the carry to kick in. So the $100mm gets split 20/80 or $20mm to carry pool, $80mm to LPs. Of the $20mm, now i get my piece of the pie which is 0.5% or $100k.

Once you account for debt, fees, preferred return, the 0.5% won't get you as far as everyone thinks, but that's why 3x return on invested capital at a megafund where you're selling businesses for hundreds of millions to billions vs. a middle market fund where you're selling for hundreds of millions at best, makes a big difference in compensation as it relates to carry.

However, most megafunds don't underwrite to 3x return because it's so difficult to generate returns like that when you're paying half a billion to billions of dollars for businesses... whereas most middle market PE shops will underwrite and expect a 3x return minimum on their investments. So there is somewhat of a balance between the two.

If you go on a deal by deal basis, you are likely to have pretty stringent clawback clauses though.

Jun 9, 2018

when looking at the fund level - wouldn't management fees have to be sub'd out from the profit pool? or does that depend on LPAs?

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Sep 12, 2011

^^^ very nicely explained man I understand it a lot more

I want a lady on the street, but a freak in the bed,

Go Bucks!!

Sep 8, 2011

Absolutely right, there are clawback clauses, but situations in which they kick in are rare as it kicks in at the fund return level (i.e. the fund as a whole is a loser), not a deal by deal level. Also, some of that clawback can be negated since almost every exit will require an escrow at close and you will not collect 100% of your carry right away.

That said, if you're at a private equity shop where losers are rare, nothing to worry about.

Sep 13, 2011

How can this be urgent when you're asking for carry comp across the board. Do you have exploding offers at every level?

Sep 13, 2011

Doing research for an MD at my firm. Didn't care to tell me why he needs it:)

Sep 13, 2011

Because he's looking to jump ship. Depends, firm by firm, obviously.

Sep 13, 2011

This is actually an interesting topic where there's not much publicly-available data. Like GameTheory said, it depends firm by firm - largely becuase of size of fund and number of people. A lot more mouths to feed at the big shops but small carry % goes a long way when based on billions.

But what do you think the typical breakout is like per aggregate level? 70% partner level, 15% principal, 10% VP, 5% Senior Associate? Just a swag. What do you guys think(know)?

Sep 13, 2011

According to Blackstone's s1 their Senior MD's were paid about 7% of the total carry in 2006.

Works out to about .13% with 57 SMD's. Curious if this is similar to other large PE funds.

Sep 13, 2011

I haven't taken the time to check that s1, but that doesn't make sense - where is the other 93% going?

Sep 13, 2011

to Steve and Peter

Sep 13, 2011

that's not right. You're misreading the s1.

Sep 13, 2011

I might be misreading it. Analysis was from Bankers Ball:

http://www.bankersball.com/2007/03/26/Blackstone-filing-details-on-comp/

In Part II of the analysis, "carry Plan Participations to our SMD's was $160,000,000.

Divided 160,000,000 by the 2 billion in Carry Dollars Created = about 7%. Where am I going wrong? Is Carry Plan Participations not equivalent to the amount of carry the SMD's recieved in comp?

Sep 13, 2011

Hah Steve wishes!

I can't get into the specifics because it's sensitive info but if you wanted to get a better view read through the compensation section. To highlight some key parts are:

Footnote to $160: "We expect to make aggregate annual performance compensation payments to the senior managing directors that work in each of our businesses that range from 30% to 40% of the revenues of the relevant business."

Definition: carry Dollars Created is calculated by multiplying the aggregate amount of Limited Partner capital invested by the carry funds in transactions during a given period by the contractual percentage (generally 20%) of the profits that we earn as a preferred allocation of income (a carried interest) from these investments, assuming we achieve specified cumulative investment returns.

Sep 13, 2011

Thanks Ivey.

So 30% to 40% of the revenues, ie 30 to 40 % of the 20% return, would be about 7% of the total fund's size, if I'm reading correctly.

IE if BX has a 100MM fund, with a 20% return, after y1 the SMD's are paid 8.4MM, or 7% of 120M, on average.

Correct?

Sep 13, 2011

Disregard, math was wrong.

30-40% of the 20% performance fee on the fund's return. So on a 100M fund, after 1y, 20M would be the return. 20% of that would be 4M, and BX partners would receive 30-40% of 4M.

Sep 13, 2011

Moony, you're confusing the "carry" and "fund size." In your hypothetical 100mm fund, 20mm (assuming IRR hurdles are passed) is the excess so the carry is 20% of the 20mm, and 30-40% of the carry would belong to the senior partners. Nobody really looks at carry as % of fund size, though.

One should note that the exerpt above mentions only GP carry from LP commitments. GP co-invest was not mentioned, and while I personally have not trolled through the s-1 I doubt GP co-invest has to be publicly reported and is housed under a separate LLC, anyways. So it'd be very difficult to know exactly how much per investment partners are really earning.

Sep 13, 2011

-

Sep 13, 2011

Game is on the ball.

Just FYI the GP co-investment is 1:1 with the common units if funded off the balance sheet (it is distributed pro-rata to all unit holders) and you'll see that listed as "other investment income" in the earnings report.

If funded by the professionals then you receive returns like an LP with a simliar waterfall. (modified slightly)

Won't get into specifics on how that breaks out since it's non public information, but the most PE partners are so to speak, obligated to keep a substantial portion of their net wealth in the fund such they really work to maximize returns.

Sep 13, 2011

GP co-invest has higher returns than LP returns. You're getting gross IRR, not net.

Sep 13, 2011
Sep 13, 2011