Question about carried interest
I wonder if someone can pitch in and tell me what you think: I own a small business ( less than $3M annual revenue ) and currently in negotiation with a VC to buy 100% of the shares for cash in hand + 30% equity in the new company they will form on top of the one I am selling. I was ready to sign but then when presented with the waterfall model, I discovered they are going to take out of my cut another 20%-30% on exit ( the "carry" ). I was very surprised and some reading on the Internet suggested that a carry is usually something the investors pay for the VC if they manage to grow the business and sell it, but nothing suggested that the founders ( me ) should be subject to the same arrangement.
Is it a common practice ?
Will appreciate any advice!
Thanks
Did they specifically refer to that piece as "carry"? Sounds to me like it could be a participating preferred and that extra cut you're referring to is the VC getting their liquidation preference before then splitting the remaining proceeds with you 70 / 30.
It is specifically referred to as carry in the waterfall structure. Here is a more detailed description: The VC will deduct from the exit sale price the initial capital they put in. From the remainder they deduct another 10% for employee options. Then they divide whatever left 70/30 ( 70 to them 30 to the founders ) and then they take another 20% carry from both parts ( I.e. both the investors and the founders are subject to carry )
This is how carry in a specific deal works - it is a % deducted from the common equity after the preferred is paid back. The folks who own that carry are presumably the key executives and maybe a few rank and file employees to make them feel "part of something"- that carry is not being paid out to the investors.
Not out of the ordinary from my perspective, though 20% is very high - we (UMM buyout shop) typically have carry structures ranging from 6% to 12% with a bunch of performance thresholds.
It sounds like you're seeing the preferred equity being paid out ahead of the common, which you have a piece of.
Preferred equity is typically the dollars the VC invests that accrue at some rate (most firms use 8% compounded quarterly) and are paid back before paying out any of the common ("upside"). This provides downside protection for the investors as they are able to get their money out before anyone else at some guaranteed return (assuming there is sufficient equity value). Since it sounds like you are not rolling any of your proceeds into the deal, you have no piece of the preferred, thus the VC guys are going to get all their money out before you get any money out.
Notably, this is different than carry, which is a percentage of the common equity that gets paid out to folks who have a slice of it (said differently, people who own incentive units). Confusingly, this carry is DIFFERENT than the carry you're probably seeing described, which is carry in the fund the dollars are being invested out of (select investment professionals will get a % of the profits created in a fund - usually 20% of the profits).
Hope this is helpful
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