What Is Carried Interest? Definition, How It Works and Examples

Economically, carried interest is a performance fee: the manager earns it only when the investment does well. Legally, in most funds and SPVs it is an allocation. That means a share of the vehicle’s profits assigned to the general partner or managing member, the party that runs the vehicle. The partnership or operating agreement sets it out. That is the carried interest definition the tax code works from. It is also why carry is taxed differently from pay.

Carry sits beside the management fee, and the two do different jobs. The management fee pays for running the vehicle, whether or not it makes money. It is often 1–2% a year of committed or invested capital, according to ILPA. ILPA is the Institutional Limited Partners Association, a trade body for fund investors. Carry is paid only out of realized profit, meaning profit from an actual sale. The “2 and 20” shorthand means that pair: a 2% fee and 20% carry. Carried interest defined this way ties the manager’s pay to yours. The manager earns real money only when you do.

Axevil describes carry the same way. It is a share of the gain, taken only when the position is sold, and a position that does not gain pays none. The fee lines on an SPV are explained in SPV fees and fees and costs.

What is a carried interest in a fund, compared with a single deal? It is the same profit share, wrapped in three mechanisms that decide the real rate. The carried interest meaning in private equity and venture funds is complete only with all three.

Hurdle, or Preferred Return

A hurdle, also called a preferred return, is a minimum return investors receive before any carry is paid. In most funds ILPA sampled it was 8% a year. It usually compounds, so the return also earns a return. Under a “hard hurdle,” carry applies only to profit above it. Under a soft hurdle followed by a catch-up, a good outcome only delays carry. The total carry stays the same.

Catch-Up

Once the hurdle is paid, a catch-up sends most or all of the next payouts to the manager. This continues until the manager holds its full 20% of the profit so far. After that, everything is split 80/20. With a full catch-up, a good outcome ends at exactly 20% of all profit. The hurdle only matters when returns are modest.

Clawback

A clawback makes the manager return any carry it was paid above its agreed share of the fund’s total profit. ILPA’s recommended practice adds an escrow. A significant part of carry, 30% or more in its example, is held back in a separate account. That way the money is there if it has to be returned.

A distribution waterfall is the order in which money from a sale is paid out. Here is a carried interest calculation on one position. Investors put in $10M, fees included, and the position is sold after five years. The terms are 20% carry, an 8% annual hurdle and a 100% catch-up. The hurdle is simple, so it does not compound. There are two outcomes: a sale returning $25M, and one returning $13M.

At $25M the hurdle changes nothing. The catch-up restores the manager to 20% of the $15M profit. At $13M the hurdle decides everything. The $3M profit sits inside the hurdle, so no carry is paid. A structure with no hurdle would take $0.6M. So test a carry clause on a disappointing outcome: that is where the terms differ.

European (Whole-Fund) vs American (Deal-by-Deal)

Here is the difference in one example. A fund invests $5M in each of two companies. The first sells for $15M. The second is written off. The fund’s profit is $5M, so whole-fund carry is $1M. Deal by deal, the first sale alone pays $2M of carry, which is 40% of the fund’s actual profit. A clawback later returns the extra $1M.

Carry in a Single-Deal SPV

In an SPV that holds one company, the two models become one, because the deal is the whole fund. Carry is measured on that single position, as SPV fees sets out. The consequence sits one level up. If you hold five SPVs, each settles its own carry. A loss in one does not offset carry on another. Across your own portfolio, the result works deal by deal.

Carry is an allocation of the vehicle’s profit. So a US manager is generally taxed on it as the kind of gain it is made of, in the year the vehicle realizes that gain. IRC §1061, the section of the US tax code on carried interest, applies to tax years beginning after December 31, 2017. Under it, gain on a carried interest counts as long-term only if a three-year holding period is met. Gain that misses it is treated as short-term. Why this treatment is contested, and what it is worth, is covered in the carried interest loophole.

• Comparing rates without the base20% of profit after fees and 20% of profit before fees are different prices.
• Assuming every vehicle has a hurdleMany do not. Check the vehicle’s own documents. The market convention for funds may not apply.
• Missing the catch-upA hurdle followed by a full catch-up protects only a modest outcome.
• Treating carry as a cost on your moneyCarry is a share of profit. With no gain, there is no carry. The management fee is charged either way.
• Offsetting losses across separate SPVsEach vehicle settles its own carry. Losses in one do not reduce carry in another.
• Reading the waterfall only at a good outcomeThe order of payment matters most when the outcome disappoints.

Carry is one line of what a vehicle costs. The risks of the structure itself are covered in SPV risks. How a fund draws the capital that carry is measured on is covered in capital calls.

Carried interest (carry)

The manager’s share of a vehicle’s realized profit. It is paid after investors’ capital, and any hurdle, is returned.

SPV (special purpose vehicle)

A company set up to hold one investment for a group of investors.

General partner

The manager of a fund or SPV, and the carried interest partner: the party the profit share is allocated to.

Management fee

A yearly fee for running a fund or SPV, often 1–2% of committed or invested capital. It is charged whether or not there is a gain.

Hurdle (preferred return)

The minimum return investors receive before carry is paid. In funds it is usually 8% a year and often compounds. Some vehicles have none.

Catch-up

The tier after the hurdle in which the manager receives most or all payouts until it holds its full carry share of profit.

Distribution waterfall

The order in which proceeds are paid: capital, hurdle, catch-up, then the profit split.

Whole-fund waterfall

The European model: carry is paid only after all capital across the fund is returned. ILPA recommends it.

Deal-by-deal waterfall

The American model: carry is paid as each deal is sold at a profit. A clawback applies if later losses mean too much was paid.

Clawback

The manager’s obligation to return carry paid above its agreed share of the fund’s total profit.

Figures and rules were last checked on October 1, 2026. Market conventions come from ILPA’s published survey of fund terms. They describe funds in general, and any particular SPV can differ. The waterfall examples are illustrative. Tax rules are US federal rules, and other jurisdictions differ.