Carried Interest Explained

Carried interest is central to how private equity professionals are rewarded, and it comes up in the context of PE-backed businesses and leadership. Here is what it means.

What carried interest is

Carried interest is the share of the profits from a private equity fund's investments that is paid to the fund's managers (the general partner, or GP) as their performance-based reward. When a PE fund's investments generate profits, a portion of those profits — the carried interest — goes to the GP, typically after investors have received back their capital and often a preferred return first. It is the primary performance reward for PE fund managers, earned on the success of the fund's investments over time.

How it works, in principle

In principle, carried interest works as a share of investment profits above certain thresholds: investors (the limited partners) generally receive their capital back and often a preferred return before the GP receives carried interest on profits beyond that. This structure means the GP's carry is earned only when the fund performs well for its investors, tying the managers' primary reward to delivering strong returns. The specifics — the percentage, thresholds, and terms — vary by fund and are governed by detailed agreements; the principle is a profit share contingent on performance.

Why it matters — alignment

Carried interest is significant because it aligns PE fund managers' interests with delivering strong investment returns — their primary reward depends on the fund performing well for investors. This alignment is fundamental to the PE model, incentivising managers to create value in their investments. It is distinct from, but related to, how value creation and leadership work in PE: the GP earns carry on fund performance, while a portfolio company's management earns their own incentives (a management incentive plan) on their company's success.

Where it fits for leaders

For leaders in or considering PE-backed businesses, carried interest is useful to understand as part of how the PE world works and how their investors are motivated, even though carry is the fund managers' reward, not the portfolio company management's. Management's own equity participation comes through the management incentive plan, not carried interest. Understanding both — how investors are rewarded (carry) and how management is rewarded (the MIP) — gives a fuller picture of incentives in a PE-backed business. Carry and equity are complex; professional advice is important.

Frequently asked questions

What is carried interest?

The share of a private equity fund's investment profits paid to the fund's managers (the general partner) as their performance reward — typically after investors receive their capital back and often a preferred return. It's the primary way PE fund managers are incentivised.

What is the difference between carried interest and a management incentive plan?

Carried interest is the fund managers' (GP's) share of the fund's investment profits; a management incentive plan is how a portfolio company's own management shares in that company's success. Carry rewards the investors' managers; the MIP rewards the company's leadership.

Related: Management Incentive Plans in Private Equity · Value Creation in Private Equity · What Is an Equity or LTI Package?