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Hedge Funds
Venture Capital
Current Expenditures
How to Compensate Sales Staff
Indirect LaborCarried Interest DefinitionWhat is carried interest? Carried interest is a portion of an investment fund’s annual profit that is given to the fund manager at the end of the year. Carried interest is designed to incentivize to the fund manager to achieve outstanding performance for the fund. Carried interest is often set at around 20% of the fund’s profits.
Carried interest can also be called carry, or profit interests, and the amount may be used to compensate fund managers and general partners at private
equity firms and hedge funds. The carried interest may be the primary source of compensation for the fund managers. It does not include any of the fund manager’s own money that he may have invested in the fund.
There may be a hurdle rate of return stipulated, as well. For instance, the policy at a private equity fund may be that all of the investors must earn at least 7% return on their initial investment, and everything above and beyond that is considered pure profit and may be used to compute the fund manager’s carry.
Carried Interest ExampleFor example, imagine a hedge fund with $100 million of invested capital from 10 investors. The hedge fund has told the investors to expect at lease a 5% return on their investment. The fund manager will earn a 20% carry on the profits above the 5% hurdle rate. The fund manager is now motivated to maximize the fund’s performance. He will earn 20% of anything above $105 million.
At the end of the year, the fund is worth $125 million. The fund made a profit of $25 million, or 25%. Let’s see how much of this profit will go to the fund manager for his efforts.
Ten investors contributed $10 million each to make the full amount in the fund, $100 million. Each of the investors was told to expect at least a five percent return on their investments, or $500,000 each. For all ten investors, this adds up to $5 million. This means, according to the hurdle rate, the fund manager earns 20% on anything above $105 million.
The fund made $25 million. Subtract the $5 million for the hurdle rate. And you are left with $20 million. Now, the fund manager earns 20% of the $20 million. This turns out to be $4 million. The remaining $16 million would then be distributed among the investors or used to cover other expenses or simply reinvested in the fund.