Carried Interest (Carry)
The share of a venture fund's profits paid to the general partner, typically 20%, after returning LP capital.
Carried interest is the general partner's performance compensation — a percentage, standardly 20% in venture capital, of the fund's profits above the amount LPs originally invested. It's the primary way GPs are meant to be paid for generating strong returns, distinct from the management fee that covers operating costs regardless of performance.
Most funds only pay carry after a hurdle rate is cleared and after LPs have received their capital back (a 'return of capital' waterfall), though the exact mechanics (European vs. American waterfall, deal-by-deal vs. whole-fund) vary and materially affect when and how much GPs actually collect.
Carried interest is taxed at long-term capital gains rates in the US rather than ordinary income rates, a long-running policy debate, since GPs are compensated for labor (managing the fund) but taxed as if it were investment gain.
Carry structure shapes GP behavior more than almost any other term. A GP who earns carry only after returning all LP capital (a European, whole-fund waterfall) thinks in portfolio outcomes. For founders, carry mechanics explain why VCs fixate on fund-returning outcomes: only massive winners generate the profit carry is calculated on.
Section 1061 of the Internal Revenue Code applies a three-year holding period to carried interest: gain on a partnership interest held in connection with performing services only gets long-term capital gains treatment if the three-year test is met, and gain that fails it is treated as short-term. The management fee, by contrast, is ordinary income.
A clawback is the GP's contractual promise to return carry it received early if, at the end of the fund, it turns out the GP was paid more than the final math entitles it to. LPs should check whether the clawback is backed by the individual partners and whether it's capped below the actual exposure.
Carry paid to GP = carry rate x (total distributions - total capital returned to LPs), after hurdle if applicableA $100M fund returns $350M total. After returning the $100M of capital to LPs, there's $250M of profit; at a standard 20% carry, the GP earns $50M and LPs keep the remaining $200M.
As an LP, always ask whether carry is calculated deal-by-deal or on the whole fund, and whether there's a clawback provision — deal-by-deal carry without a clawback can let a GP get paid early on winners even if later deals lose money and the fund never returns capital overall.
Is 20% carried interest standard for venture funds?
Yes, 20% is the long-standing industry norm, though top-tier or high-demand funds occasionally push for 25-30%, and carry structure (waterfall type, hurdle) varies more than the headline rate.
How is carried interest taxed?
In the US it's generally taxed at long-term capital gains rates rather than ordinary income rates, provided holding period requirements are met — a long-debated tax policy issue given carry compensates labor, not just invested capital.
What's the difference between a European and an American waterfall?
A European (whole-fund) waterfall returns all LP capital, and any hurdle, before the GP gets carry, so the GP only profits if the fund as a whole profits. An American (deal-by-deal) waterfall lets the GP take carry on individual winners as they exit, which is why LPs typically demand a clawback.
Is carry 20% of the fund?
No — it's a share of profits, not of the fund. A $100M fund that returns $150M has $50M of profit, so 20% carry is $10M, not $20M. The distinction matters in every negotiation.
What is the three-year rule for carried interest?
Section 1061 requires a holding period of more than three years — instead of the usual one year — for gains allocated to a carried interest to be treated as long-term capital gains. Gains that fail the test are treated as short-term.
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