What is carried interest?
Carried interest (or “carry”) is the share of a venture fund’s profits that the general partner (GP) keeps as compensation for managing the fund. The market standard is “2 and 20” — a 2% annual management fee plus 20% of profits above a hurdle rate. Carry is the single largest economic alignment tool in venture capital because it makes the GP’s upside depend directly on LP returns.
How the waterfall works
The carry distribution follows a contractually-defined waterfall — the order in which cash exits to LPs first and the GP only after:
- Return of capital — LPs receive their full committed capital back.
- Preferred return (hurdle) — LPs receive an 8% IRR (typical) on contributed capital.
- GP catch-up — GP gets paid until the realised split reaches 80/20 between LP and GP.
- Carry — all subsequent distributions split 80% LP / 20% GP.
European vs. American waterfall
The European (whole-fund) waterfall calculates carry only after the entire fund has returned committed capital plus hurdle — LP-friendly. The American (deal-by-deal) waterfall pays carry on each profitable exit individually — GP-friendly. Most institutional LPs negotiate a European waterfall with a “clawback” mechanism so the GP must return overpaid carry if subsequent deals lose money.
Tax treatment
In the US, carry is taxed as long-term capital gains (20%) rather than ordinary income (37%) if the fund holds the underlying investment >3 years — a treatment regularly debated in Congress. In Türkiye, carry distributed via a CMB-licensed GSYF benefits from corporate-tax exemption for the fund vehicle, with GP-side taxation depending on whether the GP entity is structured domestically or offshore.
Why carry shapes founder negotiation
A GP with strong carry potential on your round is incentivised to push for outlier outcomes — they need power-law distributions. A GP whose fund is past carry-recovery (deeply underwater) may push for any liquidity event including suboptimal acquisitions. Knowing your investor’s carry posture explains a lot of behaviour in exit negotiations.
Related: Fund Returns, Power Law, IRR, MOIC.