What is Carried Interest and Deferred Compensation?
Understanding Carried Interest
Carried Interest, or "Carry" as finance professionals refer to it, is the share of profits from an investment fund that is paid to the fund's managers. It is performance based and aligned with the returns that limited partners are receiving. Typically carry is 20% of fund profits, with the typical private equity fund structure being "2 & 20" aka a 2% management fee, and then 20% of profits. This structure is most common at private equity firms.
An example of Carry in Private Equity: If a fund raises $2B. After the fund returns the original capital to limited partners, plus exceed a hurdle rate (generally 8%), the fund manager is entitled to 20% of the profits above the hurdle rate. Carry generally vests over a 4-6 year period. More senior investment professionals get more of the carry pie, while younger professionals such as Associates may not receive carry until the Senior Associate or Vice President level. However, on Buyside Hub we've found that Associates can receive carry if they work at a non-NYC fund OR work in a LMM fund.
You will also see 2 & 20 structures at hedge funds, growth equity funds, and to some degree in venture capital and private credit firms. Private Credit will have carry, but performance fees will be lower than 2 & 20 due to the lower return profile.
Tax Advantages of Carried Interest
Carry is taxed as long-term capital gains, meaning its taxed at 20%, instead of at ordinary income tax rates, which for rich, finance professionals will be 37%. However, carry doesn't play out for several years and is a long term bet. Still, this is typically how private equity professionals end up making millions of dollars at a favorable tax rate.
Deferred Compensation Across Industries
Professionals in other industries will be rewarded with Deferred Compensation: This might mean a deferred cash bonus, deferred equity, a deferred compensation plan, or other bonuses that have a vesting date or a clawback.
Carried Interest
The share of profits from an investment fund paid to the fund's managers. Typically 20% of fund profits, with the typical private equity fund structure being '2 & 20' (2% management fee, 20% of profits).
Deferred Cash Bonus
Cash bonuses that vest over a specified period, often used to retain talent by creating 'golden handcuffs' that make it expensive to leave the firm before the compensation fully vests.
Deferred Equity
Stock options or restricted stock units that vest over time, aligning employee interests with the company's long-term performance and growth.
Golden Handcuffs
Deferred financial incentives that make it painful or expensive to leave a firm, designed to keep senior talent within the organization long-term.
These types of deferred compensation are going to vary significantly based on the role and size of the company, but you're almost certainly going to have vesting periods, and a certain percentage may vest every year.
For example, you could receive a deferred payment that doesn't vest for two years. Or you could receive a $100,000 payment where ⅓ of it vests every year, with full vesting after three years.
Golden Handcuffs and Career Implications
Later on in your career, you will run into golden handcuffs, which are deferred financial incentives that make it painful or expensive to leave a firm. These are meant to keep you within the firm, so you don't walk away, while also incentivizing you for the medium term or long term. Later on in life, a managing director or portfolio manager might have millions of dollars of deferred compensation that is meant to keep them around and with the firm.
These golden handcuffs make it challenging for you to leave the firm, explore other roles, and start your own fund.
Want Precise Data on Compensation Structures?
To learn more about deferred compensation and carried interest, with very precise data by industry, view our Industry Analytics today.