Carried interest is the deepest, weirdest, most-litigated piece of compensation in finance. Done right, it aligns LP and GP interests beautifully. Done wrong, it pays the GP for things the LP didn't agree to. Every clause in a fund waterfall exists because someone, in some prior fund, tried to game the previous version.
The management fee
Annual fee of 1.5–2.0% during the investment period, calculated on committed capital. After the investment period, the fee typically steps down to 1.0–1.5% on invested capital (or, in some funds, on net invested capital — committed less write-offs and realisations). The step-down matters: a $1B fund with a 5-year, 2.0% / 5-year 1.0% structure pays $150M in fees over its life, not $200M.
Modern fee offsets — required by the 2023 SEC Private Fund Adviser Rules and standard in ILPA-aligned LPAs — credit transaction fees, monitoring fees, and break-up fees collected from portfolio companies back to the management fee.
Carried interest
The GP receives 20% of fund profits above a hurdle. The 20% is near-universal; what varies is how it is calculated. Two structures dominate: European (whole-fund) waterfall, where LPs must receive their full committed capital plus the hurdle before any carry is paid; and American (deal-by-deal) waterfall, where the GP earns carry as each deal exits, subject to a clawback at fund end if cumulative returns fall short. European is LP-friendly and standard in venture and Europe; American is GP-friendly and standard in US buyout.
Hurdle and catch-up
The hurdle (or preferred return) is typically 8% IRR. Below 8%, all distributions go to LPs. Above 8%, a catch-up sweeps further distributions (often 100%) to the GP until the GP has caught up to a 20% share of total profits. After catch-up, distributions are 80% to LPs and 20% to the GP — the steady-state carry split.
Worked example: $100M fund returns $200M (2x). LPs first receive $100M back. Hurdle of 8% over 5-year hold ≈ $47M, taking LPs to $147M. Catch-up: GP receives $11.7M (20% of $58.7M). Steady state: remaining $41.3M splits $33.0M to LPs and $8.3M to GP. Total: LP $180M (1.8x), GP $20M (20% of $100M profit). The math always reconciles, given a clean structure.
Clawback
If a fund pays carry on early winners and later losers reduce the fund's overall return below the deal LPs were promised, the GP must claw back previously distributed carry. Clawback is typically secured by an interim escrow on each carry distribution and by the personal guarantees of the senior partners. Clawback machinery is more important in American waterfalls (where the GP is paid as deals exit) than in European waterfalls (where the GP is only paid after LPs are made whole).
GP commit and recycling
The GP commit is the capital the GP itself contributes to the fund. ILPA-aligned funds expect 1–5%. Recycling allows the GP to re-invest realised proceeds back into new investments, deploying more than the committed capital base over the fund's life — a form of leverage on the LP commitment that benefits both sides if used disciplinedly.