Understanding Carried Interest in Venture Capital

Carried interest, or 'carry,' is the share of profits that venture capitalists receive from investments, typically around 20%, after returning the initial fund capital to investors.

Carry is a performance fee incentivizing VCs to maximize returns. The better the fund performs, the higher the carry, aligning interests with limited partners (LPs).

Some VC funds implement a 'hurdle rate,' a minimum return threshold before carry applies, ensuring LPs receive a baseline return on their investment first.

Profits are distributed in a 'waterfall' manner; LPs get their initial investment back, then preferred returns, with any remaining profits split according to the carry arrangement.

Carry can be taxed as capital gains rather than income, subject to longer holding periods, which significantly impacts the after-tax income of venture capitalists.

Carried interest originated from 16th-century sea voyages, where ship captains received a share of the profits from successful trade expeditions.