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What Is Carried Interest?

Carried interest, also known as carry, is a type of compensation structure used in the world of private equity and venture capital. In essence, carried interest is a share of the profits that investment managers and partners in a fund receive in exchange for the work they do to generate those returns.

Profits Beyond Returns

Carried interest is usually structured as a percentage of the fund's profits, often 20%, and is paid out to the managers and partners after investors have received their initial capital back, plus any promised returns. This means that the managers and partners only receive carried interest if the fund has been successful and has generated returns beyond what was promised to investors.

Mutual Interest

The rationale behind carried interest is that it aligns the interests of the investment managers and partners with those of the investors. If the fund performs well and generates significant profits, the managers and partners stand to benefit alongside the investors. Conversely, if the fund performs poorly, they will not receive any carried interest.

Considered Long Term Capital Gain

Carried interest has come under scrutiny in recent years, with some arguing that it is unfair or even unethical. Critics argue that carried interest allows investment managers and partners to pay a lower tax rate on their income compared to what they would pay if it were classified as ordinary income. This is because carried interest is typically taxed as long-term capital gains, which are taxed at a lower rate than ordinary income.

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Despite these criticisms, carried interest remains a common compensation structure in the world of private equity and venture capital. It is seen as an important tool for attracting and retaining talented investment managers and partners, who are critical to the success of these funds. As such, carried interest is likely to continue to be a topic of debate and discussion in the world of finance and investing.

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