Understanding Carry or Carried Interest in Venture Capital Firms

A common aspect of venture capital (VC) firms is the concept of carried interest, or ldquo;carry.rdquo; Carried interest is a key component of compensation and profit-sharing arrangements among fund managers, partners, and employees. Understanding how carried interest is allocated and distributed is crucial for anyone involved in or interested in the workings of a VC firm.

General Structure

The standard carried interest is typically around 20% of the profits generated by the venture capital fund, after the initial capital investment is returned to the limited partners (LPs). This 20% of profits is referred to as the ldquo;carry.rdquo; The distribution of the carry, however, is generally contingent on the ownership stake of each general partner (GP).

Distribution Among GPs

Carried interest is usually distributed among general partners based on their individual ownership stake in the firm. For example, in a scenario where there are three partners with ownership stakes of 50%, 30%, and 20%, Partner 1 would receive 10% of the total carry, Partner 2 would receive 6%, and Partner 3 would receive 4%.

Employee Participation

Bonus Structure: Employees, such as associates and analysts, often do not receive carried interest directly. Instead, they may receive cash bonuses that are linked to the performance of the fund. These bonuses can be significant but generally do not equate to the share of carry received by GPs. Co-Investment Opportunities: Some VC firms allow employees to invest alongside the fund. These investments can provide a share of the profits from those investments, but this is separate from the carry structure and is managed differently. Carry Pool: In some firms, a portion of the carried interest is set aside in a carry pool, which can be allocated to future entitlements. This ensures a more consistent flow of income and incentive across different fund periods.

It is essential to refer to the funds operating agreement for specific terms and details regarding carried interest and other compensation mechanisms.

Conclusion

The specifics of how carried interest is split can vary significantly based on the firmrsquo;s policies, the agreements made at the inception of the fund, and the contributions of employees and partners. The distribution of carried interest is typically governed by the terms of the operating agreement for the fund. Understanding these dynamics is crucial for gaining insight into the financial and operational framework of a VC firm.

Example Breakdown

Total Carry: 20% of profits
General Partners: 3 Partners with stakes of 50%, 30%, and 20% in the carry
- Partner 1: 10% of total profits
- Partner 2: 6% of total profits
- Partner 3: 4% of total profits
Employee Bonus: Employees might receive performance bonuses that total to a small percentage of profits but this does not equate to carried interest.

Many firms do hold back a portion of the carried interest into a pool that can be assigned in the future. This can provide a more consistent and sustainable income stream for employees and partners over the life of a VC firm.

For a detailed understanding of carried interest and other elements of VC compensation, one can refer to specific VC compensation reports or industry studies, such as the Publishing Trends 2011-2012: PE/VC Employee Compensation by Thomson Reuters. These reports provide an in-depth look at the trends and allocation methods in the PE/VC industry.