How do you calculate carried interest for a venture capital fund?

1 What is the carry formula?

The basic formula for calculating carried interest is: Carry = (Fund's Net Profit - Hurdle Rate) x Carry Percentage The fund's net profit is the total amount of money that the fund returns to its investors after deducting all the costs and fees. The hurdle rate is the minimum return that the fund must achieve before the fund manager can claim any carry. It is usually expressed as an annual percentage rate (APR) or an internal rate of return (IRR). The carry percentage is the proportion of the excess profit that the fund manager receives as carry. It is usually negotiated between the fund manager and the investors, and it can range from 10% to 30%, depending on the fund size, strategy, and performance.

2 What are the types of carry?

There are two main types of carry that are used in venture capital funds: deal-by-deal carry and fund-as-a-whole carry. Deal-by-deal carry means that the fund manager can receive carry from each individual investment that generates a profit, regardless of the overall performance of the fund. This type of carry can be very attractive for fund managers, as they can benefit from early exits and high returns, but it can also create misalignment of interests and risk-taking behavior. Fund-as-a-whole carry means that the fund manager can only receive carry from the total net profit of the fund, after all the investments have been realized and all the capital has been returned to the investors. This type of carry can align the interests of the fund manager and the investors, as they both share the same goal of maximizing the fund's long-term value, but it can also delay the cash flow and reduce the incentive for fund managers.

3 What are the common terms and methods for carry?

Venture capital funds utilize certain terms and methods to define and distribute the carry. These include catch-up, which allows the fund manager to receive a higher percentage of the profit after the hurdle rate has been met; clawback, which requires the fund manager to return some or all of the carry that they have received if the fund's performance declines; and waterfall, a method of distributing the cash flow from the fund to the investors and fund manager according to a predefined order of priority. For example, a 80/20 catch-up clause means that after the fund has returned capital and hurdle rate to investors, the fund manager will receive 80% of the next profit until they reach 20% of total profit. A 10% clawback clause requires that if IRR falls below 10%, the fund manager must refund excess carry. A typical waterfall structure is: return capital to investors, pay hurdle rate to investors, apply catch-up clause to fund manager, split remaining profit between fund manager and investors according to carry percentage.