Carried interest takes the same share of the money whenever it is paid, but the earlier the general partner is paid, the more of the investor's rate of return it takes.
The timing of carried interest does not change the investor's multiple, but it does change the internal rate of return. On an illustrative venture fund that calls 100 and distributes 250 before carry, 20 per cent carry of 30 leaves investors 2.20x in every case, yet their net IRR is 14.9 per cent if the general partner takes carry from the first exit, 15.4 per cent under a whole-fund waterfall and 15.9 per cent if it is paid last. The same carry costs 2.7 points of IRR or 1.7.
Worked in full in Venture Capital by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Limited partners compare funds on both numbers, and fund documents argue about carry mostly in terms of amount: the rate, the hurdle, the catch-up. Timing gets less attention because it moves no money in total. It does move the rate, and in venture, where the proceeds arrive late and lumpy, the difference is large enough to change how two funds rank.
An illustrative fund of 100 committed, called in five equal instalments that include the management fees. Distributions start in year 4, peak in year 9 when one exit pays 80, 32.0 per cent of everything, and end in year 12. Carry is 20 per cent of profit with no hurdle, so 20 per cent of 150, or 30, under every convention.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Calls | 20 | 20 | 20 | 20 | 20 | |||||||
| Distributions | 5 | 10 | 15 | 25 | 35 | 80 | 40 | 25 | 15 |
Before carry the investor would earn 2.50x and an IRR of 17.6 per cent.
1. Early, pro rata on every distribution. The general partner takes its share of the profit embedded in each exit as it happens, as a deal-by-deal or American waterfall effectively does when every deal makes money. Profit is 150 of 250, so carry is 30 ÷ 250 = 12 per cent of each distribution, from the first 5 in year 4 onwards.
2. Whole fund, after capital is returned. Investors receive 100 per cent of distributions until they have their 100 of paid-in capital back, which happens during year 9. From then on each distribution is split 80/20. The general partner receives 14.0 in year 9 and the rest over years 10 to 12.
3. Last. Investors receive everything until they hold 220, their capital plus 80 per cent of the profit; the general partner is paid from the final distributions, 15.0 in year 11 and 15.0 in year 12. This is the extreme of a back-ended or escrowed carry.
Net TVPI, all three: (250 − 30) ÷ 100 = 2.20x
Net IRR: solve Σ (LP distributionst − callst) ÷ (1 + r)t = 0 for each schedule
Excel: =IRR(C10:N10) on the investor's net flows, one column per year
| Year | Early | Whole fund | Last |
|---|---|---|---|
| 4 | 4.4 | 5.0 | 5.0 |
| 5 | 8.8 | 10.0 | 10.0 |
| 6 | 13.2 | 15.0 | 15.0 |
| 7 | 22.0 | 25.0 | 25.0 |
| 8 | 30.8 | 35.0 | 35.0 |
| 9 | 70.4 | 66.0 | 80.0 |
| 10 | 35.2 | 32.0 | 40.0 |
| 11 | 22.0 | 20.0 | 10.0 |
| 12 | 13.2 | 12.0 | 0 |
| Total | 220.0 | 220.0 | 220.0 |
| Convention | Carry paid by year 9 | Net TVPI | Net IRR | IRR cost of carry, points |
|---|---|---|---|---|
| Before carry | 2.50x | 17.6% | ||
| Early, pro rata | 20.4 | 2.20x | 14.94% | 2.68 |
| Whole fund | 14.0 | 2.20x | 15.42% | 2.20 |
| Last | 0.0 | 2.20x | 15.92% | 1.70 |
Carry takes 12.0 per cent of the proceeds, 0.30 of a turn, whenever it is paid. Its cost in rate runs from 1.70 to 2.68 points, a spread of 0.98 points for the same contract rate on the same exits. Moving from early to whole-fund payment alone is worth 0.48 points to the investor.
Scale every distribution up or down and rerun the three conventions.
| Multiple before carry | Net TVPI | IRR before carry | Early | Whole fund | Last | Spread, points |
|---|---|---|---|---|---|---|
| 1.50x | 1.40x | 7.4% | 6.1% | 6.2% | 6.3% | 0.2 |
| 2.50x | 2.20x | 17.6% | 14.9% | 15.4% | 15.9% | 1.0 |
| 4.00x | 3.40x | 28.2% | 24.4% | 25.3% | 26.4% | 2.0 |
Timing matters most in the funds that matter most. At 4.00x the convention alone is worth 2.0 points of net IRR, while at 1.50x, with only 10.0 of carry to move, it is worth 0.2.
Comparing two funds' net IRRs as if they measured the manager alone. Two managers with identical exits, one paid early and one paid last, report net IRRs a full point apart at 2.50x. The net multiple, 2.20x for both, is the honest comparison of what was earned; the IRR also records when the general partner was paid. When a fund's net IRR looks strong against its net TVPI, check the waterfall before crediting the manager, and when a fund looks weak, check whether its carry was paid early on a few exits before the losses arrived. Early carry on a fund that later falls below its preferred terms also creates a clawback, which is a credit exposure to the general partner.
The early convention here assumes every exit is profitable in proportion. A true deal-by-deal waterfall can pay even more carry in total, because losers are not netted against winners; that is a difference in amount, on top of the difference in timing shown here.
The book computes carried interest five ways on one fund's cash flows, and the annual flows with the J-curve are in the free workbook for this case. How a multiple converts into a rate in the first place is set out in what IRR does a 3x venture capital fund actually earn.
In proportion, the multiple bears the same cost whatever the timing: on an illustrative fund distributing 250 against 100 paid in, 30 of carry is 12.0 per cent of the proceeds and takes TVPI from 2.50x to 2.20x. The IRR cost depends on when it is paid, from 2.68 points if paid early to 1.70 points if paid last.
Because the general partner is paid out of the first exits instead of after the investors have their capital back. With the same total carry, taking it pro rata from every distribution, 20.4 of the 30 by year 9, lowers the illustrative fund's net IRR from 15.42 per cent under a whole-fund waterfall to 14.94 per cent.
Yes. The better the fund, the more carry there is to move. At 1.50x before carry, early against last payment changes the net IRR by only 0.2 points; at 2.50x by 1.0 point; at 4.00x by 2.0 points, between 24.4 and 26.4 per cent.
Carried interest under different conventions on the same cash flows is worked in chapters 13 to 16 of Venture Capital. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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