What is Carried Interest?
Carried interest refers to the portion of a fund’s investment profits allocated to its general partner (GP), distinct from and on top of any management fees. In a typical US VC or private equity fund, the GP is entitled to 20% of profits above a set performance threshold, also referred to as a hurdle rate. Accurately determining this figure involves distributing cash in the exact proper order to every LP and every investment within the fund, a process known as calculating a “waterfall.”
How the Waterfall Works: The Basic Structure
To start, let’s talk about the structure of a waterfall. A waterfall simply defines the order in which cash proceeds will be disbursed when a fund exits. The sequence is extremely important; each tier must be completely fulfilled before moving on to the next one.
The order of the tiers in a standard American-style waterfall is:
- Return of capital: LPs receive back 100% of contributed capital before any profits are distributed.
- Preferred return: LPs receive a preferred return — typically 8% per year, compounded — on their contributed capital.
- GP catch-up: The GP receives 100% of distributions until it has received its carried interest percentage on all profits.
- Residual split: All remaining proceeds are split 80/20 between LPs and GP.
The accuracy of your carried interest calculation is only as good as the quality of the inputs. This includes contribution date and amount by LP, management fee offset, LP-side letters (modifying economic terms for specific investors), how accruals work for preferred return, and proceeds with timing.
A fund with 40 LPs, 18 portfolio companies, and 8 years of activity can have 1,000's of individual data points feeding a single waterfall. In my 22 years doing fund administration, the biggest mistake I saw wasn't in the formula. It was in a data entry error upstream, a capital call posted to the wrong LP, a receipt of a wire a day off, a management fee offset done for one LP but not another.
Research by Intralinks indicated 61% of fund accounting restatements from 2020-2024 were caused by errors in the LP capital account rather than the waterfall formula.
Here is what you should expect your fund administrator to handle for you automatically:
Almost every fund agreement has a clawback provision where the GP must give back carried interest previously paid if, upon closing of the fund, the GP has been paid more than the waterfall entitles to. The fund may have to return carry if the GP distributed carry based on a great exit, followed by another company that doesn't do well.
From a fund administration perspective, you must keep a ledger open that has a running amount of carry paid out, a running amount of carry escrowed (most LPAs require 20-30% holdback) and a running amount of exposure in a clawback at any given time. After LPs receive their pro-rata distribution of preferred return, the GP receives 100% of distributions until it is equal to the agreed upon carry % of all profits. A GP with 20% of carried interest has achieved its catch-up when they have received 20% of all profits combined across the preferred return and catch-up payment schedules.
On a fund we administered a few years ago, the GP realized on final close day that their waterfall model produced a different carry number on a given scenario than the fund counsel model. The difference was $340K and both models followed the same LPA. It turned out each model accrued preferred return differently on a capital call received 11 days before the distribution date. The GP went back to counsel to amend the LPA, and the GP and LPs had to wait another three weeks to receive distributions. A bad lesson: ambiguous LPAs and waterfall models with hidden assumptions lead to problems only apparent when you least want them.
Clawback Provisions and Why They Complicate Everything
Carried interest calculation. No part of carried interest calculation should be required to be managed or built by the GP, including maintenance of LP capital account ledgers, accruals of preferred return on a rolling basis, calculation of waterfall results for all scenarios, tracking of clawback escrows and preparing the distribution waterfall schedules for fund counsel review.
According to our survey data in 2025, the average time from distribution decision date to wire completion was 14 business days for funds utilizing legacy administrators. Connected administration platforms had an average time of 4.2 days.
A Practitioner Note on Waterfall Models
When is a clawback triggered?
20% is the market standard rate. Some top quartile managers will be willing to take 25% and higher. Emerging managers will occasionally accept 15% just to bring in anchor LPs. This will be set forth in the Limited Partnership Agreement (LPA).
How does the preferred return impact when the GP receives carry?
The preferred return is generally 8% compounded annually, which must be paid in full to the LPs before any amount of carried interest can be paid to the GP. If a fund takes six years to return LP capital at 8% compounded, vs. three years, the preferred return creates a very large hurdle.
What is a GP catch-up provision and how does it work?
Frequently Asked Questions
What is the standard carried interest rate for US venture capital funds?
A clawback is triggered at a wind-down of a fund when the GP has received cumulative carry that is more than the fund economics support. The LPA defines the catchup clawback calculations, % escrowed, and the GP obligation to return excess carry within the specified time period (90-180 days post the last distribution).
Should the GP build and maintain their own waterfall model?
The GP does not need to build a waterfall model to know what they expect their share of the profits will be based on the LPA. It should be maintained by the administrator so that it can be utilized and referenced as the authoritative model for distribution decisions. When a GP maintains a parallel model to the administrator model, and the two models diverge, there is no clear answer as to which model governs.
What is a GP catch-up provision and how does it work?
After LPs receive their preferred return, the GP receives 100% of distributions until the GP has received carried interest equal to its percentage share of all profits. At 20% carry, the catch-up ends when the GP has received approximately 20% of all profits across both preferred return and catch-up tiers.
When is a clawback triggered?
A clawback is triggered at fund wind-down if the GP has received more cumulative carry than the overall fund economics support. The LPA defines the calculation, escrow percentage, and GP obligation to return excess carry within 90 to 180 days of the last distribution.
Should the GP build and maintain its own waterfall model?
No. The GP should understand the waterfall but maintaining the authoritative model is the fund administrator's responsibility. When a GP maintains a parallel model, the risk is two models diverging with no clear answer on which governs.