Carried Interest Calculator
With this carried interest calculator, we aim to help you to calculate the carry distribution and carried interest of an investment fund. The carried interest is the share of the profit that investors pay to their portfolio manager. Hence, it is essential to understand the carried interest calculation.
We have prepared this document to help you understand what carried interest is and how to calculate carried interest. Besides, we will also explain the definition of the carried interest tax loophole.
What is carried interest? The carried interest definition
Carried interest is the share of an investment fund's profits that is used to pay the general partners or portfolio managers. The carried interest can also be seen as the performance fees of the investment fund.
Most investment funds charge annual fees that help the fund cover its operational expenses. The carried interest, on the other hand, acts as the primary source of income of the portfolio managers. Because the better the fund performs, the higher the carry distributions, the carried interest also acts as the tool to align the interests of the investors and the portfolio managers. You can look at our investment calculator to understand more about this.
Now, let's look at how carried interest works in practice.
How to calculate the carried interest? The carried interest calculator
To understand how to calculate carried interest, let's take Fund Alpha as an example. It has the following information:
- Initial fund value:
- Final fund value:
- Hold period:
- Hurdle rate:
- Carried interest:
The carried interest calculator is based on 4 steps:
Calculate the fund return
The fund return is the performance of the investment fund. We can calculate
fund returnusing the formula below:
fund return = final fund value / initial fund value - 1
For our carried interest example, the
fund returnis equivalent to
$20,000,000 / $10,000,000 - 1 = 100%. You can also calculate this using our rate of return calculator.
Determine the hurdle rate
The hurdle rate is the minimum fund return that an investment fund must achieve to receive its carry distribution. The
hurdle ratefor Fund Alpha is
Determine the carried interest
The carried interest is the percentage of the total fund return that the investment fund claims as its performance fee. The
carried interestfor Fund Alpha is
Determine the hold period
The hold period is how long the fund is going to last. In our example, the
5 years. You can use time duration calculator to speed up this calculation.
Calculate the carried interest and carry distribution
The last step is to calculate the
carry distributionusing the formula below:
carry distribution = (final fund value - initial fund value * (1 + hurdle rate) ^ hold period) * carried interest
carry distributionis negative, the investment fund performance is lower than the hurdle rate and so the portfolio managers will not get any carry distributions.
carry distributionfor Fund Alpha is
($20,000,000 - $10,000,000 * (1 + 5%) ^ 5) * 20% = $1,447,436.87.
That ends our carried interest example of Fund Alpha. You should now be able to answer the question "How does carried interest work?". If you need to make more quick and reliable estimations, you can always use our carried interest calculator.
For advanced option, you can also choose to have the GP catch-up option turned on. Once the fund's return surpasses the hurdle rate, the GP catch-up provision allows the general partner to receive a greater share of the profits until they "catch up" to a predetermined percentage.
What is the carried interest loophole?
The carried interest loophole definition, also known as the carried interest tax loophole, says that it's a regulation that allows the portfolio managers to treat the carry distributions they earn as capital gains instead of income.
This means that the portfolio managers only need to pay the capital gains tax on their carry distribution, which is usually much lower than income tax.
It is important to note that this calculator only focuses on one type of carry allocation, which is the European method. This means the general partner receives a percentage of the profits after the investors have received a preferred return on their investment. There are various other carry allocation methods out there such as the American method and the whole-fund method.
What is a private equity?
Private equity is described as an investment that invests only in companies that are not listed in the stock market. It is considered as an alternative investment.
What is a hedge fund?
Hedge funds are investment pools that are actively managed by portfolio managers. They use complex strategies and aim to achieve returns that are higher than the market.
Will there be carry distributions if the fund return is lower than the hurdle rate?
No, if the fund return is lower than the hurdle rate, there will not be any carry distributions. It happens when calculated carry distributions are negative.
How do I start investing actively?
To achieve success by investing actively, you need to:
- Make sure you have the time to monitor the market constantly.
- Make sure you have the relevant knowledge and skills to invest.
- Lastly, make sure you are enjoying it!