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.

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.

To understand how to calculate carried interest, let's take Fund Alpha as an example. It has the following information:

• Initial fund value: $10,000,000;
• Final fund value: $20,000,000;
• Hold period: 5 years;
• Hurdle rate: 5%; and
• Carried interest: 20%.

The carried interest calculator is based on 4 steps:

1. Calculate the fund return.

   The fund return is the performance of the investment fund. We can calculate fund return using the formula below:

   fund return = final fund value / initial fund value - 1

   For our carried interest example, the fund return is equivalent to $20,000,000 / $10,000,000 - 1 = 100%. You can also calculate this using our rate of return calculator.

2. 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 rate for Fund Alpha is 5%.

3. 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 interest for Fund Alpha is 20%.

4. Determine the hold period.

   The hold period is how long the fund is going to last. In our example, the hold period is 5 years. You can use time duration calculator to speed up this calculation.

5. Calculate the carried interest and carry distribution.

   The last step is to calculate the carry distribution using the formula below:

   carry distribution = (final fund value - initial fund value × (1 + hurdle rate) ^ hold period) × carried interest

   If the carry distribution is negative, the investment fund performance is lower than the hurdle rate and so the portfolio managers will not get any carry distributions.

   The carry distribution for 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.

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.