Private Equity: Carried and Promoted Interests Explained 🏆 In deals where assets are funded by private equity, the structure of the equity investment is typically a vehicle that is comprised of investors, or Limited Partners (LPs). These tend to contribute 90-95% of the funds, alongside the fund sponsor, or General Partner (GP) who often contribute 5-10% of capital. The GPs negotiate a more advantageous split of the profits than that of their pro-rata capital invested. This is due to the additional work undertaken to create the fund, find and vet the targets, manage the transaction as well as the ongoing investment. When a GP takes a greater share of the profits than a pro-rata investment, it is called a ‘carried interest’. Typically, in real estate deals using the same GP/LP structure, the name for this concept is a ‘promoted interest’. The Purpose of Carried and Promoted Interest: PE sponsors, or GPs, are compensated in two ways with regard to their investment funds. The first is the management fee which is based on the LP’s assets under management by the sponsor firm. This is typically around 2% and covers or contributes to the administrative costs of the sponsor firm. The carried interest (15-20%) is the sponsor’s compensation for finding the transaction, negotiating the terms, signing on to the debt, and managing the transaction until disposition. In real estate, the promoted interest is typically 20-30%. The carried or promoted interest is calculated on the profits of the deal after the debt has been paid back and any preferred returns have been achieved. Promoted Interest: The concept behind promoted interest or a ‘promote’ as it is referred to in real estate jargon is similar but the mechanics of the waterfall are a little different. A promoted interest is an advance given to the GP on the LP’s profit after the initial waterfall payments of the preferred return and capital investments are made. The remaining profits would be split according to the pro-rata capital investments, but the promoted interest allows the GP to take a negotiated percentage of the LP’s stake as well. Key Learning Points: • Carried and promoted interest arrangements give the GP a greater split of the profits than their pro-rata capital investment • PE firms usually couple this carried interest with a management fee to manage the invested funds of the limited partners • To entice LPs into funds or transactions, the GP will offer the LP a preferred return or hurdle rate that must be achieved before the GP can begin receiving a return • A carried interest is calculated on the remaining profits after achieving the preferred return or hurdle • Promoted interests work in a similar way but the promote is calculated as a percentage of the LP’s share of the profits after the preferred return or hurdle Download our free private equity resume template: https://shorturl.at/WzAEj
Sujay Paul
2mo
CFBR
Student at Surana College | Finance Enthusiast | Aspiring Equity Research Analyst
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