How do incentive structures generally work in private equity?

In private equity, incentive structures are designed to align the interests of the general partners (GPs) with those of the limited partners (LPs). This alignment typically includes a combination of management fees and performance fees, which serve distinct purposes.

Management fees, often calculated as a percentage of committed capital, provide GPs with a stable income to cover operational costs and incentivize them to actively manage the fund. On the other hand, performance fees, commonly referred to as "carried interest," are contingent on the successful performance of the investments. These fees are structured to reward GPs for generating positive returns for LPs, ensuring that GPs are motivated to maximize the value of the portfolio.

This dual focus on both management and performance fees reflects the collaborative nature of the relationship between GPs and LPs, where both parties benefit from the success of the investments. The correct answer highlights how these incentive structures are foundational in promoting shared goals and effective investment practices within the private equity framework.