What does the term 'carried interest' refer to in a private equity context?

The term 'carried interest' refers specifically to the performance fees that General Partners (GPs) of a private equity fund earn from the profits generated by the fund's investments. This compensation structure aligns the interests of the GPs with those of the Limited Partners (LPs), as the GPs typically only benefit from carried interest if the fund performs well and generates significant returns above a certain threshold.

Carried interest is usually structured as a percentage of the fund’s profits, meaning that as the fund increases its value through successful investments, the GPs stand to receive a portion of those profits, incentivizing them to maximize returns for both themselves and the LPs. This structure distinguishes carried interest from other compensation models, as it is contingent on performance rather than simply being a fixed salary or fee.

In contrast, a fixed salary for General Partners wouldn’t embody the performance-based nature of investment returns, an investment made by Limited Partners represents the capital they contribute rather than a compensation model, and common shareholder dividends relate to equity returns in publicly traded companies rather than the profit-sharing arrangement within private equity funds.